According to its SEC filing (S1/A) on December 3, 2013, AMC Entertainment Holdings (NYSE:AMC) sets the initial pricing range for its IPO to $19 (with a range of $18-$20). An interesting twist to its IPO plan is that a small fraction of the shares -- 1.85% of its Class A shares -- will be directly sold to movie fans and its employees.
Box office is hot in 2013. And stock prices of AMC's two peers, Regal Entertainment Group (NYSE:RGC) and Cinemark Holdings (NYSE:CNK), are on a tear-year to date, they are up 46% and 30% respectively. So if you are a movie fan, e.g. one of the 2.5 million AMC Stub members, would you buy AMC's shares?
AMC was bought by the Chinese company Wanda Group last summer after being owned by private equity funds for eight years. Under the new ownership, last year AMC altered terms to its loyalty program, "AMC Stubs" (previously "MovieWatchers"), and many program members felt short-changed. Is the IPO plan a gesture by AMC to make up with the fan base? Or is it just another marketing gimmick?
We perform valuation analysis to find out. Our conclusion: movie fans may be short-changed again this time; tickets for Hobbit or the Hunger Game sequel are more attractive buys than AMC shares.
Before going into the details, here are the key points of our analysis. AMC appears to price its IPO relative to a peer movie theater company, Cinemark. The key valuation metric that explains the $19 per share pricing is the Enterprise Value/EBIDTA ratio. However, this valuation metric has a few known shortcomings. Chief among them is that EBITDA does not account for the cost of investments. In addition, you have to assume that the growth rate is similar among the peers for the comparable-firm approach to work. Once we take into account these issues using a free cash flow approach, AMC's shares appear to be worth much less.
Valuation based on the Enterprise Value/EBIDTA ratio
The ratio of enterprise Value to EBITDA is a popular valuation metric used by private equity funds investing in the movie theater industry (and many other industries), and by movie theater companies themselves to obtain internal valuation for purposes such as determining executive compensations.
The table below shows that AMC's $19 price can be explained by taking the Enterprise Value/EBITDA ratio of Cinemark, and applying it to AMC's EBITDA.
Data source: RGC and CNK's financial statements, and AMC's IPO filings from SEC's website | |||||
Regal | Cinemark | AMC (IPO price) | AMC (using RGC's ratio) | AMC (using CNK's ratio) | |
Stock price ($, 12/11/2013) | 19.32 | 32.67 | 19 | 10.99 | 18.99 |
Share outstanding (m, diluted) | 155.79 | 114.45 | 95.05 | 95.05 | 95.05 |
Market cap ($m) | 3009.86 | 3739.08 | 1805.95 | 1044.99 | 1805.03 |
Debt ($m, 2013Q3) | 2877.30 | 2670.70 | 2982.53 | 2982.53 | 2982.53 |
Cash ($m, 2013Q3) | 270.20 | 479.78 | 453.23 | 453.23 | 453.23 |
Enterprise value ($m, EV) | 5616.96 | 5930.00 | 4335.25 | 3574.29 | 4334.33 |
EBITDA ($m, 2013Q3 ttm) | 625.50 | 544.56 | 398.03 | 398.03 | 398.03 |
EV/EBITDA (2013Q3 ttm) | 8.98 | 10.89 | 10.89 | 8.98 | 10.89 |
(AMC's cash position takes into account the expected IPO proceeds of $322.6m)
In columns 2 to 4, we start from the current stock prices of Regal and Cinemark and the IPO price of AMC to estimate their enterprise values , and then compute their EV/EBITDA ratios based on trailing 12-month EBITDA as of 2013Q3. It shows that based on the IPO price of $19, AMC's enterprise value is $4335.25m, with an EV/EBITDA ratio of 10.89. This happens to be the same as the EV/EBITDA ratio of Cinemark (difference only in the third decimal point). That is, based on this particular metric, AMC is fairly priced relative to Cinemark. However, Regal's EV/EBITDA ratio is only 8.98. Therefore, Cinemark and AMC appear to be more richly priced than Regal. There is a reason for the difference in this ratio between Cinemark and Regal, which will be discussed below.
In the last two columns of the table, we work from bottom up. We take the EV/EBITDA ratios of Regal and Cinemark respectively, and apply them to AMC's EBITDA to back out its enterprise value, and then back out its intrinsic stock price. Using Cinemark's EV/EBITDA ratio, AMC's intrinsic stock price is $18.99 per share, very close to the IPO price. However, using Regal's EV/EBITDA ratio, AMC's intrinsic stock price is only $10.99, much lower than the IPO price.
Thus, two issues emerge from this exercise. First, is EV/EBITDA a reliable valuation metric? And second, which peer's EV/EBITDA ratio should be more relevant for pricing AMC's IPO, Regal or Cinemark?
