Movie Theaters: The Case for M&A

For years, the major Hollywood studios owned the movie theaters as well. This changed after an anti-trust case was brought which resulted in the Paramount decree which required divestiture in order to limit the power of the studios to pursue strategies such as block booking or to keep rival or independent movies out of the theaters. A few month ago, the Paramount decree was repealed on the basis that the proliferation of streaming platforms and multiplexes has eliminated the need for the protection provided by the decree, and this has opened to door to vertical integration by the major Hollywood studios. The current difficulties presented by COVID-19, including forced theater closures and delayed releases have hammered movie theater company stocks. This has created a perfect storm for large scale M&A in the movie theaters industry with motivated buyers finding distressed and motivated sellers.

Pros and Cons

           There are many pros and cons to this recommended strategy for the studios, theaters and the consumers. From a studio perspective like Disney, if it does not acquire a Movie theater company, it runs the risk of being unable to place its movies in theaters owned by competitor studios or being forced to do so on unfavorable terms. Owning a theater provides them negotiating leverage with other studio's theater while also allowing them to keep 100% of the revenue from their own films, rather the 50% they now keep after splitting revenue with the theater company. Owning the theaters also allow for added retail, ticket sales, themed concessions offerings (toys/meals) and experiential opportunities reminiscent of premieres that would be in line with CEO Bob Chapek’s hospitality experience. In essence, it would allow for a mini Disney theme park in every city in America. Disney could also use the theaters in a synergistic way with its other media assets like ABC/ESPN to allow for live viewing parties. There would likely be significant cost savings in the form of eliminating redundant positions. Disney or other studios owning their own theaters would help ensure the survival of the current business model in the streaming era by ensuring a supply of content. While most believe that the theaters will never fully go away despite the success of the recent Disney plus Mulan release, the theaters have been under pressure to shorten the theatrical release window as evidenced by the release of the Irishman on Netflix and the recent deal between AMC and Universal.

           There are definitely some cons that may arise as a result of these deals. For film investors, actors, producers and the IRS, these acquisitions may actually by unpopular. Hollywood is renowned for its “creative” accounting practices which limit the payouts to those holding residuals and participations. By eliminating the third-party theater companies, it will be even more difficult to know for sure which movies made what at the box offices. Also, as mentioned previously, owning the theaters will provide leverage in placing films in competitor theaters; however, this can be a double-edged sword as it may become more difficult for a theater owned by Disney to get movies from a competitor studio if the competitor views it as a conflict of interest leading to complex negotiation reminiscent of placing tv channels on cable system broadcasters owned by rival firms. Additionally, the consumer may be forced to pay higher ticket prices at the box office while perhaps getting a better experience in the process. (Maybe they’ll accept Disney Dollars).

Deal Structure

           The movie studios like Disney face the choice of moving quickly to acquire market share or risk being left out or being forced to play catch up. There are a few strategies which could be pursued in order to gain a foothold in the exhibition space. One is to purchase an established movie theater company. An alternative to acquiring a movie theater company would be to buy a minority stake in multiple exhibitors to ensure access to their screens; however, if most large chains are acquired this may not be feasible. Third they could buy portions of several different theaters, conduct bolt-on acquisitions of smaller regional theater chains and rebrand them into its own Disney brand. Finally, they could avoid M&A altogether and pursue new builds; however, this seems unlikely given Disney’s recent M&A spree and time and knowledge it would take to pursue this strategy. 

I believe it is likely Disney will acquire a large company like Regal/Cineworld and perhaps portions of other companies like AMC, bolt on smaller players and eventually build new theaters, perhaps in and around existing Disney properties. I believe the Regal/Cineworld would be the ideal company for Disney to acquire for many reasons. Regal has a large presence in Orange County/Los Angeles County where Disney/Disneyland is based and it pursues a family friendly strategy which makes it a perfect cultural fit. Additionally, Cineworld is the second largest movie theater company in world and would have the size and global reach in the US and UK demanded by Disney. Another potential company which Disney may acquire some or all of is AMC. AMC is the largest movie theater company in the world, cobbled together via a spate of acquisitions but that is heavily influenced by Chinese ownership (Wanda). AMC theaters are more often found in urban centers with less of a safe/family friendly feel and may not go together as well with Disney’s brand. Given Disney’s recent ventures into China, perhaps they could see some value in partnering with Wanda in order to gain a greater foothold into China, either via an acquisition of some of AMC or Wanda’s Chinese affiliate Wanda Cinema Line. Given current tensions between the US and China and restrictions on the entrance into China of foreign films, it may not make sense to acquire a huge number of theaters in China, but certainly a few would make sense, especially if it can be done without relinquishing equity to Wanda or its affiliates.

