- Reading International is a unique business with unique assets and a unique management team.
- It operates cinemas in the US, Australia, and New Zealand - all of which fund the company's real estate business.
- We like the business on a micro level, but our macro concerns cause us to take a "wait and see" approach with this one.
Reading International (NASDAQ:RDI) is a globally diversified cinema and real estate company. The company is unique in many ways. Aside from having one of the most detailed (and enjoyable!) annual reports we’ve ever read, RDI is family-controlled (21,240,044 shares of class A non-voting common stock and 1,680,590 shares of class B voting common stock) and uses the profits from the cinema business to fund its real estate development segment. Even putting aside the company’s corporate governance issues, the two wildly unrelated operating segments would certainly be reason enough for the market to have trouble pricing the equity. This is largely because the real estate segment produces virtually zero operating profits and should be valued more on an NAV basis, whereas the cinema business produces ample cash flow and should be valued on a present value basis.
One look at the chart below and you can see the discrepancy between the two segments in terms of revenue generation (in that the real estate segment produces essentially zilch). What you’ll also see is that the business is diversified across three countries.
(Source: Company 2019 Annual Presentation)
As mentioned, the company produces one of the best 10-Ks we’ve read in some time. We’d encourage all of you to take the time and read it. At a high level, RDI’s basic strategy is to fund its real estate purchases and development via the cash flows from the cinema business. RDI then keeps the assets on its books (usually at a much lower price than market value) and rents out the real estate to tenants; or the company plans on developing the real estate and monetizing the property at some point in the future. RDI strikes us as the archetypal deep value investment that would be sold at a much higher price than the going rate of the stock, but no one really knows if that will ever happen, as the company is majority-controlled. For now, let’s move on and figure out what an SOTP valuation could look like for Reading International.
The cinema business is easy enough for anyone to understand. RDI simply operates movie theaters where it rents films from the major distributors and sells tickets to moviegoers. The business is quite stable (albeit cyclical) and is a mid-tier competitor in the space. RDI’s brands include Reading, Angelika, Consolidated Theaters, and City Cinemas. As noted, the company operates movie theaters in the US, Australia, and New Zealand. The company has 60 theaters and 484 screens spanning across those geographies.
As hit on before, the cinema business is the true driver of earnings in the business, as over 90% of RDI's consolidated revenue stems from this segment. 65% of revenue is from box office receipts, 29% from food and beverage (F&B), and 7% from advertisements. The most profitable product line is, of course, F&B. The company is investing in the cinema business by improving its current theaters (adding recliners, enhancing the interior, etc.), in addition to making alcoholic purchases available in its theaters. RDI further invests in this segment by selectively acquiring individual theaters.
Of the $40 million invested back into the US business in 2018, $23 million was for real estate and $17 million for cinema. In the Australia business, of the $12 million invested back, $6 million was for real estate and $6 million for cinemas. In the New Zealand business, of the total $1.8 million, $1 million was for real estate and $.8 million for cinema. Moving forward to 2020 and 2021, the company anticipates to invest $61.95 million into its US division, A$46.00 million into its Australia division, and NZ$21.03 million into its New Zealand division.
We mentioned earlier how candid management comes across in the annual report. Here’s an example of such candidness when management was laying out its strategy in deciding whether to allocate capital to the cinema business or the real estate business:
Pure cinema operators can encounter financial difficulty as demands upon them to produce cinema-based earnings growth tempt them into reinvesting their cash flow into increasingly marginal cinema sites, overpaying for existing cinemas or entering into high-rent leases. While we believe that there will continue to be attractive opportunities to acquire cinema assets and/or to develop upper-end specialty type theaters in the future, we do not feel pressure to build or acquire cinemas for the sake of adding units or building gross cinema revenues. This strategy has, over the years, allowed us to acquire cinemas at multiples of trailing theater cash flow below those paid by third parties in recent acquisitions.
It’s a compelling strategy and certainly gives the impression that management operates the business in the interest of shareholders. As alluded to earlier, there has been some controversy with the family who controls RDI, the Cotters.
After posting strong results in 2018 with revenue and EBIT up 10% and 40% respectively, RDI has had a rough 2019 with revenue and EBIT being down 12% and 40%, respectively. We view these swings to the negative as largely cyclical - the box office as a whole shrank a little bit in 2019 compared to 2018.
In 2018, the cinema’s operating income was $39 million. Peers easily trade at a 15x P/E EBIT, but this, of course, doesn’t factor in a lot of real expenses the business incurs (especially in this case, as we have yet to factor in G&A), so let’s go with a 10x multiple. Doing so leads us to believe the cinema business should be worth ~$390 million.
RDI has a formidable real estate portfolio. Management detailed the type of real estate projects by categorizing them in three ways: 7 value creation projects, 11 operating properties, 3 future long-term value creation projects.
For the most conservative approximation of value for the company’s real estate holdings, we can simply look at the book value figures RDI presents for each of the above sections (in the annual report). When we do so, we get a value of ~$266.8 million. This is conservative because the company owns vast stretches of real estate with no debt that is undeveloped.
Adding the value of the cinema business with the value of the real estate business gets an enterprise value of $656 million. If you recall, in our valuation of the cinema segment, we had yet to net out G&A ($21 million), interest ($7.4 million), taxes ($1.7 million), and net debt (~$190 million). That leaves us with an equity value of $436 million. Against a share count of 23 million, we have a target price of ~$19.
We believe the above is correct and conservative. However, the company’s operating income is down 70% in the first 9 months of 2019 compared to 2018. Reading International saw similar results during the Great Recession. Additionally, the company has substantial operations in Australia, a country many have speculated is in the midst of a housing bubble, which has gone almost 40 years without a recession, and, to us, seems ripe for a financial crisis.
Additionally, RDI has a business model that is acutely exposed to negative economic impacts posed by the novel coronavirus. If the virus persists well beyond flu season, it's quite reasonable to assume that movies would be an activity individuals would readily pare back on - especially if health officials urge communities to avoid public gatherings.
In other words, RDI is a buy, though not yet. We anticipate the company’s stock will go on sale in a dramatic way in the next few years. Considering that it is down nearly 45% since the beginning of February alone, we suspect patient investors will have the chance to initiate a meaningful position in the next few quarters. We will update readers accordingly.
This article was written by
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