The September 30, 2010 Just One Stock interview highlighted theater exhibitor Reading International (RDI). The article mentioned several near- and long-term catalysts that could improve Reading’s depressed stock price. The largest near-term catalyst remains the culmination of the on-going auction to sell Reading’s massive undeveloped Burwood Square property in Melbourne Australia. (See May 27, 2010 and May 16, 2010 articles for Burwood Square sale info.) However, another smaller catalyst, relating to substantial forgiveness of a seller note on Reading’s large 2008 cinema chain acquisition, has just been triggered.
According to a October 7, 2010 8-K filing recently made by Reading, quantification and timing of forgiveness of almost the entire “U.S. Nationwide Loan 1” on Reading’s most recent June 2010 10-Q has now been set in motion. As a result of this reduction in debt principal and associated reversal of accrued interest, Reading’s debt should be reduced by more than $14.9MM, during the current Q4 ended December 2010.
Reading’s $35MM of adjusted EBITDA for its cinema segment (LTM ended June 30, 2010) already includes the reduced cash flow upon which this debt forgiveness is based. Therefore the subsequent reduction in Reading’s net debt accrues directly to Reading’s shareholders by reducing EV and no longer EBITDA.
In February 2008, as described in this press release, Reading bought 181 movie screens in Hawaii and California from an affiliate of Pacific Theaters. It was an almost entirely debt-financed acquisition comprised of senior debt from GE Capital plus subordinated seller financing from Pacific’s affiliate, Nationwide Theatres. This subordinated seller note included certain provisions for the downward adjustment of the principal amount owed, depending upon the possible occurrence of certain events. Among them, the introduction of new competition to the large Valley Plaza 16-plex in Bakersfield California that was part of this cinema purchase transaction. In July 2009, Maya Cinemas opened a new theater in the competitive radius with Reading’s Valley Plaza cinema. This new theater contributed to the recent closure of a Regal Cinemas (RGC) United Artists theater nearby and reduced cash flow at Reading's Valley Plaza 16.
According to the “Competitive Project Adjustment” clauses in the Nationwide subordinated seller note agreement, a multiple times Valley Plaza’s cash flow reduction during its first year after a competitive theater’s opening would be reduced from the seller note’s principal value. In addition, under terms of the note, all accrued interest on the forgiven principal retroactive to the February 2008 purchase date would also be forgiven and reversed.
Calculations and accounting impact:
The $14.9MM reduction in Reading long term debt is a combination of $12.5MM of debt principal reduction and at least $2.4MM I estimate (see below) to be accrued interest, up through the most recently reported June 30, 2010 quarter, that will be reversed. The $12.5MM of debt principal reduction will be accounted for as a reduction in balance sheet goodwill and the $2.4MM of reversed accrued interest will flow through Reading’s income statement to its bottom line as a reduction of interest expense. Book value for Reading will grow for the bottom line benefit from the reversed interest. And also, Reading’s tangible book value will rise from both accrued interest reversal and the substantial reduction of balance sheet goodwill associated with the debt principal reduction.
The October 7, 2010 8-K filing discloses that Reading calculates it is due a $12.5MM reduction of principal on the Nationwide note and that the remaining principal on after the reduction, would be only $592K. Nationwide has 30 days to dispute the calculation. Once the final calculation is agreed to, the amount of accrued interest to be reversed would become finally determinable. Based on Reading’s 8-K disclosure, one can calculate that the pre-forgiveness principal balance on the note is $13.092MM ($12.5 plus .592). Furthermore, given the most recent June 2010 10-Q total debt balance on U.S. Nationwide Loan 1 of $15.6MM, one can calculate accrued interest at that date to be $2.508MM ($15.6 less $13.092). Finally, with the $12.5MM principal reduction over 95% of the pre-forgiveness principal, it is fair to estimate that at least $2.39MM of accrued interest will be reversed in Q4. It will flow through Reading’s income statement to its bottom line as a reduction of interest.
Disclosure: At time of writing, funds the author manages hold a long position in RDI and RDIB. The funds or its affiliates may buy or sell securities of this issuer at any time.