For movie theater companies, waiting until after COVID restrictions are lifted would be the preferred path as it would lead to higher valuations and selling price, except it is a luxury many may not have as they face impending bankruptcy or debt restructuring. For instance, Cineworld (Regal) has announced that it necessary for it to restructure its ￡6.2 billion debt load (including leases) especially now that it is closing all of its locations in order to reduce expenses. Its share price has plummeted a point where its total asset value (break-up value) is ￡3 billion greater than its enterprise value. One potential solution for Cineworld would be to sell non-core assets (perhaps Regal) to an acquirer while restructuring its debt via a refinance and potential debt for equity swap while waiting out the reopening. Realistically, it may be difficult for them to arrange financing on preferable terms with no end to COVID in sight as it could be viewed as throwing good money after bad unless it is part of a lend to own strategy on the part of an acquirer.

 Similarly, AMC recently announced that it was issuing additional equity of else risk facing a potential bankruptcy within 6 months. AMC has been the subject of rampant takeover speculation, with Amazon being the rumored acquirer, although those have died down recently. If allowed to go bankrupt it could be easier to acquire some, rather than all of the company, and avoid the acquirer needing to shutter poorly performing locations as part of the post-merger integration. Absent a government bailout, it seems that these theaters will be forced to do something or else enter bankruptcy. One potential way the theaters could sell now but protect their shareholders who would most likely be selling at a steep discount, would be to put in place an earnout on any transaction such that if the economy vastly improves as a result of a vaccine, they would be able to share in some of the upside while avoiding the downside of the bankruptcy proceedings. I believe the strategy I have outlined above would be ideal for a studio such as Disney, so long as it is careful to avoid antitrust scrutiny with its acquisition of parts of two large players, as it allows them to scale quickly

After divesting assets and restructuring debt, a movie theater company in strong financial position hoping to ride out the storm or stay independent indefinitely could buy a stake in several studios to help ensure access to their pipeline of content; however, this strategy may be cost-prohibitive and could be viewed as a conflict of interest by the studios. Ultimately it appears merely a matter of time before the studios own most of the movie theaters given the leverage they have in controlling the movie release schedule and the increasing distribution channels available to them. While it is true some studios like Disney are facing some budgetary issues as a result of COVID related closure, overall, I believe these deals represent a flight to quality for current investors in the theater companies while also adding value for existing and future studio shareholders. These conglomerate studios can easily afford such deals given that their massive size and diversified product offering have left them relatively insulated.

Movie Theater Companies

When considering acquiring Movie theaters there are some key consideration worth noting. One major issue is whether the theater is leasing its land or if it owns the land that it is built upon. This is important not only from a valuation perspective of determining equity value and choosing comparable companies for multiple creation (for reasons I explain here) but also from a business perspective. Movie theaters are anchor tenants. Landlords such as malls provide them rent concession in exchange for signing long-term leases because it helps convince other, smaller businesses like restaurants, bars and retail establishments to sign leases next door. There is a synergistic relationship whereby movie theaters bring in customers that then become patrons of the surrounding companies and vice versa. Often movie theaters take stakes in or form alliances with smaller businesses around them, so that often wherever the movie theater is found, the allied firm has a franchise as well. Given today’s struggling retail and hospitality environment there is likely smaller leases locations available near theaters where Disney could put in franchises of companies with which Disney has pre-existing relationships or else they may choose to take a stake in firms with which Regal or its landlords already have alliances, either via franchise or at the corporate level. Holding stakes in allied firms like stores and restaurants could have several advantages for Disney:

·        Lead to synergies in its parks, hotels, etc.

·        Retail (Disney store or otherwise)

·        Ticket booking and Sales (travel agency)

·        Helps ensure control over surrounding businesses creating theme park type environment

·        Provides negotiating power with landlords

Any potential cannibalization of concession sales by surrounding restaurants is more than made up for by the increased ticket sales. These relationships would also be helpful in any new builds that occur on properties owned by Disney/Regal. This suggested strategy of in theater or small format stores is line with Disney's decision to shutter 20% of its domestic Disney stores in order to further pursue its e-commerce and store within a store Target alliance for reasons similar to those which I discuss here.

While Regal has traditionally avoided upscale dining option and alcohol sales in its location whereas alcohol is more prevalent at AMC, there has been a trend toward these offering in the industry, in smaller chains like Arclight and Alamo Drafthouse, and Regal has recently begun offering these services in a few locations, albeit in a much more clandestine fashion than other companies. Upscale dining in theaters can lead to increased labor costs, a less enjoyable movie experience for other guests due to distraction, increased equipment costs, need for greater storage space and food prep areas and more difficult inventory management due to competing concerns of spoilage if the menu has too many items that require unique ingredients which must be balanced with not being able to offer all items on the menu. While alcohol sales can be successful in the right markets, Regal has traditional preferred to maintain the family friendly experience and perhaps utilizing a different brand name is better suited for this type of experience. Liquor laws as they apply to movie theaters can be very challenging and can cause underage guests to be turned away and encourage some customers (families, critics, movie buffs) to look elsewhere for a more enjoyable experience. Additionally, serving alcohol inside the theaters requires bouncers, bartenders, additional janitors, can lead to property damage, obnoxious behavior that makes the experience less enjoyable for others and increased legal costs. Leaving these offerings outside the theater can be mutually beneficial and should be considered prior to any acquisition to ensure the appropriate cultural fit.