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Cineworld's big American bet

By Chris Bailey | Wednesday 6 December 2017

Disclosure: I own shares in one or more of the stocks mentioned. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

Almost everyone - apart from some cheapskate standouts or those lucky enough to have a next-generation home cinema capability - likes going to the cinema. In the wider scheme of things it is fun, inclusive and compared to many other trips out it does not completely trash the bank account (although the cost of a small plastic bottle of my favourite soda tipple Dr Pepper Zero was ludicrously expensive when I was stupid enough to buy one there). I have never owned Cineworld (CINE) but I have admired its progressive upgrades and solid management of my recent cinema and helped out by some half-decent blockbusters it has built up a solid position here and across various eastern European geographies. Cash generative, paid a dividend, growing market wonder the share tripled between early 2013 and the middle part of this year. The recent share price chart has not been so hot though.

Worries about the economy hitting cinema spend? Not at all...the trading update of a couple of weeks ago talked about some good progress across its various geographies and hopes that various film releases - inevitably including the new Star Wars release which for reasons discussed nearly a year ago I will not be bothering with - will do the business. All broadly very worthy. However some other news hit the tape at a similar time. Cineworld was betting the ranch on a big American acquisition play.

That deal has now been confirmed with the announcement that: 'Cineworld Group plc and Regal Entertainment Group today announce that they have reached agreement on the terms of a recommended proposal for Cineworld to acquire, for cash, the entire issued share capital of Regal...The acquisition price of US$23.00 per Regal share values the entire issued and to be issued share capital of Regal at US$3.6 billion (£2.7 billion), with an implied enterprise value of US$5.8 billion (£4.3 billion)...The Acquisition will create a globally diversified cinema operator across ten countries and allow Cineworld to access the attractive North American cinema market, which has the largest box office market in the world with an industry box office of greater than US$10 billion in each year since 2008 and stable admissions in excess of 1.25 billion in each year over the same period.'

Well bully for it. Lots of big numbers here especially as today's market cap of Cineworld is only £1.5 billion, with an EV of less than £2 billion - you see what I mean about betting the ranch financially and geographically. Of course the announcement talks about the deal being earnings accretive, albeit that this is after the first full year of ownership which is anticipated to be 2019. Pretty much anything is earnings accretive at today's ultra-low interest rates. More interesting to me though are the hoops that Cineworld's balance sheet is having to jump through to pull off a deal which will clearly way more than double the size of the company. Here's how the deal is going to be funded: 'the proceeds of the fully underwritten Rights Issue, which will raise approximately £1.7 billion...approximately US$4.0 billion (£3.0 billion) through committed Debt Facilities...and existing cash on balance sheet'.

At least the rights issue is fully underwritten by the big (and to be fair highly supportive and smart) large shareholder but all of this will push the net debt to ebitda figure to an estimated...four times. That's punchy by anyone's standards. So inevitably anticipation of all of this has weighed on the shares...and quite rightly so. Pacing through the deal metrics it is buying the Regal business for about half the multiple the Cineworld shares were trading at six months ago. Clearly there is some scope for synergies but judging by the numbers produced in today's update, no more than a handful of percent of the acquisition price. Undoubtedly a bigger potential going forward will be to export some of the best know-how from Europe to the US into an American cinematic market which itself is oligopolising as a response to structural shifts like the aforementioned home cinemas and streaming.

Now don't get me wrong I like big US deals sometimes and have written positively about the actions of DS Smith (SMDS) and Greencore (GNC) in recent months and weeks (respectively). The latter though is a good insight into the potential for a big and prolonged share price overhang after a material US deal. Put it all together and I am not lining up to buy a ticket for the latest Cineworld corporate adventure.

What I want to see from it over the rest of the decade is what I am seeing from the two names above currently: cash flow generation to chivvy down debt (and neither of these two names leveraged their balance sheet so much) and only then might I reconsider. Far better today to rock up to your local Cineworld and buy a ticket to watch a film...even if it is Star Wars.

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