The Business Of

Movies | Cineworld | What Do They Do With Their Profits?

Morning All!

Before we jump in, let’s have a quick recap on what we’ve covered the last couple of days.

• Cineworld has 2 main revenue streams - Movie Tickets (53% of revenues) and Food and Drink sales (31%). Advertising makes up the remainder.

• In terms of margins though, we see Movie Ticket sales have a gross margin of 47%. Whilst Food and Drink has much stronger margins at ~80%!

• Putting that all together, Cineworld had pretty strong, consistent EBIT margins of 12-15% from 2012-2019. Before COVID showed up…

But if we look at the chart below. We can see that Cineworld’s margins pre-COVID were fairly decent vs the previous 5 companies we’ve looked at in our newsletters.

So it does beg the question. What went wrong for Cineworld? Why did they file for bankruptcy? And today is the day we’ll dive into these questions! Using our usual methodology of looking at how Cineworld used their profits/cash…

Foolish or Unlucky?

So, the first use of cash we’ll talk about with Cineworld is acquisitions. The company has a history of acquiring other cinema operators. The table below gives us the list…

And the reason for these acquisitions was to reinvest into the business. By acquiring Picture House, Cinema City and Regal, Cineworld added sales and profits to their business. And this is what we saw with LVMH 2 weeks ago. The luxury giant acquiring brands, to acquire sales and profits.

However, there was one problem with the final acquisition in that table above. Well, two problems. And when those two problems collided - it spelled trouble.

So what was the first problem? The first problem was that Cineworld didn’t have the cash to make the Regal acquisition. The company took out a pile of debt in order to acquire the US cinema operator. Now, taking out debt in order to acquire a company isn’t bad in itself. Many companies do this - even one of the world’s richest men used debt to purchase Twitter last year. However, it was the amount of debt that Cineworld took out that was worrying. Because it was a lot of debt… like a lot!

$4.1bn of debt was raised. Which increased Cineworld’s net debt from $378 million at the end of 2017 to a whopping $3.7 billion at the end of 2018. This raised the company’s Net Debt/EBITDA from 1.5x to 4.0x. If you’re feeling a little lost here and want a bit more info about debt and these ratios - this article from Investopedia is brilliant!

So Regal gets acquired. And management say they plan to pay down the high debt amount through their profits (EBIT). And they targeted lowering the Net Debt/EBITDA ratio to 3x by 2019. However, this didn’t reassure the stock market. And investors were worried as soon as the acquisition was made. The stock price fell 16% on news that the merger was being discussed. The amount of Cineworld stock held by short sellers increased rapidly.

What were investors worried about? Well, what if cinema admissions continued to struggle? And profits started to fall? What if interest rates rose? And the debt payments started to rise? The concern for investors was simple - the company may not be able to pay their debts! The chart below shows how short sellers pounced on the CIneworld stock as soon as the Regal acquisition was announced in late 2017…

The reason I’m stressing the pre-COVID period here is because it’s very easy to argue that Cineworld’s struggles were only due to COVID. And without COVID, everything would have been fine. However, as we can see - the huge debt load taken on to acquire Regal left Cineworld already in a precarious position.

Saying all that, the first problem for Cineworld was made a whole lot worse by the second problem. And this problem was bad timing. Less than 2 years after the Regal acquisition, Cineworld’s worst nightmares were surpassed when COVID hit. Suddenly, paying back that debt went from challenging - to pretty much impossible. Because how on Earth can you pay back debt through profits… if your cinemas are all shut!

Tough to sell tickets and popcorn when the doors are closed…

So, was the writing on the wall? Did management know straight away that they would be unable to pay their debts. Well, not exactly. In April 2022, when Cineworld released their 2021 annual report, management issued the following statement…

Cineworld’s management believed that if 2022 admissions could rise back to 85% of the 2019 levels in the US (and 90% in the UK). Then the company’s profits would be enough to pay off their debts. However, as we saw on Tuesday - admissions have been nowhere near 85% of 2019 levels. And 2022 admissions were actually 30-40% below 2019 levels.

With admissions not hitting their (optimistic) expectations, management finally had to throw in the towel in August 2022. Cineworld weren’t going to pay off their debts. And the company filed for Chapter 11 bankruptcy. Probably not quite like how Michael Scott declared it…

In tomorrow’s newsletter we’ll look at what Chapter 11 actually means. And whether Cineworld will even exist as a company soon!

Cineworld Shareholders… Turn Away

So we saw what happened to the short interest when the Regal acquisition happened. But what’s happened to the Cineworld stock price since the acquisition? And since COVID? And the bankruptcy filing? Well, the chart below paints a pretty glum picture…

Cineworld’s stock price was £3.08 in April 2019. It is now 1p. That is a loss of 99%. Meaning if you had invested £10,000 in Cineworld shares in April 2019, that £10,000 would now be about £100. Ouch!

6th Apr 2023

Nigel Jacob CFA