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Background

On April 4, 2011 I posted an article on Carmike Cinemas (NASDAQ:CKEC) that made the argument that CKEC is undervalued.

In the article I referenced several key valuation drivers:

  • The value of CKEC's profit interest in Screenvision;
  • The improved film slate in the second half of 2011; and
  • The earnings impact of deleveraging.

The validity of the CKEC investment thesis as summarized by these valuation drivers remains very much intact despite some of the issues currently facing the broader film exhibition industry.

Early Home Viewing

This issue under debate, which has been brewing for a while, came to the forefront recently when four movie studies [Sony Corp. (NYSE:SNE), Universal Pictures, Warner Brothers, and Twentieth Century Fox] announced they were going to make select movies available for home viewing early, thereby shrinking the exclusive window to only two months. DirecTV (NASDAQ:DTV) is planning to offer the Adam Sandler Sony movie "Just Go For It" starting tomorrow for $30. The film, released February 11, was still in theaters last week.

Clearly this is a threat to movie exhibitors like CKEC and Regal Entertainment (NYSE:RGC) and they are not taking it without a fight. Regal has suggested that they will no longer show trailers or advertise films that could end up being release to home viewing early.

In addition, high profile filmmakers such as James Cameron and Peter Jackson have also vocalized their displeasure with this plan suggesting that it harms the financial model of the film industry.

I am not going to argue that this won't have any impact on Carmike, but it does not change the investment thesis. Carmike is insulated for two key reasons:

  • In their location (small to mid-size non-urban markets) going to the movies is still a key part of the social fabric of society and a popular entertainment option; and
  • With 3-D capabilities in 84% of their theatres and 27% of their screens (set to increase by summer 2011) CKEC can offer premium viewing experiences not available at home.

CKEC First Quarter Earnings

CKEC should report first quarter 2011 earnings in early May.

An examination of first quarter box office receipts on Box Office Mojo reveals that the total box office in the first quarter of 2011 was $1.9 billion versus $2.4 billion in 2010. Box office revenue was down over 20% in the first quarter.

From 2008 through 2010 CKEC's admission revenue averaged 3.6% of the total domestic box office with a range of 3.2% on the low end and 4.4% on the high end.

Eleven analysts published revenue estimates for CKEC. The median estimate is $103mm with a low of $97.3mm and a high of $121.0mm.

Table 1 below applies the low, average, and high box office percentages to the first quarter total box office to calculate CKEC's admissions revenue. Concession revenue is calculated by applying the year-over-year admissions growth rate to the concession revenue of $41.9mm in the first quarter of 2010.

Table 1: CKEC First Quarter Revenue Calculation

Admissions Revenue

($mm)

Year-over-Year

Growth (%)

Concessions Revenue

($mm)

Total Revenue

3.2% of Box Office

$60.6

(26.3)%

$30.9

$91.5

3.6% of Box Office

$68.2

(17.1)%

$34.7

$102.9

4.4% of Box Office

$83.3

1.3%

$42.5

$125.8

The results show that at the historical average tracking percentage of 3.6% the implied total revenue is equal to the analyst median estimate representing a decrease of 17.1% versus the first quarter of 2010. This decline should not be a surprise given that the first quarter of 2010 includes the highest grossing movie of all time ("Avatar") and the significant box office generated by "Alice in Wonderland" at a time in the year typically devoid of large blockbuster films. There were no such notable films in the first quarter of 2011.

What does this mean for CKEC?

If CKEC generates $102.9mm in revenue and the operating margin is identical to the first quarter of 2010 operating income would equal $5.4mm. All of the $5.4mm and more will be wiped out by the interest expense from their $353mm of debt (including a $238mm term loan) leading to negative earnings.

But here is more to consider. First, will CKEC's theatres in smaller towns track above or below the three year average, which will determine whether or not they miss or exceed analyst expectations. Second, a full quarter of CKEC's profit interest in Screenvision will be reflected in earnings from unconsolidated subsidiaries. Recall that in the fourth quarter of 2010 this was $900,000. The Screenvision deal closed in mid October therefore the $900,000 did not represent a full quarter. We should assume that Screenvision seasonality mirrors that of the exhibition industry and therefore the first quarter is not as profitable as the fourth. Finally, do not forget that CKEC pledged to use the after-tax proceeds of the Screenvision payment received in January to pay down debt in the first quarter. If the pay down occurred towards the end of the quarter it may not materially impact the interest expense in the first quarter financials, but it certainly will on a go-forward basis. Further, CKEC will likely allocate operating cash flow over the balance of the year to additional debt pay down, which will further assist the return to profitability that is very close at hand.

The summer movie season is almost here with movies like "The Hangover Part II," "Pirates of the Caribbean: On Stranger Tides," "X-Men: First Class," "Transformers: Dark Side of the Moon," "Harry Potter and the Deathly Hallows Part Two," and many more waiting to draw people to the theaters.

Watch the trailer for Hangover Part II and tell me, would you rather watch this at home with a few friends than in a theatre with 150 other people laughing hysterically?

Source: Carmike Cinemas: Issues Facing the Cinema Industry Don't Change the Investment Thesis