Carmike Cinemas: A Deleveraging Story With an Unappreciated Imbedded Asset

Includes: CKEC, CNK, RGC
by: Adam Muller
Company Description: Carmike Cinemas (NASDAQ:CKEC) is a motion picture exhibitor with theater locations in small to mid-sized communities with populations of fewer than 100,000. As of December 31, 2010, Carmike had 220 theaters and 2,103 screens on a digital-based platform including 596 screens with 3-D capability.
Carmike entered bankruptcy in August 2000 after having overspent building megaplexes and renovating existing theaters. Carmike exited Chapter 11 in 2005 and over the last few years has been focused on controlling costs and paying down debt.
Carmike is trading around $6.85 per share, equating to a market capitalization of $92mm and an enterprise value of $433mm. Carmike generated $64mm of EBITDA in 2010 from $491mm of revenue and trades at 6.8x trailing EBITDA, a discount to other cinema exhibitors Regal Entertainment (NYSE:RGC) (8.9x trailing EBITDA) and Cinemark Holdings (NYSE:CNK) (8.0x trailing EBITDA). Importantly CKEC generated $11mm of free cash flow in 2010 for a free cash flow yield of 11%. The company is currently levered at 5.5x trailing EBITDA.
Click here for Carmike’s Q4 and full year 2010 earnings.
Investment Thesis: Carmike is at a financial inflection point in 2011. The company has been focused on controlling costs and paying down debt, which will result in positive earnings in 2011 for the first time since 2005. Further, Carmike has an imbedded asset in its Screenvision profit stake (discussed in detail below) that is not currently factored into its valuation.
Film Exhibition Industry: The motion picture exhibitor industry had a very strong Q4 2009 and Q1 2010 due to the performance of Avatar, the highest grossing movie in history followed by the success of Alice in Wonderland in the first quarter of 2010, which was released in 3-D. As a result on a comparable basis the box office in the fourth quarter of 2010 was weak and to date the first quarter of 2011 has also been weak. Year to date the box office is down over 20% versus 2010. However, the industry should rebound in the second half of the year based on a movie slate with multiple franchise sequels coming out and significantly more films (including franchise films) released in 3-D, resulting in premium ticket prices.
Select 2011 films that are sequels to successful movies include: Pirates of the Caribbean On Stranger Tides (3-D), The Hangover Part II, Kung Fu Panda 2, X-Men First Class, Cars 2, Transformers: The Dark Side of the Moon, Harry Potter and the Deathly Hallows Part Two (3-D), The Twilight Saga: Breaking Dawn Part One, Happy Feet 2 (3-D), Mission Impossible: Ghost Protocol, and Sherlock Holmes: A Game of Shadows. The fourth quarter of 2011 includes two films directed by Steven Spielberg - The Adventures of Tintin: The Secret of the Unicorn (3-D) and War Horse. Other notable films such as Moneyball from the Michael Lewis book starring Brad Pitt with a screenplay written by recent academy award winning screenwriter Aaron Sorkin, Super 8 written and directed by J.J. Abrams, and The Girl with the Dragon Tattoo from the best-selling novel add to the overall 2011 movie slate.
This year has almost three dozen 3-D titles in the movie slate versus two dozen in 2010. With 600 screens currently 3-D capable and another 115 planned to be 3-D by the summer, Carmike is poised to take advantage of the increase in 3-D movies.
Looking ahead to 2012 the movie slate also looks promising with a Men in Black sequel in 3-D, Madagascar 3, a Star Trek sequel, the reboot of the Spider-Man franchise, the third batman film from director Christopher Nolan, and the final installment of the Twilight franchise.
Screenvision: Screenvision is the second largest provider of cinema advertising, offering on-screen advertising, in-lobby promotions and integrated marketing programs to national, regional and local advertisers and providing comprehensive cinema advertising representation services for its theatrical exhibitor partners. The Screenvision cinema advertising network is comprised of over 15,000 screens in 2,500 theater locations across all 50 states and 93% of DMAs nationwide, delivering through more than 150 theatrical circuits, including 10 of the top 15 exhibitor companies. In September 2010, Shamrock Capital Growth Fund, a private equity fund founded in 1978 by Roy E. Disney focused on the media and entertainment industries, acquired Screenvision.
Carmike is part of the Screenvision network and in October 2010 CKEC extended its existing agreement with Screenvision, which had been set to expire in July 2012.
The key terms of the new agreement are as follows:
  • The term is extended for 30 years.
  • Screenvision pays CKEC a one-time $30mm payment (the payment was received in January 2011). The $30mm payment will be amortized over the 30 years of the agreement.
