Within the context of the cautious view Fitch Ratings has maintained on the longer-term prospects for the movie exhibition industry over the past several years, Fitch believes the operating outlook for U.S. movie exhibitors remains relatively stable. The solid film slate (including several sequels to successful series, such as ‘Harry Potter,’ ‘Transformers,’ ‘Terminator,’ ‘Angels & Demons,’ ‘Ice Age,’ ‘X-Men’ and ‘Star Trek’) should keep attendance from slipping dramatically and exhibitors may continue to attempt to drive modest increases in average ticket prices to partially offset any attendance weakness. Fitch expects movie theaters to continue to demonstrate their hit-driven characteristics (i.e. dependence on a strong supply of films from the studios) and be relatively resilient on the top-line compared with other media sub-sectors in the face of cyclical economic weakness. However, given the limited control over their core revenue stream, relatively inflexible cost structures, high debt levels, constrained credit market conditions and potential covenant issues, Fitch is cautious regarding the credit outlook for major movie exhibitors in 2009.
Attendance, Price, Film Financing & SAG Strike
Industry box office revenues for 2008 of $9.6 billion (down 0.5% from 2007) were driven by declines in attendance (down 4.3% from 2007) partially offset by average ticket price increases (up 3.9% from 2007). Over the past decade attendance has been volatile with a high of 1.6 billion in 2002 and a low of 1.3 billion in 2008. Fitch notes that 2008 attendance levels have reverted back to 1996 levels. While 2002 benefited from an unusually high number of blockbuster releases, attendance has still deteriorated significantly since 2003 (down 12%). Fitch is concerned that the quality of film product has not had a more positive effect on attendance, given that many highly anticipated films have been released in recent years.
Fitch also remains cautious regarding movie exhibitors’ capacity to maintain their pricing power when film product may be less robust during an economic downturn. Fitch notes, in two of the last three recent economic downturns (early 1980s and 2000/2001), exhibitors increased average ticket prices and attendance grew. In the early 1990s average ticket prices fell cumulatively 2.1% while attendance increased 4.7% cumulatively over the same period.
Fitch notes the decline in attendance and volatility in commodity prices has had a negative impact on high margin concession revenues in recent periods. Exhibitors have mitigated these factors, to an extent, with concession price increases. However, Fitch is cautious that consolidated margins could be vulnerable to reduced per-guest concession spending due to cyclical factors or a re-acceleration of commodity prices. Concessions represent approximately 25% of over-all revenue and can carry gross margins of more than 80%.
The recent closing of several studios and pull-back in film financing is expected to reduce the inventory of films available to exhibitors. However, Fitch expects much of the reduction in film quantity will be born by the ‘art-house’ category. Fitch does not believe that any changes in the characteristics (number and quality) of mid-to-large budget films (from which exhibitors derive a meaningful portion of their revenue) will be sufficient to generate material credit concerns for the larger exhibitors.
Also, as previously stated, Fitch believes there would be limited impact from a SAG strike in 2009, as the majority of 2009 releases are believed to be in the can.
Financial Policies, Liquidity, Recovery and Covenants
Absent a few unexpectedly large hits, operating liquidity for Regal Entertainment Group (Regal, rated ‘B+’; Stable Outlook by Fitch) and AMC Entertainment Holdings Inc. (AMC, rated ‘B’; Stable Outlook) is expected to remain weak; however, revenue is expected to be sufficient to cover cash costs, capital expenditures, scheduled debt service and dividends. Excess cashflow available for debt retirement is expected to be limited. Fitch expects companies to maintain their historically shareholder-friendly financial policies over the longer term, but given the current credit environment this risk has diminished somewhat (on Jan. 21, 2008 Regal reduced its dividend by 40%).
Liquidity for movie exhibitors can usually be supported by working-capital days which are typically negative. Theater operators typically carry limited inventory and sales are generally settled immediately, making receivables very short while payables are extended on traditional business practice terms. In general, liquidity (excluding covenants described below) is not expected to be a major concern for exhibitors in 2009.
Due to the limited tangible asset value, recovery prospects for unsecured bondholders of movie exhibitors can be limited in some cases. Several larger companies have secured facilities that encumber a significant portion of distressed enterprise value, meaning that under financial strain, little residual value is left for unsecured bondholders and other subordinated claims. For Fitch’s recovery analysis, leases are a key consideration for movie exhibitors. Fitch estimates that leases would be rejected for 30% of the portfolio (a lower percentage than for other media companies and for the corporate sector more broadly, incorporating the importance of the leased space to the core business prospects as a going concern) to reflect the closure of underperforming theaters.
Key covenants for major exhibitors (Regal, AMC, and Cinemark) include limitations on debt/leverage covenants, sale of assets/use of proceeds covenants and dividend restrictions. These covenants provide some protection for bondholders from financial policy revisions and financial distress. On Jan. 21, 2008 Regal announced it had amended its bank credit agreement financial covenants. While the amendment postponed a 0.25 times (x) stepdown in both Regal’s leverage (3.75x to 3.5x) and adjusted leverage (5.75x to 5.5x) ratios until 2011, Fitch calculates that there is still limited flexibility around both ratios, leading to a heightened risk of a covenant breach.
Digital Opportunities and Ancillary Revenues
Fitch notes that the industry, through its Digital Cinema Implementation Partners, LLC (DCIP) stakes, is making strides to take advantage of digital opportunities. Digitization is believed to enhance the theatrical experience with high-quality image and 3D optionality as well as provide greater programming flexibility in the form of sports, educational, religious and music concert programming. Digital cinema may help minimize defections of some moviegoers in the long term.
Over the past few years, theater exhibitors, most notably through their equity stake in National CineMedia (NCM), have taken advantage of the shift away from traditional advertising media by selling increased amounts of ad space prior to a film’s start. Fitch expects modest secular growth off of a very low base as this nascent advertising medium continues to gain traction (Jack Myers Media Forecast projects 8% growth in 2009 and 2010). Regal, AMC and Cinemark (58% owners of NCM) are expected to benefit from this growth predominately through the dividends paid by NCM.
Longer-Term Outlook
Fitch understands that movie-going remains one of the most popular and affordable forms of entertainment compared to most sporting events, live shows, amusement parks, casinos and other out-of-home alternatives. However, longer term, Fitch believes revenues and profitability of movie theatres could be increasingly challenged by factors that are largely out of managements’ control, such as quality and quantity of movies from the studios and increasing indirect competition from other distribution channels such as DVD (including collapsing distribution windows), video on demand (VOD) and the Internet. These challenges cause concern for Fitch, as many operators maintain high debt levels combined with fairly high levels of capital expenditures to maintain property and equipment, and reposition their theater portfolios. Also, the significant degree of operating leverage means that cashflow can be meaningfully affected by moderate top-line declines. These factors and financial policy decisions will remain the main drivers of credit quality over the longer term.
For further information, please see Fitch’s Oct. 14, 2008 AMC Entertainment Credit Analysis report or Fitch’s April 30, 2008 Regal Entertainment Group Credit Analysis report, available on the Fitch Ratings web site at www.fitchratings.com.
Fitch’s rating definitions and the terms of use of such ratings are available on the agency’s public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch’s code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the ‘Code of Conduct’ section of this site.
