Cineplex: Selling Itself For $34? It Is What It Is

Summary

• Cineplex has a history of taking risks and diversifying its business.
• It is likely selling itself to gain more clout in its negotiations with Hollywood studios.
• An offer price of $34 a share seems a bit short compared to what it was trading at more than 2 years ago, but it is fair.

In mid-December, Cineplex (OTCPK:CPXGF) announced a friendly takeover deal that will see Cineworld Group (OTCPK:CNNWF or OTCPK:CNWGY ) purchase Cineplex for $34 (in CDN) a share. This represented a 42% premium at the time, but the stock had traded above $34 from mid-2013 to late 2017. To sell at a $34 price, quite a bit of value has been given up here.

In its most recent Q3 quarterly earnings update, Cineplex's management highlighted the following:

• A record 3rd quarter high of $418.4 million in total revenues
• A new record high of BPP (box office revenue per patron) of $10.16
• A new record high of CPP (concession revenue per patron) of $6.68
• Mobile app usage increased by 24% from the prior year
• Media revenue is up 30.6%

With the company enjoying such success, why sell a company now that was at one period trading at $50?

I can only think of a few reasons why:

1. $34 is the quickest way to generate value. For Cineplex to reach $34 a share on its own, this could take a few years or even longer.
2. Despite diversifying its business into other entertainment avenues, the growth hasn't materialized as well as management hoped
3. The movie theater industry is consolidating and to not merge could leave Cineplex at a disadvantage

Cineplex Management: An Entrepreneurial Approach to Business

Over the years, I have been bullish on Cineplex because of its attitude to wanting to try something new. In the last decade and a bit, Cineplex had made efforts to be more than just a movie theater company:

• In 2007, it partnered with Scotiabank (BNS) and launched its loyalty program: SCENE
• In 2015, Cineplex ventures into eSports
• In 2016, it opened its first arcade / bowling alley / VR / restaurant concept: Rec Room
• In 2016, it created its mobile app to make it easier for movie-goers to purchase tickets
• It late 2016, it created an Amusement Division
• In 2018, it partnered with Uber Eats to deliver concession items to people's homes
• In late 2019, management confirmed its opening of its first Topgolf location in Toronto
• In 2019, Cineplex announces Junxion offering a different state of the art cinema experience.

This diversification strategy has shifted its business where more than 20% of its total revenue now comprises of Media / Amusement / Other:

(Source: 2018 Annual Report)

Cineplex's Diversification Results were Mixed, and This Punished the Stock Price

In all ventures, not every hit is a home run. Recently, Cineplex has disclosed in its latest earnings call that it is looking for a strategic equity partner for its online eSports business.

Profits in its media division have been low because of low installation revenues.

Revenue from its Rec Room restaurants is expected to come down because of the honeymoon period of 12 to 18 months.

Although revenue growth across all areas have improved over the prior year. It appears the Amusement division is seeing slowing sales momentum:

(Source: Cineplex Financials)

These minor hiccups combined with a gradual decline in theater attendance had punished the stock's value in the last 2 years. But in the last 5 years, Adjusted EBITDA and Adjusted EBITDA Margins remain strong and consistent:

(Source: 2018 Annual Report)

Financially, Cineplex was still posting strong numbers but the narrative had changed 2 years ago that the movie theater industry is dying because of new streaming services. This is likely the reason why the stock could not regain its former value and nothing management did could change that.

Taking a friendly takeover offer of $34 per share was the quickest way to creating the highest value.

The Industry is Consolidating

There are economies of scale in having a larger theater chain network. A larger theater chain network puts it in a stronger negotiating position with movie studios especially when movie studios are also consolidating itself.

Cineplex acquired Famous Players in 2005 and purchased 24 Empire theaters in Atlantic Canada in 2013. Buying out its competitors has always been a part of Cineplex's strategy and this was what positioned it into a national chain. So a sale to a much bigger theater operator with a network across the globe seems like a natural progression.

The Deal is still Subject to Government's Approval

This friendly takeover is subject to the Investment Canada Act. Since Cineworld is a foreign corporate entity, its acquisition still needs to go through regulatory approval.

There have already been complaints in the Canadian film circles that a Cineplex sale would hurt the Canadian film market, because there could be less opportunities for Canadian films to be shown on theater screens now.

How the political winds blow on this deal is rather hard to say. I'm not sure how the Canadian government would view a foreign entity owning more than 75% of Canada's theater business. I think it is likely the deal will go through but politics is always hard to guess.

Conclusion: $34 a share, It is a Fair Deal

I can understand Cineplex's angle in this but I also can't help but wonder whether management had pulled the trigger to sell too early. There are merits to selling itself to gain more clout on the bargaining table. But I don't think there was enough time for its non-theater businesses to play out.

Its Junxion concept announced in November 2019 to build a food hall with food trucks, surrounded by video and redemption games has appeal. It has the potential to be a game changer but since it is not theater business related, would Cineworld nix these plans after its acquisition? It is possible.

Cineplex has until Feb 2, 2020 to find a better offer. A better offer would probably come from another theater operator but to come up with the financing at such a short time is difficult. Realistically, the likelihood of a better offer is low since this is a friendly takeover so it has the blessing of both Cineplex and Cineworld management.

In light of what is going on in the industry and the mixed results Cineplex has made to diversify itself, I think $34 a share is a fair deal. I don't think it is the best but it isn't bad either.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.