Now the general who wins a battle makes many calculations in his temple ere the battle is fought. The general who loses a battle makes but few calculations beforehand.
– Sun Tzu, The Art of War, I-26
The proposed merger between US cinema advertising majors National CineMedia (NCM) and Screenvision has been called off. NCM announced in a press release that it has agreed with Screenvision’s owner SV Holdco to terminate the merger agreement signed on 5 May 2014. The announcement comes four months after the US Department of Justice (DoJ) filed a suit with the aim of blocking the proposed USD $375 million merger.
The announcement must come as a major defeat for NCM, its management and its shareholders. The company seems to bury the lede by sub-heading the press release “National CineMedia Reaffirms 2015 Financial Outlook”, going on to trumpet the excellence of its advertising platforms along with a positive forecast for the box office in 2015.
While the trial initiated by the DoJ was scheduled for mid-April, NCM’s merger financing commitment was only set up to last until 1 April. NCM was said to be working with their banking group to extend those commitments in order to accommodate the litigation process. So while NCM may have been intent on taking the fight to trial, it may be that their bankers and financiers got cold feet, thus forcing today’s about face.
Despite calling off the merger, the North American cinema advertising market will not return to the status quo. Certainly no new merger attempt will take place between NCM and Screenvision in their current configurations. Let’s take a quick look at some of the winners and losers coming out of this thwarted merger.
While NCM continued to trumpet the benefits of the NCM-Screenvision merger, the delay caused by the DoJ suit and the cost and management bandwidth that this drawn out battle consumed took its toll behind the scenes. NCM acknowledged as much in its press release:
NCM and Screenvision together determined that the ongoing cost and distraction of the suit to their employees, advertisers and exhibitor partners could no longer be justified and that both companies would be better served pursuing their independent businesses as standalone companies.
It is worth remembering why the DoJ sought to block the merger of a combined entity that would service 88% of all movie theatres in the United States. As the DoJ Antitrust Division’s filed a lawsuit in the United States District Court for the Southern District of New York last November it issued a press release stating:
“The proposed combination of NCM and Screenvision is a bad deal for movie theaters, advertisers and consumers. This merger to monopoly is exactly the type of transaction the antitrust laws were designed to prohibit,” said Assistant Attorney General Bill Baer of the Justice Department’s Antitrust Division. “If this deal is allowed to proceed, the benefits of competition will be lost, depriving theaters and advertisers of options for cinema advertising network services and risking higher prices to movie goers.”
NCM did a very good job of selling the benefits of the proposed merger to both Wall Street (investors) and Madison Avenue (advertisers), but in doing so neglected K Street (Washington DC lobbyists and bureaucrats) and Main Street (in this case, smaller cinemas), who required extra convincing and assurances which NCM never offered adequately enough.
As we wrote at the time (“NCM’s Acquisition of Screenvision Is Hard To Fathom“) in our analysis of the proposed merger, “people in the [cinema] industry should be demanding that NCM Inc. makes a stronger case as to why this deal should be allowed to go through. As it has currently been proposed, it doesn’t appear to pass the public or industry interest test.” Although there are still many merits to consolidating the cinema advertising market in North America, by not presenting this aspect of their case for a merger, NCM’s strategy was flawed and thus doomed to fail once the DoJ filed it suit.
We will now look at each of the key players as the dust settles and they march or stumble away from the battle field.
National CineMedia, Inc.
For the parent company that owns 45.8% of National Cinemadia LLC calling off the merger is a costly loss which no doubt feels momentarily humiliating. Speaking shortly after the DoJ suit in November, Kurt Hall stated that “We feel very confident that our arguments continue to be strong and clearly some of the claims that the DOJ has made can be proven incorrect or misguided.”
While every CEO needs to project a positive outlook in the face of setbacks, this position underestimated the scale of the fight and could be seen as smacking of hubris and arrogance. Contrast Hall’s pronouncement with that of Screenvision shareholder Carmike Cinemas’ CEO David Passman, who at the same time said that “[w]e hope that Screenvision and NCM will be able to demonstrate the benefits of the transaction to the DOJ. ”
Because of the way the proposed deal was structured there was a costly “kill fee” built in, which NCM (“the Company”) was lucky in being able to claw back a small proportion of, as outlined in the press release:
The termination of the Merger Agreement is effective upon the Company’s payment of a $26.84 million termination payment, which the Company has agreed to make within the next 10 business days. This payment is $2 million lower than the reverse termination fee contemplated by the Merger Agreement. NCM LLC has agreed to indemnify the Company for the termination payment as well as other costs incurred in connection with the transaction. The Company and the founding member theatre circuits each will bear a pro rata portion of this fee based on their aggregate ownership percentages in NCM LLC. The total after tax cash cost for NCM, Inc. related to the proposed merger with Screenvision including the termination fee and all legal and other expenses is projected to be approximately $11 million.
