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Is the German Cinema Market Coming Good At Last? And Is CinemaxX the Cheapest Exhibition Stock in Europe?

Since reunification Germany’s cinema market has had a floor of around 125 million admissions a year. Given that last year’s 126.6 million admissions barely crept above this level – and those for the first half of 2011 are reported to be just 2.2% higher than the corresponding period in 2010 – it might seem odd to see anything very positive going on in this market.

In fact there is. Germany’s screen count is falling, slowly and steadily. The last five years have seen 4% of screens go, and this holds out the promise of at least an improvement in profitability. As noted in our recent Cinemagoing North West Europe report: “ The key to this almost certainly lies in getting the balance between the numbers of cinemas and the audience right – that is, in eliminating the over-screening that is such a bugbear in this market. This would allow the best operators to embark on much-needed consolidation strategies and spread improvements in marketing and operating strategies across the industry, and perhaps finally find the answer to the question of why Germans do not go to the cinema.”

Taking even a little bit of excess capacity out of the market can have a marked impact on profits. Cinemaxx, the second-largest circuit, saw its pre-tax profits climb to €17.6 million in 2010, from a loss of €4.4 million only two years before, despite higher industry-wide admissions in the earlier year.

Indeed, CinemaxX is starting to look as though it might be a good investment. At it’s share price of €3.30, almost three times the level of two years ago, the company’s Enterprise Value, including net debt of €73 million, comes out at €160 million, just 4.25 times its EBITDA of €37.5 million, while diluted earnings per share of €1.05 give a historic P/E of 3.15. Following further progress in the first half of 2011, CinemaxX stock seems relatively inexpensive despite the absence of a dividend.

Compare Belgium’s Kinepolis Group: at around €54, the shares trade on a multiple of EBITDA to Enterprise Value of about 6.8 times, though as previously noted in this blog, land and buildings valued at €197 million owned by the company form a significant proportion of its enterprise value of €434 million. Excluding these assets the company’s EV/EBITDA multiple falls to around 3.7 times, although executing the series of transactions (sale and leaseback of the property, return of cash to shareholders) needed to realise this hidden value would not yield such a precise result, nor is it likely to happen under the current management, whose strategy is explicitly based on owning the properties from which it trades.

Kinepolis arguably offers slightly better value, though not the continuing recovery prospects of CinemaxX. Britain’s Cineworld, a pure cinema operating company which owns no property, on an EV/EBITDA multiple of 6.3 times at a share price of £1.90 looks unequivocally more expensive. The dividend yield of over 5% offered by the company may be a factor. But a lack of cross-border traffic in investment in these small cinema exhibitors also seems a candidate for explaining why valuations vary so widely. And of course the problems of the Euro may also be relevant.

Italy and Spain Catching Up in Consolidation Stakes

The multiplex business is eminently scalable: refreshments, staff roles and training, not to mention film product, are all duplicated from site to site. Today’s ongoing migration to digital projection may increase this scalability with the promise of centralising some projection functions. There are substantial benefits to building large circuits with centralised offices and enhanced buying power that can conduct large scale marketing campaigns.

Following on from my last post, Coming Soon: the World’s First 10,000 Screen Circuit?, it’s interesting to look at levels of concentration in the major Continental European markets in 2010.

Top 3 Circuits: % Share of Screens

It is notable that Italy and Spain lag Germany and France in terms of the share of screens operated by the top three circuits in each country. Which neatly contextualises the spate of recent consolidation activity in these territories: Cineworld’s purchase of Cinesur (Cineworld’s Spanish Venture: Buy When There’s Blood In The Streets?); Odeon UCI’s acquisition of UGC’s Spanish cinemas and two sites from Coliseo; its purchases of the UGC and Vis Pathe circuits in Italy and, most recently, 51 screens from Giometti in a deal due to close this month. It is Spain and Italy which have offered the greatest opportunity to buy choice assets which can be combined to form larger, more profitable circuits. By our calculations, it looks as though the top three Italian circuits will control a minimum of 20% of Italian screens by the end of 2011, the top three in Spain a quarter of all screens in Spain – nearly the current level in France and Germany.

Valuation Anomalies: A Tale of Two Small European Countries

The recent sale of the Finnish exhibitor, Finnkino Oy, to the Swedish private equity firm Ratos AB, reminded me of a conversation with a UK exhibitor in the early 1990s. His company had looked at Finnkino, then also for sale, but they’d concluded that if the then current owners couldn’t make any money out of it, they probably couldn’t either.

Today Finnkino is a profitable, well-run company, with significant exhibition interests in the Baltic States alongside its dominant position in the Finnish market. But Finland is still a low attending country as far as cinema is concerned, with the relatively high operating costs typical of Northern Europe.