Before addressing the above questions, we take a small detour here. The movie theater industry sometimes relies on a variation of EBITDA, called "adjusted EBITDA," which adjusts for items that are deemed "non-recurring." According to AMC's IPO filings, its trailing 4-quarter adjusted EBITDA as of 2013Q3 is $450m, higher than the raw EBITDA of $398m. Both Regal and Cinemark provide their adjusted EBITDA numbers as well - $622m and $628m respectively, as of 2013Q3 (tailing 4-quarter). The table below shows that the difference in the EV/Adj. EBITDA ratio between Cinemark and Regal is smaller than that in the unadjusted ratio; however the valuation implication for AMC remains similar. That is, AMC's IPO is priced closely to Cinemark, and more richly relative to Regal. AMC's intrinsic stock price is $18.09 using Cinemark's ratio, versus $16.16 using Regal's ratio.
Data source: RGC and CNK's financial statements, and AMC's IPO filings from SEC's website | |||||
Regal | Cinemark | AMC (IPO price) | AMC (using RGC's ratio) | AMC (using CNK's ratio) | |
Stock price ($, 12/11/2013) | 19.32 | 32.67 | 19 | 16.16 | 18.09 |
Share outstanding (m, diluted) | 155.79 | 114.45 | 95.05 | 95.05 | 95.05 |
Market cap ($m) | 3009.86 | 3739.08 | 1805.95 | 1536.38 | 1719.65 |
Debt ($m, 2013Q3) | 2877.30 | 2670.70 | 2982.53 | 2982.53 | 2982.53 |
Cash ($m, 2013Q3) | 270.20 | 479.78 | 453.23 | 453.23 | 453.23 |
Enterprise value ($m, EV) | 5616.96 | 5930.00 | 4335.25 | 4065.68 | 4248.95 |
Adj. EBITDA ($m, 2013Q3 ttm) | 621.70 | 628.04 | 450.00 | 450.00 | 450.00 |
EV/Adj. EBITDA (2013Q3 ttm) | 9.03 | 9.44 | 9.63 | 9.03 | 9.44 |
(Note: there are some small differences in how these three companies adjust EBITDA.)
Issues with EBITDA based valuation
It is important to note that EBITDA (and its adjusted version) is not a perfect performance metric, and sophisticated investors are weary of the use of EV/EBITDA as a valuation metric. For example, Warren Buffett wrote in his 2002 letter to Berkshire Hathaway's shareholders that, "references to EBITDA make us shudder."
And AMC's IPO filing acknowledges this:
"Adjusted EBITDA has important limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under U.S. GAAP. For example, Adjusted EBITDA:
• does not reflect our capital expenditures, future requirements for capital expenditures or contractual commitments;
• does not reflect changes in, or cash requirements for, our working capital needs;
• does not reflect the significant interest expenses, or the cash requirements necessary to service interest or principal payments, on our debt;
• excludes tax payments that represent a reduction in cash available to us;
• does not reflect any cash requirements for the assets being depreciated and amortized that may have to be replaced in the future; and
• does not reflect management fees that were paid to the Former Sponsors. "
In the case of AMC IPO pricing, perhaps the most important is the first aspect; i.e., EBITDA does not take into account investments needed for a firm to generate future growth or even maintain the status quo. This is important because it has to do with why Cinemark's EV/EBITDA ratio is higher than Regal's, and has to do with which peer is a more appropriate comparable firm to value AMC.
The table below illustrates the differences in investments and revenues among Regal, Cinemark, and AMC in recent years:
Source: Compustat | ||||||||||||
Regal | Cinemark | AMC | ||||||||||
Revenue ($m) | EBITDA ($m) | Investment CF ($m) | Capex ($m) | Revenue ($m) | EBITDA ($m) | Investment CF ($m) | Capex ($m) | Revenue ($m) | EBITDA ($m) | Investment CF ($m) | Capex ($m) | |
2007 | 2661 | 509 | -48 | 114 | 1683 | 355 | 93 | 146 | 2504 | 389 | -139 | 152 |
2008 | 2772 | 510 | -339 | 132 | 1742 | 340 | -95 | 106 | 2265 | 269 | 101 | 105 |
2009 | 2894 | 515 | -111 | 109 | 1977 | 415 | -183 | 125 | 2418 | 300 | -96 | 104 |
2010 | 2808 | 447 | -83 | 98 | 2141 | 449 | -136 | 156 | 2423 | 170 | -250 | 129 |
2011 | 2682 | 440 | -101 | 87 | 2280 | 479 | -247 | 185 | 2601 | 295 | -164 | 139 |
2012 | 2824 | 534 | -183 | 89 | 2474 | 570 | -234 | 221 | 2654 | 381 | -244 | 167 |
(note: Cinemark became publicly traded in 2007. Before 2012, AMC's fiscal year ends in March; starting from 2012 its fiscal year ends in December. Its 2012 numbers in the table span the four calendar quarters of 2012).
