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Summary

  • Regal Entertainment has been paying steady dividends to shareholders for several years, even as attendance figures have shown a decline over the past decade.
  • Industry competitor AMC Entertainment is shaking up the traditional theater business model in a way that requires significant capex investments for the next several years.
  • Regal's cash flows and dividend payouts will come under pressure in the future if it needs to embark on a similar capex spending strategy.

What has always struck me as curious about the movie theater business is that the primary product, which draws the audiences into the theater -- the motion picture film -- is something that the theater owners themselves do not produce or control. Couple that with the major changes in the entertainment industry over the past several years: improving technology of TVs and sound systems for home theaters, streaming of film content into your living room or on your mobile device, and the tension between studios and theaters over theatrical release windows. After doing some work on the major movie theater companies with public equity, I believe that Regal Entertainment's (NYSE:RGC) cash flows and dividend payments could come under pressure.

Regal and a competitor, AMC Entertainment (NYSE:AMC), have some key differences in their strategies for delivering value to shareholders (note that AMC Entertainment is different from AMC Networks). In Regal's case, management seeks to add value through accretive acquisitions. On the other hand, AMC is going in the direction of changing the theater business model from one focused on quantity of seats to one focused on fewer but more comfortable seats and better amenities for its customers. AMC's strategy is bearing fruit and could prompt a change across the industry. As a result, the higher capex spending needs would put some pressure on the funds available for Regal to grow dividends in the future, and RGC shareholders should sell down their exposure.

First, some industry data on attendance. The National Association of Theater Owners (NATO) provides U.S. box office and attendance data (see page 18 of AMC Entertainment's 2013 10-K and page 3 of Cinemark Holdings' 2010 10-K). From 2001 through 2013, attendance peaked at 1.57 billion in 2003 and hit the lowest point in 2011 at 1.28 billion. For 2013, attendance came in at 1.34 billion, for a small recovery from the 2011 trough but still a general decline from the peak.

Looking at Regal from 2006 through 2013, attendance fell from 247.4 million to 212.3 million (note the 2013 figure excludes attendance from certain theaters that were acquired during the year to allow for accurate comparison). Over the same time period, average ticket prices went up from $6.98 in 2006 to $9.01 in 2013. Similarly, average concessions spending per customer went up from $2.92 to $3.57. (Regal discloses attendance figures, average ticket prices and concessions spending per patron in its 10-K filings.) So Regal has offset declining attendance through higher spending by its customers.

The question is: Can the falling attendance become a problem at some point for Regal's cash flows and, as a result, its dividend payments? Home theater systems bring some of the picture and sound quality of the theater into your living room. Furthermore, you may have to incur some other costs associated with going to the theater such as parking, food and a babysitter. The tradeoff is that you have to wait for the movie to be available for home viewing. The attendance figures suggest that some of these factors are in play.

It appears that Regal has been relying on price increases, especially for concessions where gross profit margins exceed 85%, to combat the attendance declines (I calculated concessions gross profit by subtracting Cost of Concessions from Concessions Revenue on Regal's income statements). Regal has also used acquisitions to grow. Regal acquired 301 screens from Great Escapes in November 2012 for $90 million, or $299,000 per screen. It then acquired 513 screens from Hollywood Theaters in March 2013 for $242.3 million, or $472,000 per screen.

At the end of 2012 and 2013, the RGC stock prices generated total enterprise values that implied $572,000 and $631,000 per screen, respectively (Table 1 below shows the calculations). So the acquisitions were accretive on a valuation basis. In fact, during the earnings call for Q4 2013, management stated that accretive acquisitions are a key method for delivering shareholder value and that Regal sees the potential for future M&A opportunities.

For the past five years, Regal's recurring free cash flow available to pay dividends has ranged from $200 million to $300 million annually and totaled $1.3 billion (I calculated free cash flow available for dividends from the cash flow statement as follows: Operating Cash Flow - Capex - Cash Taxes paid - Cash Interest paid). The free cash flow amounts include capex spending over the same time period that ranged from $90 million to $110 million and totaled $495 million. Regular dividends (excluding special dividends that Regal has paid) over the same five-year period totaled $615 million.

On the other hand, it appears that AMC is embarking on a different strategy that virtually changes the movie theater business model in pursuing quality over quantity. In the most recent 10-K filing, AMC management states that "after more than nine decades of business models driven by quantity of theaters, screens and seats, we believe the quality of the movie going experience will determine long term, sustainable success." The company has started renovating its theaters by removing all the old seats and installing more comfortable reclining seats even though seating capacity is reduced 66% (as highlighted in the IPO prospectus). In essence, the company is trying to bring the comfort of your living room to its theaters.

AMC's strategy has required an approximately doubling of capex spending to $261 million of capex in 2013 compared to $130 million and $140 million spent in FYE March 2011 and FYE March 2012, respectively. AMC's management discussed its plans during its Q4 2013 earnings call (you can find the transcript on Bloomberg). Management pointed out that these renovated theaters see an 80% jump in attendance after the new seats are installed and, after about a year, an 8% increase in ticket prices that exceeds industry average of about 2%.

I believe AMC's effort will be successful in driving attendance, market share and profits higher. Consequently, Regal's cash flows available for dividends will come under pressure. Regal ended 2013 with 580 theaters and 7,394 screens but spent $112 million of capex for the full year, much less than AMC's capex spend even though Regal has more theaters. If Regal should have to embark on a similar strategy as AMC, and Regal's capex needs to be double the current spending, then its dividend payout ratio could come under pressure and the company's ability to sustain its dividend payout in the future would be in doubt. Thus, RGC shareholders should sell at the current market price.

Table 1: Calculation of Enterprise Value per Screen for RGC

($ in millions, except per screen value)

Dec-2012

Dec-2013

Notes

Regal Market Equity Value

$2,375.9

$3,041.1

(1)

- Market Value of NCMI Stake

(334.4)

(402.8)

(2)

= Adjusted Regal Equity Value

2,041.6

2,638.3

+ Debt

2,003.0

2,312.1

(3)

- Cash

(109.5)

(280.9)

= Regal Total Enterprise Value

3,935.1

4,669.5

divided by # of screens

6,880

7,394

= TEV per screen

$571,959

$631,524

  1. FY 2012 uses RGC stock price on date Q4 earnings reported; FY 2013 uses most recent market price for RGC shares.
  2. Value of Regal's stake in National CineMedia (NASDAQ:NCMI).
  3. Excludes unamortized debt discounts/premiums.
Source: Regal Entertainment: A Competitor's New Strategy Could Pressure Future Dividends