Ratos is hoping to improve profits by building new cinemas to drive attendance, and also presumably anticipating an economic recovery in the Baltic States. In 2010 Finnkino made EBITDA of €8.5 million from revenues of €88.6 million. Ratos, however, was persuaded to pay €94.3 million for the circuit. At 11 times EBITDA this is a demanding valuation: Ratos would need to get Finnkino’s EBITDA margin up to around 15% of revenue instead of 2010′s 10% just to match the recent Vue deal (see How To Value a Cinema Chain: Part 2). Although this is probably do-able, more progress will depend on getting significantly more Finns into cinemas. Given that attendance levels have been flat since the 1980s, this might prove tricky.

Contrast the situation of another small country exhibitor: Belgium’s Kinepolis, which is quoted on the Brussels bourse. Like Finnkino, Kinepolis dominates its home market and has interests in neighbouring countries, and it is regarded as among the best-run and most innovative exhibitors in Europe. At its current share price of €54, however, stock market investors value the company at an enterprise value of roughly €430 million, less than seven times its 2010 EBITDA of €65 million. This low valuation is all the more remarkable considering Kinepolis, unusually for a cinema circuit, owns its own land and buildings – to the tune of €197 million in its 2010 accounts.

So both valuations seem anomalous, one too high, the other too low, but with private equity’s aversion to hostile takeovers and stock market investors’ less optimistic view of exhibition, such anomalies may well persist.

Coming Soon: the World’s First 10,000 Screen Circuit?

A lesser-known Dodona Research publication is a compilation of circuit screen counts across around 60 territories, laid out as a grid. So circuit A has x screens in territory D, y screens in territory J, and z screens in total. It’s a survivor from the rush into international markets of a decade ago. With exhibitors having spent the last few years tidying up sub-scale foreign investments, nowadays our Cinema Exhibitors Database mostly serves as a prospects list for equipment manufacturers.

But it’s not without interest in its original role of measuring market concentration. For example, the three circuits which dominate the US market – Regal, AMC and Cinemark – are vastly larger than their nearest competitors with more than 17,000 screens between them. Fourth-placed Organizacion Ramirez Cinemas, based in Mexico, has 2,337.

Despite their size, however, they are less dominant within their home market than other exhibitors elsewhere. Not just small markets like Finland or Sweden but even the UK which, measured by box office, is currently the fifth largest theatrical market in the world after the United States, Japan, India (if you believe the figures), and France.

After a round of consolidation, the UK’s top three circuits now account for more than 60% of the country’s screens compared to the 40% of US screens owned by Regal, AMC and Cinemark. Both countries show a long term trend towards greater concentration, as the graph below illustrates.

Top 3 Circuits: % Share of Screens

Today Regal has 6,777 screens in the United States. In the UK it took 15 years for the share of the top 3 circuits to go from 40%, where the US is today, to 60%-plus. If the US follows suit, the odds are that its leading circuit will operate over 10,000 screens. If, as seems possible, digital technology makes running big circuits easier and more profitable, this milestone could come even sooner.

Cineworld’s Spanish Venture: Buy When There’s Blood In The Streets?

On 7th April Cineworld announced it had agreed to acquire 10o% of the share capital of Cinesur Circuito Sánchez-Ramade, S.L. Gross assets of €18.6 million, comprising 11 multiplexes with a total of 136 screens, were to be acquired, though the value of the transaction was not disclosed.

To add a little detail to the company’s brief press release, in fact only a part of the Cinesur circuit is being acquired. Four cinemas: Plaza Eboli in Madrid, the Alkazar in Cordoba, Cervantes in Jaen, and Cinesur Larios in Malaga did not form part of the package. The last two-named have already closed. The sale itself is reported in Spain to be part of a cash-raising exercise designed to rescue the larger Sanchez Ramade group, whose property development subsidiary Noriega has already filed for bankruptcy. The Spanish press is less useful on the question of price, though one report cited a source suggesting the transaction was in the range of €30 to €50 million, rather than the €60 million at which the circuit had been offered in Summer 2010.

This is an interesting figure. EBITDA of the acquired company was €2.3 million in 2009, a figure which is unlikely to have increased in 2010 when Spanish admissions fell around 12%. So either the four cinemas not acquired were making losses at the EBITDA level or Cineworld has paid a very full price – if one believes €30 million suggested in the press.

Concerning the wider logic of the deal, there are two key aspects. The first is the condition of the Spanish market itself: Spanish cinema admissions declined from 435 million a year in 1965 to 93 million by 1991, a pattern familiar from many other European countries. By 2001 the market had recovered to 147 million admissions, again not untypical. The decline since then to just 97 million last year, 2010, has rather fewer parallels. With a piracy problem of long-standing and, now, huge youth unemployment, the big positive about this cinema market is that it probably cannot get much worse.

The second aspect is that, as Cineworld has hinted, Spain looks a suitable candidate for a consolidation strategy. There are many survivors from among the regional circuits that used to dominate the industry and, in the way of things, some are run better than others. Cineworld can buy some of these circuits, close head offices, lose under-performing cinemas and, in some cases, apply improved management. We have every belief that management is capable of executing such a strategy successfully, only assuming the company avoids overpaying for acquisitions.

Cinesur Circuito Sánchez-Ramade, S.L.