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Kinepolis Group NV
One of cinemas’ last stands: good enough to survive (and thrive)?
Kinepolis Group NV ($KIN.BR) is a €1.2 billion company that operates cinema complexes in Europe and North America: in total, it currently operates 110 cinemas (51 of which it owns) with 1,124 screens and more than 200,000 seats.
Europe accounts for two thirds of current sales, and North America for the remaining third.
Kinepolis operates along 7 business segments.
Box office: the traditional sale of cinema tickets. Revenues here are highly dependent on a number of external factors, including film content, weather and holiday periods.
In-theatre sales (ITS): all activities related to the sale of beverages and snacks in the cinemas. This business has become more important in recent years, due to innovations in the infrastructure and the products offered.
Business-to-business: with their technologically-advanced, flexible infrastructure, most Kinepolis cinemas are also ideal B2B venues for conferences, premieres and corporate events.
Film distribution: Kinepolis Film Distribution (KFD) focuses on distributing international and domestic movies in Belgium and Luxembourg.
Screen advertising: launched - in Belgium only - with the acquisition of advertising agency Brightfish in 2011.
Digital cinema services: DCS comprises all technical expertise in digital projection and sound, primarily used in-house but also provided to third parties.
Real estate: a separate business unit within the group, tasked with coordinating the management, utilisation and development of the property portfolio. The group owns a large part of its real estate and footfall at these businesses (mainly shops and cafes) is mostly generated by the presence of the Kinepolis cinema.
#1 and #2 still account for more than 80% of revenues.
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History and acquisition spree
Kinepolis was formed in 1997 following the merger of two family-run local cinema groups (owned by the Bert and Claeys families since the 1960s) and was first listed on the Brussels Stock Exchange (now part of Euronext) in 1998. Kinohold, the investment vehicle ultimately economically owned by four members of the Bert family, today controls 46.5% of the shares (Joost Bert, President of the Board of Directors and son of co-founder Albert Bert, personally controls another 2%), with the rest being free float.
With the international expansion beginning in the second half of the 1990s, Kinepolis has become one of Europe’s leading cinema operators, driven by the same instinct to innovate (digitisation, development of 3D cinema) and customer focus that the founders showed in the early days.
Following the liquidation of the Spanish Abaco Group, in 2014 Kinepolis took over its two largest complexes (Abaco Alcobendas in Madrid and Abaco Cinebox in Alicante): given the situation, Kinepolis got a total of 28 screens and around 5.700 seats for just €1.1 million. In the same year Kinepolis also acquired the Wolff Bioscopen Group in the Netherlands, comprising of 9 existing cinemas and two construction projects.
In 2015 it acquired Utopolis, which had a total of 13 complexes in 4 countries (Luxembourg, France, Belgium and the Netherlands – although the Belgian cinemas were quickly sold to French group UGC for antitrust reasons), and Cinema Mégaroyal, a single complex in France.
In 2017 it expanded beyond Europe by buying Canada’s second largest cinema operator, Landmark Cinemas, owner of 44 complexes located all over the country with a ~10% market share. At a total enterprise value of CAD 123 million (€82 million at the time), it implied an EV/sales multiple of 0.8x and EV/EBITDA of less than 7x.
In 2019 it further grew its North American presence with MJR Digital Cinemas, a Michigan-based movie theatre chain, its most expensive acquisition: US$152 million (€139 million), for a 2x EV/sales multiple but just 8.5x EV/EBITDA. Still in 2019 Kinepolis also acquired Arcaplex in the Netherlands and two complexes from El Punt Group in Spain.
The cinemas’ market: running to stand still?
The last two decades show a flurry of mergers in the theatre chains business in an attempt to gain scale and spread fixed costs over a larger seats/screens/visitors base. But with the exception of maybe airlines, I don’t recall a sector that destroyed more value for investors through subsequent restructuring and bankruptcies.
Today, there are very few remaining listed theatre chains: AMC ($AMC), Cinemark ($CNK) and The Marcus Corporation ($MCS) in the US, Cineplex ($CGX.TO) in Canada, CJ CGV ($079160.KS) in South Korea. As far as I know Kinepolis is the only remaining listed European company after Cineworld ($CINE.L) – the world second largest theatre chain after AMC and owner of Regal Cinemas in the US - filed for bankruptcy protection last autumn. The market, especially in Europe, is still very fragment: there are dozens of private operators, small and big.
Here is an abridged list of how many recent operations ended up. In 2017, at the same time that Kinepolis was also expanding in North America, the UK-based Cineworld acquired Regal Entertainment Group of the US for an enterprise value of US$5.8 billion (US$3.6 billion in equity), to create “a globally diversified operator across 10 countries with access to the attractive North American cinema market”. Cineworld was Europe’ second largest chain (behind Odeon & UCI Group, an AMC subsidiary) having bought – among others – Poland’s Cinema City International in 2014 for £500 million.