During the past 6 years, Cinemark is the one with the most visible growth trend in revenue and EBITDA. Its investment spending is also increasing, in support of the growth. By contrast, Regal's numbers fluctuated without a clear trend. AMC's revenue, EBITDA, and capital expenditure declined during 2008-2010, and slightly came back in 2011 and 2012. However, time is too short to infer a trend.
By sales revenue, Regal is the largest, followed by AMC, and Cinemark the smallest. However, Cinemark seems to invest most aggressively. During the past 6 years, its investment cash outflow is on average about 5.97% of its revenue. AMC's investment cash outflow to revenue ratio is 5.15%, close to Regal's, 5.17%.
The implication of these numbers is the following. When investors value Regal and Cinemark, they regard Regal as a stable cash cow and Cinemark as a growth story. This is why Cinemark's EV/EBITDA ratio is higher than Regal's.
Then where does AMC fit in? The EV/EBITDA ratio implied by its IPO price means that AMC wants investors to believe it is more like Cinemark than Regal. However, AMC has yet to show a clear growth trajectory.
For sure, under the new ownership by Wanda since last summer, AMC has been investing more aggressively in hope to generate revenue growth. According to its IPO filing, it plans to spend $245m on investments each year in the next three years. This would double the average dollar amount of annual investments in the past 6 years, and add some credibility to its growth story. But again, time is too short to convince investors of a trend yet.
To figure out how AMC's aggressive investment plan is going to impact its valuation, we note another problem it faces. The problem is that, historically, AMC is less effective in turning revenue into operating cash flow, than either Cinemark or Regal. This can be inferred from the EBITDA/Revenue ratio, as EBITDA is approximately before-tax operating cash flow. The ratios can be calculated from the above table, and we put them in the table below.
EBITDA/Revenue | |||
Regal | Cinemark | AMC | |
2007 | 19.11% | 21.09% | 15.54% |
2008 | 18.38% | 19.52% | 11.89% |
2009 | 17.81% | 21.01% | 12.39% |
2010 | 15.92% | 20.96% | 7.03% |
2011 | 16.40% | 21.02% | 11.35% |
2012 | 18.89% | 23.03% | 14.37% |
average | 17.75% | 21.11% | 12.09% |
During the past 6 years, AMC's EBITDA/Revenue ratio is on average 12.09%, lower than Regal's 17.75% and Cinemark's 21.11%. Note that the ratios are quite stable over time for each company. They are determined to a large extent by the nature (e.g., status and geography) of the movie theaters each company has, and cannot be changed overnight. The valuation implication is the following. Assume that one dollar capital investment generates the same amount of revenue for AMC and Cinemark. If AMC wishes to generate the same amount of EBITDA, it has to invest much more than Cinemark. This means when AMC and Cinemark invest the same amount, AMC's free cash flow is lower.
Thus, the EV/EBIDTA ratio should be different between Cinemark and AMC even if we believe they have the same revenue growth rates. How different? We turn to the free cash flow valuation approach to sort things out.
Valuation based on free cash flows
The nice thing about the free cash flow valuation approach is that it can be used to tie various things coherently together, from expectations about revenue growth, to capital investments required to support such growth, and to the ability to turn revenue into operating cash flows.
We start with Cinemark. The following assumptions we use are pretty mechanical, but they turn out to explain Cinemark's stock price reasonably well.
1) Revenue growth: take analysts' consensus revenue forecasts for 2013 and 2014 ($2.7B and $2.91B, from Yahoo! Finance). From 2015 to 2016, assume the revenue growth rate remains at the analysts' projected growth rate for 2014, 7.78%. Afterwards, the growth rate gradually declines to a steady state of 2.5%. We have been using the steady-state growth rate of 2.5% consistently to price companies that generate revenues domestically (Although Cinemark has a relatively small movie theater operation in South America).
2) Investments: assume that investments growth at the same rate as revenue.
3) Profitability: assume a constant EBITDA/revenue margin of 23.03% (the 2012 number) for all future years.
4) Depreciation and net working capital: assume a constant rate of depreciation and amortization to long term assets (i.e., total assets minus current assets) at the 2012 level, 4.94%. And assume a constant ratio of net working capital to revenue at the 2012 level, -8.7%.
5) Tax rate: 40% (in its 2012 income statement, the tax rate is 42.5% but the rate is lower in previous years).
6) Finally, discount rate assumptions. We assume a beta of 0.6 for 2013 (based on Yahoo! Finance), which gradually converges to 1.0 by 2022. The risk free rate is 3% for 2013 and 2014, and 4% afterwards. The equity risk premium is 6%. The ratio of debt to enterprise value is assumed to be 45%, close to its current number. The cost of debt is 3% above the risk free rate, close to the yield spread on its bond maturing in 2023. These assumptions translate into a discount rate of 5.25% for 2013 and a graduate increase to 7.39% by 2022.
