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How To Value a Cinema Chain: Part 2

On April 1st London’s Financial Times newspaper carried a report that Guy Hands’ private equity firm, Terra Firma, fresh from its EMI misadventure, was looking to sell its Odeon and UCI Cinemas chain for £700 million to £1 billion or, alternatively, refinance it with £600 million of new debt. With the company’s 2009 accounts claiming around £80 million of EBITDA and maybe £100 million of freehold property in the UK, the lower of the two figures looked about right: 7.5x EBITDA for the operating company, the same multiple as in last year’s Vue sale, plus the property.

By the 12th April, however, the FT was reporting that  BC Partners and OMERS Private Equity were in exclusive talks to buy the chain for £1.2 billion, and awaiting approval from their respective investment committees. On the 14th the price was still rising. FT’s Lex column reported that Odeon and UCI’s EBITDA grew 20% in 2010,  enough to support a valuation in the £800 million to £850 million range. Instead the article repeated the £1.2 billion figure and extolled the growth prospects of the business, suggesting Terra Firma might do better to keep it.

By the 23rd reality set in. In a half-page article headlined “Cinemas price seen as fantasy” pundits were tapped for opinions and, predictably, expressed scepticism that Odeon might fetch 12 times its current year expected EBITDA of £100 million. Whatever the outcome, however, the coverage looks to have added value for Terra Firma, creating the perception of a successful and profitable investment in Odeon.

Is Cinema Recession Proof?

After the financial blow-up the question of whether cinema was recession proof quickly became a topical one on the telephone lines in our office. It is tempting to say the answer is yes, and leave it at that. After all, cinema endured the great depression of the thirties and, in normal times, it is impossible to find any evidence of economic cycles in cinema attendance (though the economic cycle does have a big bearing on investment in new sites).

In the last couple of weeks the question, for me at least, raised its head again. The reason for this is that I was finishing a new report, Cinemagoing Southern Europe 2010, wondering whether the forecasts in it were really sustainable in the face of the crisis in Ireland and, more pertinently, the forces marshalling to attack Portugal, Spain and Italy, in what looks likely to be a real life manifestation of the domino theory.

As it happens, the decision was made to let the forecasts stand, mostly on the grounds that this was the last of our European reports this year, and it seemed desirable that it should be written against the same background assumptions as the others. Even so, the forecasts in this particular report are not very optimistic. They look forward to a lengthy period in which exhibitors will be fortunate to do more than grind out flat admissions, and the best way to lift profits is likely to be a continued process of consolidation or, in plain English, buying up other cinemas.

But it may be right to question the conventional thinking on the relationship between the economy and cinema. Most of the time, cinema ignores the economy. The Argentinian default of 2001, for example, left the cinema business virtually untouched (though not exporters of films to Argentina, who found themselves being paid in devalued pesos). On the other hand, Latvia’s austerity measures hit its cinema market hard: 2009 admissions were down over 17%, and a doubled rate of value added tax on tickets took a further chunk out of industry revenues.

In the short run forecasting the cinema business is still all about product, most noticeably demonstrated over the last year by Avatar, but also by a whole raft of animated pictures like Ice Age: Dawn of the Dinosaurs and  Toy Story 3 and, as I write, by the latest episode of another long-running franchise, Harry Potter and the Deathly Hallows: Part 1. While this flow of product continues – and there are numerous instalments of a number of heavy-hitting franchises in the works – the proposition that cinema is recession proof is probably not going to be seriously tested in any but marginal, poorly established markets. But with some Western European consumers about to be hit hard as governments wrestle with the ongoing debt crisis, a few months without a good picture may well produce a scare.

Danish Exhibitors Reject 3D Version of The Last Airbender

According to an account circulated among European exhibitors, after a screening of The Last Airbender 80% of Danish exhibitors independently decided not to show the film in 3D but only in its 2D version. Concerns cited included the fact that the quality of the film’s 3D was very poor, and the long term effects of charging premium prices for non-premium product.

Although the 3D version’s prospects were probably not improved by a release date a week ahead of Toy Story 3, cinema owners declining to participate in the exploitation of the hype around 3D in order to make a quick killing out of a bad conversion is, so far, a unique development – and a new type of row to add to boycotts elsewhere over theatrical windows and payments for 3D glasses.

India Forecasts Downgraded

Recent press surrounding the release of PricewaterhouseCoopers new Indian Entertainment and Media Outlook 2010 put a positive spin on the report numbers, citing the 12.4% compound growth forecast for the filmed entertainment industry which, if fulfilled, will take revenues to 170.5 billion rupees by 2014.

 Compared to a year ago, though, PricewaterhouseCoopers is somewhat less optimistic. A stand-off over terms between producers and exhibitors saw a three month hole punched in the country’s 2009 release schedule, and box office drop 14% to 70 billion rupees from 81.3 billion in 2008. Although this could be argued to be a one-off event with limited implications for future growth, PricewaterhouseCoopers has taken the opportunity to downgrade its previous forecasts.

 In 2009 the company was forecasting total film industry revenues for 2013 of 184.3 billion rupees, a figure now cut to 157 billion. Looking at domestic box office alone, the new forecast of 116 billion rupees in 2013 compares with a year-ago forecast of 132.3 billion.

 With India’s inflation rate running at around 10%, PricewaterhouseCoopers’ new forecasts suggest fairly modest growth in real terms. This seems an adjustment in the right direction. India’s film business has been over-hyped recently. Its exhibition sector is huge and well-established, serving between two and three billion patrons each year and appears in many respects a mature market. Clearly there is scope for modernisation and a gradual growth in revenues from higher ticket prices, but India is not starting from the low base which has been a characteristic of other fast-growing cinema markets.

 You can download the full PricewaterhouseCoopers report using the link below.


How to Value a Cinema Chain

A report in the Financial Times on July 17th suggested OMERS (Ontario Municipal Employees Retirement System) would be a bidder in an auction for the Vue circuit due later this year, alongside the private equity firms Kohlberg Kravis Roberts and Permira. Although OMERS itself is a pension fund, it is the private equity arm of OMERS that is expected to bid. 

So how much is the successful bidder going to have to pay? Cinema circuits have traditionally been valued in terms of a multiple of EBITDA (earnings before tax, depreciation and amortisation), or broadly operating profit with depreciation charges added back. Currently circuits are selling for six or seven times EBITDA.

 Coincidentally, the closest comparable quoted circuit to Vue, Cineworld Cinemas, is trading on an implied valuation of around seven times historic EBITDA. At £1.98 each the company’s 141.7 million shares give a market capitalisation of £280 million; adding £109 million of long term debt, the resulting EV (enterprise value) of £389 million works out at 7.1x its £55 million of EBITDA in 2009.

 The comparable EBITDA figure for Vue is £50.7 million so on this basis Vue is likely to be valued at close to £360 million.

 Further consolidation in the UK cinema market is complicated due to competition concerns, all but ruling out a domestic trade buyer. Equally, it is hard to see why an overseas-based exhibitor would want to invest in the mature UK cinema market. Which leaves a private equity buyer or a flotation.

 The problem for a private equity buyer will be to work out how to make a return on its investment. Vue is already a big player in what is essentially a mature market. Another flotation could still be on the cards.