In December 2019 Cineworld also agreed to acquire Cineplex (Canada’s largest chain) for around US$2 billion. But with the pandemic striking just a couple months later, in June 2020 Cineworld announced that the purchase was off, citing “certain breaches” of the contract. Cineplex obviously sued and in 2021 it was awarded US$850 million in damages.
Similarly, VUE International (which has grown by acquisitions in the Netherlands, the UK, Germany, Poland and Italy and has been owned since 2013 by Alberta Investment Management Corporation and Omers Private Equity, the investment division of Ontario Municipal Employees Retirement System) also required a recapitalisation this year, with a debt-for-equity swap of approximately £500 million (out of a total of over £1 billion) handing a 100% equity ownership of the business to its first-lien lenders.
Strategy and financials
Al least until Covid struck, Kinepolis’ strategy was clear and straightforward: expand the portfolio of theatres, increase the profitability of the acquired assets, pay out 50% of profits and retain the other half to repeat the process.
How do they increase profitability? Usually by taking over companies/assets with a lower EBITDA/customer, applying its scalable products (real estate portfolio management, self-service in-theatre sales, cutting costs...) and so increasing revenues per customer at the same level as the rest of the group.
Historically, this strategy has worked pretty well: return on capital and margins were slightly diluted by the 2017 and 2019 acquisitions (it does take some time to refurbish and reposition the newly-acquired complexes), but they were decent and stable. And the market seemed to approve: the stock price jumped 6% both times they were announced.
As many other businesses, Kinepolis is slowly trying to recover to pre-pandemic levels. In 2022 its theatres accommodated over 29 million visitors generating €500 million in revenues, an +88% increase over 2021. However, compared to 2019 (the group’s best year), revenues were only ~90% and visitors 73% (it had over 40 million in 2019 and over 35 million in 2018) despite having more cinemas today. Net profits were €28 million, a marked improvement from the losses of the previous two years, but still half the profits registered in 2018 and 2019 (€47m and €54m, respectively).
On the other hand, sales and profitability per visitors remain strong, resulting in a faster recovery of turnover vs visitor numbers. The trend is certainly positive, but it represents a mediocre ~4% CAGR for both metrics over the last decade.
Q1 2023 continued along the same lines: visitors (8.1 million) were 36% higher vs Q1 2022, and Box office and In-theatre sales were both up (overall and per visitor), and both better than the first quarter of 2022 and 2019.
Unfortunately, the other side of the expansion strategy (and then the pandemic) is that net debt is much higher than just few years ago. While more or less stable since 2019 at c.€800 million, net debt has doubled since 2017 due to the financing required for the two North American purchases.However, there are no pressing issues with the maturity profile: only €80 million and €100 million are to be repaid in 2024 and 2025, respectively (both amply covered by cash from operations). The first big maturity is in 2026, when the €225 million private placement issued in 2019 is due: this bond is currently trading at around 92 and is fixed rate with step-up provisions based on the group’s leverage ratio (as the ratio exceeded the limit in 2020, the coupon has been increased by 0.5% to 3.25% the following year).
Problem #1: streaming
This is Pulcinella’s secret.
With theatres shuttered in 2020, box office revenues naturally plummeted worldwide; they then jumped 70% in 2021, with superheroes like Spiderman drawing audiences back to the big screen. In 2022 the recovery continued, rising 27% year on year as studios released further instalments of big franchises like Avatar, Top Gun and Jurassic World: after two years during which the operation of cinemas was prevented or significantly hindered for a long time, 2022 heralded the first year of real recovery for the sector.
Nevertheless, the global box office in 2022 was still 39% beneath the market in 2019.
The decline in movie theatre attendance began well before the pandemic as flat-screen technology improved, streaming services gained ground, and as content producers shifted focus from tentpole releases toward similarly produced television series. Those developments also drove continued declines in cable television, with US subscribers falling from 100 million in 2012 to 70 million in 2022. Big hits are now streaming on a television near you.
Other broad problems impacting the industry:
Release windows: the exclusive theatrical window (the period in which a film is exclusively available in cinemas) has been reduced constantly over the past 25 years (and Covid just accelerated this development), as payment-based home entertainment channels have emerged and studios experimented with release strategies and launched their own streaming services.
Customers are more selective: the shortening of the cinema window and the increase in the number of content providers mean that cinemas have been programming more and more films in recent years, while the customer seems to becoming more selective. Selecting the right films for the right target audience and promoting them in a targeted manner will become increasingly important in the future.
Demographic factors: Cinemas also have to adapt to the ageing of the population and continue to appeal to the widest possible audience, while Hollywood’s blockbuster offerings often appeal to a younger audience (which is less and less interested in TV and movies in favour of online content consumption).
