(Editors' Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.)
Digital Cinema Destinations (DCIN) ("Digiplex", "DCIN", or the "Company") is a fantastic opportunity to invest in a simple, cash-flowing business in a stable industry run by a successful management team who have already successfully built two public businesses. Digiplex is rolling up small "mom-and-pop" theaters across the country at ~4.5x theater level cash flow inclusive of digital upgrade costs using flexible purchase financing.
The following are the reasons Digiplex is a timely investment now:
- Multiple Arbitrage: Digiplex is buying theaters at ~5x EBITDA when comps are trading at 7x to 9x: We expect a sale of the business in two to three years at industry multiples (still accretive to the purchaser due to ability to improve film margin via scale and strip out public company costs). According to our base-case estimates, DCIN is trading at ~4.0x FY2015E EBITDA, versus larger peers and private market transactions which have taken place between 7.5x-10.0x EBITDA. As such, a 50%-100% return over ~30 months is expected.
- Operationally Focused: Bud Mayo & team are focusing on alternative content to increase certain Monday through Thursday time slot revenue up to 10x. Even in the absence of multiple arbitrage, DCIN should be highly profitable due to CEO Mayo's proven ability to drive EBITDA per theater higher.
- Solid management team who understands the industry as well as anyone: CEO Mayo and team have organically built multiple successful public companies, including Clearview (theater circuit sold in 1998 for 3x IPO price) and Cinedigm (CIDM). Mr. Mayo is crucial for the roll-up, primarily due to his industry contacts and status.
- Stable operating results and cash flow: The Company has a predictable cash flow profile, which should only improve with the maximization of low-revenue, mid-week feature films being traded out for alternative content.
- Recently-completed secondary equity issuance irrationally reduced trading price: IPO priced last year at $6.25 and the October 2013 secondary priced at $5.00, which seems to be a function of a changing shareholder base getting up to speed rather than any operational missteps or adverse business prospects. We expect the pricing dynamic to correct in short order.
- Sub-scale company for many buy-side investors (yet too complex for some investors to understand): Not many professional investors are small enough to capture this opportunity, yet most institutional-caliber funds are too large for DCIN to move the needle.
- Highly Leverageable Business Model: The theater space has steady recurring cash flows. In fact, CEO Mayo indicated they desire a "1 to 1" ratio of debt-to-invested equity capital. Based on our read of the financing markets and expectation for an ever-growing monthly EBITDA figure, we expect DCIN to be able to achieve their desired financing structure. While implying a leveraged equity play, the risk to the equity is mitigated by the quality of management and the stability of DCIN's cash flow.
Why Now and Why Does This Opportunity Exist?
Taking a step back, we believe DCIN shares are priced attractively due to the following reasons:
- Larger industry players (i.e. Carmike (CKEC), Regal (RGC), etc.) overlook the opportunity to acquire mom-and-pop operators with one to five theaters, especially those not upgraded to digital. Hence, an inefficient market is created, and Digiplex has been taking advantage of this environment by purchasing assets below 5.0x theater level cash flow.
- As previously mentioned, with a $40.0MM market cap, the Company currently is not investable for most institutional investors.
- The name looks optically expensive, which is a factor due to lumpy EBITDA as acquisitions are bolted on at different times of the year and one-time expenses. Backing out these numbers and annualizing acquisition results paints a different picture.
- Over the past decade, there has been a disruptive shift from analog film to digital for cinemas. The transition to cinema has many benefits and potential cross-sale/cost-saving opportunities, however, the upgrades tend to cost operators roughly $50k-$100k per screen. This has created an environment of forced sellers. DCIN benefits through purchasing these smaller theaters at 4x-6x theater level cash flow, inclusive of capex upgrades to digital.
- Many investors are taking a "wait and see" approach with the acquisitions. If DCIN was pitched as a blind-pool middle-market private equity fund, this would be viewed favorably as "opportunistic" middle-market private equity.
Founded in 2010 by industry veteran Bud Mayo and a team of industry veterans (Brian Pflug CFO, Chuck Goldwater and Brett Marks), Digiplex is a movie theater exhibition company with an understanding of the theater as a content delivery platform. As of 12/31/2013, the Company had 185 screens, not including recently-announced 2014 transactions. (~10 screens).
