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July 13, 2006

Taking A Look At Regal's Ownership of National Cinemedia

Regal Entertainment (RGC) was one of the only green stocks on my monitor yesterday and has held up extremely well against the losuy market envrionment over the past few months. Yesterday,the stock benefited from an upgrade by Bear Stearns, even if the upgrade was only from sell to neutral. Previously, a firming box office and a recommendation from Lehman Brothers boosted the shares.

Interestingly, the rationale behind the Bear Stearns upgrade was not due to recent box office strength. Rather, the analyst believes that a liquidity event for RGC's joint venture company, National Cinemedia (NCM), could be in the near future. NCM is a privately held joint venture between RGC, Cinemark, and AMC Theatres. The company provides in theatre advertising on 11,000 screens controlled by its owners. Revenue is derived from the sale of the advertising you see before the trailers begin along with ads on flat screen monitors in theatre lobbies, on lobby signage, and on concession packaging. Most of the revenue is generated by the presentation shown on screen before the trailers that includes local and national advertising. Bear Stearns estimates that NCM will produce about $250 million in revenue and $150 million in EBITDA in 2006.

Investors in RGC have been excited about NCM for sometime. The company is growing rapidly and comparables like Lamar Advertising trade at hefty EBITDA multiples. Recently, NCM announced that it brought aboard a seasoned theatre industry veteran as CEO in conjunction with hiring JP Morgan to come up with a capital plan to raise the billions necessary to upgrade the nation's movie theatres to digital cinema projectors. Studios spend hundreds of million annually to create and ship prints of films to theatres. Digital cinema would eliminate this expense and improve picture quality and the consumer experience. The studios and theatres have been hung up over how to pay for the transition. NCM appears to be angling to raise capital to fund it and charge a virtual print fee to the studios to recoup the investment and earn a return.

I have no opinion on whether it makes sense for NCM to be the financing vehicle for the digital transition. However, when I first saw the press releases about it a few weeks ago, my immediate thought was that this would be the event that triggered an IPO of NCM. And for RGC that is good news.

RGC owns 49.9% of NCM. Based on a 14.5 EBITDA multiple for the IPO, Bear Stearns calculates that RGC would receive $600 million in proceeds. That would be enough to pay RGC shareholders a special dividend of $4 per share or repurchase 17% of the outstanding shares at a 10% premium to the current stock price. RGC has a history of paying significant special dividends.

Additionally, isolating the value of NCM from RGC's income statement would reveal that RGC shares are trading closer to 7 times EBITDA from the exhibition business. I think the stock probably reflects some of the NCM value already but this would still be an incremental positive for RGC shares.

RGC shares have performed relatively well as the market has pulled back.....

Despite a late April purchase, most clients have a total return of several percent on the position. As mentioned previously, the stock has benefited from better box office numbers and its addition to Lehman's 10 Uncommon values list. An NCM IPO later this year provides another catalyst. And if I am right that summer box office strength takes a little of the home theatre/download/short DVD window/alternative entertainment pressure off theatre industry valuations, then investors might actually look ahead to next May which will be probably the biggest month in box office history as it will feature the openings of Spiderman 3, Shrek 3, and Pirates 3. Shrek and Spiderman are presently the # 3 and #6 grossing movies of all time. Pirates 1 is #21 and Pirates 2 looks like it is headed into the top 10.

Put it all together and RGC remains a good long. It should have good earnings the next couple of quarters, pays a current yield of over 6%, has an event driven catalyst in the NCM IPO, and could get a valuation lift as the gloom over the box office moves toward a more realistic, less bearish view.

Posted by Steve Birenberg at July 13, 2006 10:45 AM in RGC