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October 26, 2006

Good Quarter For Regal Offset By Share Issuance

Regal Entertainment (RGC) reported better-than-expected third-quarter 2006 earnings. Revenue of $675 million rose 7.5% ahead of the consensus estimate of $650 million. Good performance on expenses allowed the incremental revenue to flow through the income statement as adjusted earnings before interest, tax, debt and amortization rose 14%. EPS came in at 20 cents, ahead of the 18-cent consensus.

These results normally would have pushed the shares higher, but simultaneously with the earnings release, the company announced that one of the private equity firms that is a significant shareholder is going to force a secondary of 7.7 million shares. RGC has about 150 million shares outstanding. According to Lehman Brothers, the firm, Oak Tree Capital Management, has been a regular size seller in the open market about twice per year. While a sizable secondary by an insider is never good news, the offset could be less supply in the year ahead.

Despite the better-than-expected results, due to the secondary, RGC's share price initially slid about 2%. I think it is a positive sign that by late afternoon the shares had fought back and ticked higher on day. Looking at the internals on the quarter it is easy to understand why buyers showed up....

Despite conventional wisdom that movies are in secular decline, RGC's better-than-expected revenue was driven by 5.4% growth in attendance. Ticket prices rose just 2.6% in the quarter. The attendance growth is proof that if the product is good, ticket buyers will show up. The movie-going experience is still unique and a good value relative to many other entertainment options -- in and out of the home.

Also impressive is the fact that RGC experienced increased attendance on a 2.3% decline in the number of theatres it operates and a 5.1% drop in the number of screens. RGC's closely smaller, less profitable locations improve overall corporate financial performance and the supply-demand balance in individual locales.

I have decided to hang onto RGC for another six months. Northlake's original investment was made in the spring with the expectation that summer box office strength would drive the shares to $23-$24, allowing clients to book a 15%-20% gain and bank a couple of 30-cent quarterly dividends. A secondary catalyst was the potential IPO of National Cinemedia (NCM), a rapidly growing theatre advertising firm in which RGC has a 41% stake.

The best the stock has done is reach slightly over $21, but now the company has reported a good quarter and the NCM IPO has been filed. There is a high likelihood that RGC will pass through its share of the NCM proceeds in the form of a special dividend that could be several dollars per share. Additionally, October box office strength has partially insulated the company against tough comparisons this holiday season. (The current fourth-quarter consensus calls for a 1% revenue decline.)

Looking ahead to 2007, first-half comps are not challenging, and next May will be biggest month ever for the movie business, when the third installment of blockbuster franchises Shrek, Spiderman and Pirates of the Caribbean hit theatres.

Awaiting these positive catalysts, investors earn a healthy 6% current yield providing downside support until the secondary gets priced. If all goes according to plan, the $23-24 target is still in play along with the positve impact of the NCM IPO.

Posted by Steve Birenberg at October 26, 2006 09:10 AM in RGC