The exhibition film industry in the U.S. is moving fast; some mergers have taken place in the recent past. Cinemark (CNK) purchased Century Theaters in August of 2006, and AMC merged with Loews Cineplex in 2005. Currently, Regal Entertainment (RGC) is the largest movie exhibitor in the U.S., with 6,623 screens in 530 theaters in 37 States, but Cinemark is catching up quickly, thanks to an excellent dual strategy that includes exclusivity (theaters in non-competitive areas) and diversification (23% of screens in Latin America). These two strategies have positioned Cinemark in a much better to take advantage of the growth and development of this industry in the coming years. Listed below is a head-to-head comparison among the four biggest motion picture exhibitors in the U.S:
*Fiscal year data from 2010 annual reports.
Looking at this table, you can immediately deduce something interesting: Cinemark had the highest attendance in the fiscal year 2010, with fewer screens than AMC and Regal. So let’s talk about Cinemark and why I like the company and this stock.
Cinemark Holdings, Inc. (Cinemark) is a motion picture exhibitor with theaters in the United States, Brazil, Mexico, Chile, Colombia, Argentina, Peru, Ecuador, Honduras, El Salvador, Nicaragua, Costa Rica, Panama and Guatemala. 23% of its screens are outside the U.S. In the 1990s, Cinemark was an innovator in the industry; it was one of the first chains to incorporate stadium-style seating into it theaters. The stairstep style was designed to provide better viewing, more seat and leg room for all patrons, and enhance the movie-going experience.
Today 86% of Cinemark’s first-run auditoriums feature stadium seating, Cinemark is the movie exhibitor who is most committed to improving the movie experience. Cinemark enjoys a leading position in this industry, and a big part of this success is due to four reasons:
Four Reasons I Love Cinemark
Cinemark’s theaters in the U.S. are primarily located in mid-sized U.S. markets, including suburbs of major metropolitan areas. These markets are generally less competitive and generate high, stable margins. Cinemark’s theaters in Latin America are primarily located in major metropolitan markets, which are generally underscreened.
Cinemark is the sole exhibitor in approximately 91% of the 247 film zones in which first-run U.S. theaters operate. In film zones where there is no direct competition from other theaters, Cinemark selects the films--from those offered to them by film distributors--that they believe will be the most successful. This is important, because in free zones, movies can be booked without regard to the location of another exhibitor within that area. However, in competitive zones, the distributor allocates their movies to the exhibitors, which they generally base on demographics and the grossing potential of that particular area.
In the international marketplace, films are not allocated to a single theater in a geographic film zone, but played by competitive theaters simultaneously. Cinemark’s theater personnel focus on providing excellent customer service, providing a modern facility with the most up-to-date sound systems, comfortable stadium-style seating, and other amenities typical of modern American-style multiplexes. This gives them a competitive advantage in markets where competing theaters play the same films. Of the 1,113 screens Cinemark operates in international markets, approximately 75% have no direct competition from other theaters.
Cinemark has balanced its risk through a diversified international portfolio. It currently operates theaters in twelve of the fifteen largest metropolitan areas in Latin America. Cinemark has achieved significant scale in Brazil and Mexico, the two largest Latin American economies, with 409 screens in Brazil and 296 screens in Mexico as of December 31, 2010.
Cinemark has 1,113 screens in 13 countries in Latin America. The significant presence of Cinemark in the U.S. and in Latin America has made them an important distribution channel for movie studios, particularly as they look to capitalize on the expanding worldwide box office. Why is this important? Because it provides diversification, added value for movie studios, and less exposure to domestic economic crises. Cinemark is also benefiting from the appreciation of international currencies against the dollar, and this situation is unlikely to change as long as the interest rates set by the government continue to stay close to zero.
International box office revenue continues to grow. According to the Motion Picture Association of America, international box office revenues were $21.2 billion for the year ending December 31, 2010, which was a result of ticket price increases, new theatre construction, and increasing acceptance of movie-going as a popular form of entertainment throughout the world.
MPAA statistics also show that Latin American box office revenues were $2.1 billion for the year ending December 31, 2010, which represents a 25% increase from 2009. Growth in Latin America is expected to continue to be fueled by a combination of robust economies, growing population, attractive demographics (i.e., a significant teenage population), substantial retail development, and quality product from Hollywood, including an increasing number of 3-D films. In many Latin American countries, particularly Mexico and Brazil, successful local film products can also provide incremental growth opportunities.