The recovery of cinema attendance in 2022 demonstrate the resilience of the industry and the desire of audiences for a shared Big Screen experience. Several major studios are also re-committing to the theatrical window: after all, cinemas have often proven to be indispensable for maximising the revenue of a film (and much of the revenue generated in cinemas flows back to the producer, in contrast with other carriers and platforms). A further recovery is therefore expected for 2023, thanks in part to some major blockbusters.
But cinema’s glory days appear already in the past.
While still early to draw definitive conclusions, the fifth episode of Indiana Jones (“Indiana Jones and the Dial of Destiny”) seems destined to do worse than the 1981 “Raiders of the Lost Ark” without even accounting for inflation.
Problem #2: “this thing ain’t cheap…”
On almost all valuation metrics, Kinepolis is far from being a distressed company or even one in secular decline: it’s trading near 20x EV/EBIT and P/E.
And while EBITDA is an often-used metric, it is completely useless for a business that necessitates constant maintenance capex.So 10x EV/EBITDA is not cheap for a movie theatre.
To put these multiples into further perspective, let’s also look at recent transactions. As previously discussed, Kinepolis itself paid 0.8x EV/Sales and 7x EV/EBITDA for Landmark Cinemas, which had at the time a 11% EBITDA margin, and something more (2x EV/Sales and 8.5x EV/EBITDA) for MJR Digital Cinemas, which had better margins (22%, in line with Kinepolis). Similarly, Cineworld paid 1.8x EV/sales and 10x EV/EBITDA for Regal, and that acquisition wasn’t exactly a success. In its then aborted bid, Cineworld was willing to pay 1.7x EV/sales and 7x EV/EBITDA for Cineplex.
Finally, this is how much Kinepolis paid for its expansion strategy:
There is a big dispersion depending on size, age of cinemas, footprint, … (and again showing that MJR was much more expensive than Landmark). Excluding Abaco (bought out of liquidation, so extremely cheap) and Arcaplex (not sure why they paid so much for a single complex), Kinepolis’s current valuation is much higher than what it paid for the same assets:
It’s true that Kinepolis has better profitability than most peers and markedly improved the assets it bought, but all these multiples are lower (sometimes much lower) than were the company is trading today, and they all refer to rosier times (pre-Covid, pre-mass streaming).
Good company, just not my cup of tea
Can a “premiumisation” strategy work?
Possibly: all headwinds notwithstanding (streaming, demographic trends, …), it seems that Kinepolis is managing to extract more revenues/operating income per visitor by giving its clients a full, high-quality cinema experience, as film lovers seem to be more selective and demanding in what they want.
Kinepolis is certainly one of the best managed cinema chains in the world (see for reference ROIC and margins pre-2020, and its ability to create value through external growth), and the family ownership ensures that they do not bet the farm on an empire building strategy (as many competitors have indeed done). But this is exactly one those instances when this famous quote by Warren Buffet applies:
“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
This does not mean that Kinepolis can’t perform well in the medium term: expectations are that it will surpass the 2019 records either this year or next (if not in terms of visitors – unlikely in 2023 - at least in revenues), although this depends very much on the success of new movie releases this summer. Average consensus has come down a bit, but some analysts are forecasting an even better second half of the year as cinema attendance is typically not affected by a weaker economic climate (but rather by the quality of content).
There is also always the acquisition lever (“buy and improve”) that can be used, which especially valuable in the European market. To be honest, I’m not sure why the decided to expand far away from their local base: I personally wouldn’t be surprised to see a spin-off or outright sale of the North American activities one day to focus more energies and money on consolidation in the European market.
On the less positive side, there are two main problems:
the stock is not cheap: the current price already assumes a lot of improvements / high expectations for the next few years.
Debt, which killed many competitors, is not (yet) a worry but remains high at 5.5x net debt/EBITDA, and much higher compared to FCF if you consider required maintenance capex.
So, a much better company than one might think at first (not a clown show like AMC…), and it seems that in terms of “clients” Covid (working from home) as so far had a more meaningful impact on offices than streaming had on cinemas.
It just doesn’t fit my criteria, both for long-term fundamentals and current valuation, for an investment.
In its quarterly updates and presentation, the company quotes a much lower figure (€425 million) as they exclude lease liabilities. I don’t have the exact details for the leased properties, but it’s unlikely that the company can simply hand the keys to lenders and walk away from these properties: operating leases for buildings typically include massive payments for early termination.
Among capital expenses for Kinepolis for maintenance and internal expansion projects there are the further roll-outs of premium cinema experiences such as the “VIP/Premiere Seats” in the US and Canada, energy saving investments, new laser projectors, and ICT developments.