For those who care about the details of the model, a copy of the valuation spreadsheet can be found here.
And here is what comes out of the valuation model: the intrinsic stock price for Cinemark is $31.06, slightly (4.92%) below the market price of $32.67 as of December 11, 2013. Thus, it appears that investors are using a similar (and simple) set of assumptions to price Cinemark.
Now turn to AMC. If we are willing to believe that AMC can grow as fast as Cinemark, what will be AMC's intrinsic stock price? It should be pointed out that this is perhaps an optimistic belief; therefore the resulting valuation should be viewed as somewhat an upper bound.
Specifically, we keep assumptions 1), 5), and 6) above for AMC. That is, we assume AMC can grow its revenue at the same rate as Cinemark, and keep the same tax rate and the discount rates. But assumptions 2), 3), and 4) are based on AMC's own ratios. Specifically,
2) Investments: AMC's investments in 2014 to 2016 are $245m per year, according to its IPO filing. After 2016, we assume the investment growth rate is the same as the revenue growth rate.
3) Profitability: AMC's EBITDA/Revenue ratio stays at its own level as of 2013Q3 (trailing 4 quarters), 14.56%.
4) Depreciation and net working capital: depreciation rate is 6.13%, and net working capital to revenue ratio is -18.30%.
We additionally take care of the following three issues in the valuation exercise. First, after the ownership change last year, AMC re-valued its assets on its balance sheet and changed the fiscal year end from March to December. But in its IPO filing, it does not provide annual financial statements for the fiscal year that ends in December 2012. Therefore we rely on its balance sheet as of 2013Q3 and income statement for the 12 months ending in 2013Q3 to infer various ratios.
Second, partly due to asset re-valuation, its long term assets jumped from $3.23b in March 2012 to $4.08b in September 2013. And using the re-valued long-term assets, the depreciation rate is 4.94%, while the historical depreciation rate has been slightly above 6% before re-valuation. We are not sure if 4.94% is a reliable rate going forward. Therefore we compute an adjusted long term assets value as if there were no re-valuation, based on the long term assets in March 2012, investment cash flows and depreciations reported for the period from March 2012 to September 2013 (from various sub-period statements in the IPO filing). The adjusted long term assets stand at $3.3b as of 2013Q3, and based on it, the depreciation rate trailing 12 months is 6.13%. We use this depreciation rate based on adjusted long-term assets going forward.
Thirdly, AMC has currently more debt than Cinemark; thus its cost of equity should be higher. However, their fundamental business risks are similar, their WACCs should remain similar (except for the tax effect). This justifies the assumption of Cinemark's discount rate for AMC.
Our model for AMC is available in the same spreadsheet file as for Cinemark. And here is what comes out of the model: the intrinsic stock price for AMC is $14.83. At this intrinsic price, the IPO price of $19 is 28% too high. As we point out earlier, since AMC can unlikely grow as fast as Cinemark, even the $14.83 price should be viewed as an optimistic scenario,.
Conclusions
AMC's IPO appears to be priced relative to Cinemark based on the Enterprise Value/EBIDTA ratio. However, AMC has not had Cinemark's pace of revenue growth and has not had Cinemark's investment intensity. Thus their Enterprise Value/EBITDA ratios should not be the same. Even if we assume AMC has Cinemark's revenue growth rate, its investment profitability, i.e., its ability to generate operating cash flow from its investments, is much lower. All in all, its $19 IPO price appears too rich.
Under Wanda's ownership since last summer, AMC has increased capital investments and plans to maintain a relatively high level of investments in the future, potentially accelerating revenue growth. However, the company has not increased its EBITDA margin to a level comparable with Regal or Cinemark. Indeed, one year is too short a time period to convince investors that the new owner has turned the company around. If it waits for one or two more years, it may deliver a more convincing case. The decision to pursue an IPO right now may be due to the way Wanda's investment in AMC is financed (Wanda borrowed money to pay for its equity investment). Or it may simply be because of market timing, i.e., the market is valuing movie theater companies favorably right now. An even wilder guess is that Wanda wants to use AMC as a financing vehicle for further investment in the U.S.
AMC attempted, and withdrew from, IPO efforts a few times previously when it was owned by private equity funds. It was sold to Wanda at a price that valued its equity at $700m. At this price, the private equity funds made a meager profit exiting their AMC investment. At $19 a share, however, Wanda's equity stake would be worth over $1.4b, doubling its initial purchase price. This may be a rosy scenario. But as long as AMC is priced above $9.13 a share, Wanda comes out ahead of its initial investment.