Many international markets for theatrical exhibition have historically been under-served, especially those in Latin America. Penetration of movie screens per capita in Latin American markets is substantially lower than in the U.S. and European markets.
Cinemark’s international screens generated revenues of $564.2 million, or 26.4% of the total revenue, for the year ending December 31, 2010, compared to $421.8 million during 2009. Cinemark has successfully established a significant presence in major cities in the region, with theaters in twelve of the fifteen largest metropolitan areas. With a geographically diverse circuit, Cinemark is an important distribution channel to the movie studios. Approximately 84% of Cinemark’s international screens offer stadium seating. Cinemark is well-positioned--with its modern, large-format theaters--to take advantage of these factors for further growth and diversification of revenue.
Cinemark’s expansion in Latin America continues to be a priority: Cinemark has commitments to build eight new theaters with 51 screens during 2011 and five new theaters with 34 screens in 2011, investing an additional $63 million in Cinemark’s Latin American markets. Cinemark also plans to install digital projection technology in all of its international auditoriums, which allows them to present 3-D and alternative content in these markets.
Cinemark’s geographic diversity throughout Latin America has allowed it to maintain consistent revenue growth, notwithstanding currency and economic fluctuations that may affect any particular market.
Alternative or “downstream” film distribution in Latin America is much more limited than in the U.S, where these channels include DVDs, network and syndicated television, video on-demand, pay-per-view television, and Internet (Including Hulu and Netflix). Because of this, going to the theater is the most affordable and convenient way to enjoy a movie for a lot of people in Latin America.
I always prefer dividend stocks, because I firmly believe they outperform non-paying dividend stocks in the long term. It’s no wonder that almost 100% of Warren Buffet’s holdings pay dividends! Chuck Royce, president, and co-chief investment officer and portfolio manager of Royce Funds, is a huge advocate of dividend stocks. His mutual fund is one of the most successful in the world, and he is one of the successful mutual fund managers that I admire the most.
Currently Cinemark's dividend yields 4.3%. It has paid dividends consistently starting in 2007. The current dividend yield of Regal is higher at 6.6%; Carmike (CKEC) pays no dividend.
4. Strategic Partnerships
Ticket price is just one part of revenue for movie exhibitors. Other income comes from concessions, advertising, and videogame arcades.
Concession sales are Cinemark’s second-largest revenue source, representing approximately 30% of total revenues for each of the years ending December 31, 2008, 2009 and 2010. Concession sales have a much higher margin than admissions sales, so Cinemark has devoted considerable management effort to increasing concession sales and improving operating margins. These efforts include implementation of the following strategies: Optimization of product mix, staff training, theatre design (to optimize efficiencies at the concession stands) and cost control. This is possible because Cinemark is able to negotiate prices for concession supplies directly with concession vendors and manufacturers to obtain volume rates.
Besides concessions, Cinemark is investing in different strategic partnerships that can improve its operating margin, and diversify its income. These initiatives are pre-feature screen advertising and conversion to digital technology.
Cinemark has done a lot of progress in these two fronts. Here some of the highlights:
Pre-Feature Screen Advertising
As of December 31, 2010, Cinemark had an approximately 15% ownership interest in National CineMedia (NCM), which operates an “in-theatre digital network.” NCM’s primary activities affecting Cinemark’s theaters include:
- Advertising through its branded “First Look” pre-feature entertainment program;
- Lobby promotions and displays;
- Live and pre-recorded networked and single-site meetings and events; and
- Live and pre-recorded concerts, sporting events and other non-film entertainment programming.
Cinemark receives a monthly theatre access fee for participation in the NCM network. In addition, Cinemark is entitled to receive mandatory quarterly distributions of excess cash from NCM.
In many of Cinemark’s international markets, they outsource the screen advertising to local companies who have established relationships with local advertisers who provide similar benefits as NCM.
Conversion to Digital Technology
The exhibitor movie industry began its conversion to digital projection technology during 2009, which has allowed exhibitors to expand their product offerings. Digital technology allows the presentation of 3-D content and alternative entertainment such as live and pre-recorded sports programs, opera, concert events and special live documentaries. These additional programming alternatives may expand the industry’s customer base and increase patronage for exhibitors. Cinemark’s plan includes the installation of digital projection technology in 100% of its U.S. and international auditoriums, of which 40-50% will be 3-D compatible.