Investing in Digiplex is akin to investing in a focused industry middle-market private equity fund, except the GP (management in this case) have the same pay-out and return symmetry with outside shareholders. Further, unlike most buy-outs which are consummated through richly-priced investment bank auctions, DCIN has consistently rolled up theaters at ultra-low multiples of TLCF, as seen below:
*Source: Company presentation
DCIN is led by Bud Mayo, an industry veteran who started Clearview Cinema Group, a top U.S. theater circuit based in NYC which was sold for $24 per share, or 3x its IPO price in 1998. Bud would later go on to start Cinedigm Digital Cinema, assisting with the industry's transition to digital. Further, Bud has many industry accolades, as he was inducted in the film exhibition hall of fame in 2010 and no doubt is viewed as an industry expert, which we find helpful in the strategy. Bud owns 10.8% of the shares outstanding through class b super voting shares.
Porter's Five Forces Analysis
Threat of New Entrants
Threat of Substitute Products
Bargaining Power of Suppliers
Bargaining Power of Customers
Scenario Valuation Analysis
The base case portrays a conservative growth path and no sale of the business within 2 or 3 years. Below are the assumptions used in the base-case scenario:
- Sales are expected to grow at a 49.9% in FY14 and 25.2% in FY15 due to screen acquisitions, and grow 1% thereafter (may prove to be conservative).
- Gross margin forecast to grow from 42.3% in FY13 to 46.5% in FY18, due to an increase in average ticket prices (in line with past trends) and operating leverage.
- EBITDA margin expected to improve from 7.6% in FY13 to 17.6% in FY15, driven solely off the operating leverage embedded in the business.
- Capital expenditures forecast at $2.4MM annually.
The upside case portrays a strong five-year forecast for the Company when compared with our base-case forecasts. Below are the assumptions used in the upside-case scenario:
- Sales are expected to grow at a 55% in FY14 and 45% in FY15, and taper off thereafter due to screen acquisitions.
- Gross margin forecast to grow from 42.3% in FY13 to 50.0% in FY18, due to an increase in average ticket prices (in line with past trends) and operating leverage.
- EBITDA margin expected to improve from 7.6% in FY13 to 8.9% in FY15, driven solely off the operating leverage embedded in the business.
- Capital expenditures forecast at $2.4MM annually.
Digiplex is a tough company to model, as we do not know exactly the pace or financing of upcoming screen acquisitions. Hence, Free Cash Flow to the Firm ("FCFF") was one method used to determine the intrinsic value for our two cases. The Company's terminal value was calculated using both the perpetuity growth and EBITDA exit multiple methods, 2.0% and 8.0x, respectively, for the base case, 3.0% and 9.0x for the upside case.
Private market value is another strong guide for what this asset may ultimately be worth, especially given the age of the CEO at ~72. Over the past decade, cinema operators have historically been taken out between 7.5x to 10.0x EBITDA. Larger circuits can often pay more for decent-sized chains given the benefits from economies of scale in terms of lower costs and the elimination of duplicate SG&A. Assuming the Company can grow EBITDA to ~$14MM in FY16, expanding screens to ~300 (which is below the 400 near-term estimates), and deducting an extra ~$25MM in debt financing, leaves us with an estimated EV of ~$126MM and an equity value north of $85MM, which translates into an $11 per share price or ~90%+ upside. It's an ironic cycle, as DCIN plugs mom-and-pop theater operators into its own system, only to potentially sell its theaters at a higher multiple to larger cinema operators.
Catalysts to Value Realization
Announcement of a Bank Financing Package
"Virtuous Cycle" and Ultimate Sale
Risks & Mitigants
Lack of Financing
No acquisitions or expensive capital
Class B Shares
Mis-allocation of capital
Why the Consensus is Wrong / Recommendation
In conclusion, Digiplex offers investors a chance to invest in a middle-market theater roll-up (excluding the fees) run by an industry veteran with a two potential exit catalysts, inclusive of a potential sale to a larger cinema chain/financial sponsor or through greater investor visibility as the Company builds momentum and compounds EBITDA and TLCF. Overall, we believe DCIN is an interesting asymmetric bet and potential double, supported by an industry jockey who has the "know-how" and "know-who".