  • CKEC receives a profit interest in Screenvision of between 15% and 25% (the percentage could fluctuate up or down if CKEC adds or subtracts from its total screen count). For CKEC in Q4 2010, this resulted in an earnings boost of $900,000, listed on their income statement under earnings from unconsolidated subsidiaries, for the portion of Q4 post close of the transaction.
Since Screenvision is a private company there is limited financial information available. An 8-K filed in December 2010 provides financial information for 2009 and the first half of 2010. In 2009 Screenvision generated $179.5mm in revenue, $28.2mm in EBITDA, and earnings of $7.8mm. In the first six months of 2010 Screenvision generated $79mm of revenue, $5.2mm of EBITDA, and negative $0.7mm of earnings versus $63mm, -$4.6mm, and -$5.8mm in the first half of 2009. It can be inferred from this data that the second half of the year is stronger than the first half and that the first half of 2010 was significantly better than 2009.
CKEC’s $900,000 of earnings in its Q4 2010 financials grossed up to represent the full quarter would be $1.1mm. Assuming that the third quarter of 2010 would equal the fourth quarter, dividing by CKEC’s 15% interest, and adding in the negative earnings from the first half of 2010 implies total Screenvision 2010 earnings of approximately $13.7mm.
Screenvision’s main competitor in the theater advertising space is National CineMedia (NASDAQ:NCMI). Since NCMI is a publicly traded company it can be used to approximate the value of CKEC’s profit interest in Screenvision. NCMI is trading at approximately 29x its 2010 earnings. Given that Screenvision is smaller it seems appropriate to haircut the multiple. A 20x multiple applied to Screenvision’s 2010 earnings of $13.7mm results in a market cap of $274mm. CKEC’s 15% interest would then be worth $41mm or approximately 45% of CKEC’s current market capitalization.
According to Wall Street research, NCMI’s adjusted EPS is expected to grow approximately 25% in 2011 and another 10% in 2012. If Screenvision grew earnings at half this rate it would see 2012 earnings of $16.2mm. Again using the “haircut” multiple of 20x the resulting value of CKEC’s interest would be worth $48.6mm or over 50% of CKEC’s current market capitalization.
The Screenvision deal also provides another source of benefit to Carmike. Carmike will use the after-tax proceeds from the $30mm payment to pay down debt. At stated in its year-end conference call CKEC plans to pay down $15mm of debt by the end of the first quarter of 2011. CKEC will also use operating cash flow generated over the course of the year to pay down additional debt. Further, again from the information in the December 2010 8-K filing, in 2009 Screenvision paid a cash dividend of $22mm to its shareholders. CKEC would be entitled to its share of any future dividend paid by Screenvision providing another potential source of cash. Once CKEC gets debt down to its stated target of $200mm (per CKEC guidance) they will have excess capital that they can elect to return to shareholders in the form of dividends and/or stock repurchases.
Finally, as a precautionary measure, in the fourth quarter of 2010 CKEC negotiated with its banks to increase its debt covenants, providing more cushion should 2011 cinema attendance prove weaker than expected.
CKEC Valuation: Given the imbedded asset, the appropriate way to value CKEC is using a sum-of-the-parts approach. Creating the base exhibition business at a 7x EBITDA multiple (a discount to its larger peers) results in an enterprise value of $446mm. Adding Carmike’s interest in Screenvision, valued at approximately $41mm (per the analysis above), results in a total enterprise value of $487mm implying an equity market capitalization of $148 or $11 per share, a 60% premium to where CKEC trades today.
This valuation provides a comfortable margin of safety and also ignores further upside drivers such as continued debt pay down and growth of Screenvision. It’s also important to note that Shamrock Capital will seek to grow and then monetize Screenvision through a sale or an IPO and CKEC is entitled to a portion of the proceeds.
And although not a primary driver of the investment thesis, it is also worth mentioning that CKEC itself would also make a good strategic acquisition target for a larger cinema exhibitor.
Risks: There are several risks that need to be considered. Industry attendance has trended down over the last several years and although the revenue decline has been mitigated by price increases and the price premium for 3-D films, if this trend continues it will eventually impact exhibitors. Poor economic conditions, high unemployment, and rising gas prices could lead to less movie attendance. CKEC depends on the quality of the movies being produced by the movie studios and therefore has no influence over the quality of its product. On March 30th several movie studios announced plans to release certain of their films to the home through video-on-demand only 60 days after theatrical release. This could negatively impact exhibitors. Theater operators were not consulted or informed of this decision by the studios. The National Association of Theater Owners (NATO) is strongly against this change.
Click here for a New York Times article regarding the movie release window. And click here for NATO talking points regarding the movie release window.
Finally, CKEC is a small cap company and as a result the stock is highly volatile.

Disclosure: I am long CKEC.