During 2007, Cinemark, AMC, and Regal Entertainment entered into a joint venture known as Digital Cinema Implementation Partners LLC, or DCIP, to facilitate the implementation of digital cinema in our U.S. theaters, and to establish agreements with major motion picture studios for the financing of digital cinema. Digital projection improves operating margins because exhibitors can charge a premium for 3-D feature screens and can also save because digital projection doesn’t need prints. Printing an 80-minute feature film can cost $1,500 to $2,500, so making thousands of prints for a wide-release movie costs millions of dollars. In contrast, at the maximum 250 megabit-per-second data rate (as defined by DCIP for digital cinema), a feature-length movie can be stored in an off-the-shelf 300 GB hard drive for a minuscule fraction of the cost. With several hundred movies distributed every year, the industry could save billions of dollars. Cinemark has a 33% voting interest in DCIP and a 24.3% economic interest in DCIP.
As of December 31, 2010, Cinemark became an investor in Real D (RLD), which licenses 3-D technologies to motion picture companies. Cinemark has vested in a total of 1,085,828 Real D options to purchase shares of Real D common stock.
Risks: Long-Term Debt
There are two main risks associated with this stock. The first one is a big debt as a percentage of shareholders’ equity. The long term debt of the company was $1,521.6 million as Dec. 31, 2010, and this debt was acquired in October 2005 in connection with the Century Acquisition. Cinemark also entered into a senior-secured credit facility that provided for a $1,120 million term loan and a $150 million revolving credit line at that time. In my opinion, this was a necessary move because it was the only way Cinemark could come close to the same number of screens owned by Regal Entertainment. In this industry size really matters, especially when it comes to negotiations with distributors. So I see this as a smart move.
So far this debt has been managed properly. Approximately $924.3 million of the company’s remaining outstanding $1,083.6 million term-loan debt was extended from an original maturity date of October 2013 to a maturity date of April 2016. The remaining term loan debt of $159.2 million that was not extended, matures on the original maturity date of October 2013. Payments on the extended amount are due in equal quarterly installments of $2.3 million through March 31, 2016, with the remaining principal amount of $866.6 million due April 30, 2016. Below is a summary of the payment plan set by Cinemark from now to 2016. I’ll closely monitor the progress of this loan payment which for Cinemark is generating 2,141.1 million a year in revenues and 146.1 million in net income, but it shouldn’t be a problem.
Cinemark, just like any other movie exhibitor, relies on film distributors to supply the films shown in its theaters. The film distribution business is highly concentrated, with six major film distributors accounting for approximately 82.7% of U.S. box office revenues, and 47 of the 50 top-grossing films during 2010. This is a lot of leverage for distributors whose main interests don’t necessary align with movie exhibitors.
Over the last decade, the average video release window, which represents the time that elapses from the date of a film’s theatrical release to the date a film is available on DVD (an important downstream market), has decreased from approximately six months to 3-4 months. If patrons choose to wait for a DVD release rather than attend a theatre for viewing the film, it may adversely impact Cinemark’s business.
Film studios have announced their intention to offer consumers a premium video-on-demand option for certain films 60 days following the theatrical release, which would also cause the release window to shrink further. It is difficult to predict if these release windows, which are determined by the film studios, will shrink further or be eliminated altogether. When these windows shrink, film studios gain, and movie exhibitors lose.
A research paper in the Journal of Marketing in 2007 estimated that film studios could increase revenues by 16 percent if films were simultaneously released in theater, on rental DVD and video-on-demand, with a three-month window to DVD retail; on the flip side, theater revenues would drop by 40 percent. Thanks to the diversification and location of Cinemark’s theaters, they are the company in the industry with less exposure to this risk. Cinemark’s complexes are more than just theaters; they offer a whole movie experience, from parking to customer service and concessions.
I believe, at this time, that Cinemark offers a good opportunity for investors. Even with the acquisition of Century in 2006, the long term debt is lower than Regal Entertainment. The company is still growing fast, and recently achieved a new milestone, reaching 5,000 screens in the U.S. and international markets combined.
Cinemark has commitments to build 196 additional new screens over the next three years. This continued international expansion will remain focused primarily on Latin America through construction of modern, state-of-the-art theaters in growing urban markets. Cinemark has commitments to build eight new theaters with 51 screens during 2011, and five new theaters with 34 screens in 2011, investing an additional $63 million in Latin American markets. If Cinemark continues innovating and is able to pay all its debt by 2016, this is a stock to hold for a long time. The company will become the indisputable leader by then, with more cash, mode screens and more diversification than any other company in the industry. My target price for Cinemark is $30 by 2016.
Disclosure: I am long CNK.