This means that NCM Inc. and its shareholders will each take a hit based on its percentage ownership in NCM LLC, with NCM Inc. having to pay almost half. This loss is large but not substantial. Nobody will lose their job, at least not immediately, over the collapse of this deal. However, the failed deal had already proved a drag on previous quarters, as acknowledged in the most recent earnings call (transcript by Seeking Alpha):
Q4 may have also been negatively impacted by an increase in open Sales Account Director positions due to a delay in hiring to provide opportunities for Screenvision’s local salespeople had the merger closed. While we are beginning to fill some key positions, we are hiring slowly and in some cases, asking existing sales personnel to cover more theaters.
While NCM can look forward to a strong box office in 2015, which should soften the blow somewhat, many clients may have booked with the anticipation of a merger. As Kurl Hall acknowledged in the most recent earnings conference call, “It should be noted that while none of our upfront commitments are contingent on the Screenvision merger, consistent with the structure of TV upfront commitments, there are options to cancel a portion of these commitments.” Though historically cancellations have been low, that’s not to say that there won’t be any.
Questions can and will be raised internally and by outside shareholders about the tactics if not the aim of the merger.
Investment banks and lawyers make plenty of money steering mergers and acquisitions through. For this deal it was particularly busy
at the feeding trough around the conference table: J.P Morgan acted as as financial advisor to NCM Inc., while Sherman & Howard LLC and Dechert LLP acted as legal counsel. Meanwhile Moorgate Partners and GreenbergTraurig, LLP advised NCM’s independent directors. Barclays was the exclusive financial advisor to Screenvision, while its legal counsel was Latham & Watkins LLP.
Both NCM and Screenvision would appear to have been given poor guidance by their financial and legal advisors right from the start. Because in this game there is only one metric of success; the merger did not go through.
Cinema Advertising Council (CAC)
Although the CAC would have been reduced to little more than a fig-leaf of an interest organisation in the event of a merger, it will not be strengthened by the aborted merger of NCM and Screenvision. With NCM and Screenvision returning to be all-out competitors, it is likely that the CAC will once again be bogged down by the type of paralysis that insiders complained of prior to the merger talks.
The CAC will have to re-invent itself to find a reason and purpose, other than just “to address the unique consumer research needs of the cinema media industry.” After all, NCM does not sell itself on the strength of the research that the CAC does, but the research that NCM does in-house. This will only come about if NCM and Screenvision can agree on what they want for CAC and at the moment they both may be too sore to care much about CAC.
The exhibitor with the largest stake in Screenvision was counting on a sale and the windfall this would bring. It is highly likely that it would have promised a most favoured nation (MFN) or sweet-heart deal on advertising terms from the merged NCM-Screenvision entity. Now it is stuck with Screenvision both as a cinema advertising contractor and as a stake-holder.
One could even speculate the discussions which have supposedly been going on about Carmike selling itself (though the exhibitor itself is refusing to comment on such market talk) could have been initiated by the exhibitor having an inkling that the merger would not go through and that it is looking for a Plan B.
The trade body of cinema owners was the dog that did not bark. As a lobby group NATO’s main purpose is to defend the interests of all exhibitors against outside parties, be they government looking to regulate aspects of cinema going or distributors seeking to shrink or eliminate tiered release windows.
However, when it comes to internal matters NATO is effectively split over whether to defend the interests of the majority of its (smaller) members, or that of the larger members who represent the majority of seats, screens and cinemas as well as contribute more to NATO’s annual budget. By remaining silent or staying out of the debate about the merits of the merger NATO could be perceived as tacitly supporting the merger.
While NATO is in an unenviable and nearly impossible position of balancing all of its members’ interests, its lack of position on the issue may have ruffled the feathers of smaller exhibitors that were not supportive of the proposed NCM-Screenvision merger, but who lacked the channels to voice such opposition collectively. In this regard NATO had to stay silent and it is also why it neither a winner or a loser.
Department of Justice
The clearest winner of the collapsed merger is the US federal government’s Department of Justice. While NCM was not an adversary on the scale of cable giant Comcast, the DoJ has proven that it is no paper tiger and is prepared to take on and win battles where it feels the public or industry interest is not being served.
This is particularly important to remember since many expected the NCM-Screenvision deal to be rubber stamped. Even when the DoJ filed its suit, NCM’s CEO dismissed it as “incorrect” and “misguided.” The lesson (or reminder) here is that you take on the anti-trust authorities at your own peril.
Screenvision is not just a winner because it walks away from the deal almost USD $27 million richer, thanks to the termination fee payout. It is important to remember that this deal was pushed for by Screenvision’s parent company SV Holdco and particularly its majority shareholder Shamrock Capital Growth Fund II (who would rightly also belong in the ‘Losers’ section, had the deal not valued their holding at twice what they originally invested).
Screenvision itself only agreed to be swallowed by NCM with gritted teeth amongst many of the staff. The merger would inevitably have created overlaps and duplications, and though we are not privy to the post-merger plans, it is to be expected that many or even most of the redundancies and cuts would come from Screenvision’s side.
This is not to say that it will be smooth sailing from Screenvision henceforth. Now that they are not merging, NCM will come after Screenvision and its advertisers and exhibitor clients with everything they have. NCM will sell itself to clients (advertisers, agencies and brands) on its reach, its desirable demographic and its technological innovation. But at some point it will be a matter of price and one of the reasons that NCM pushed for the merger (according to the DoJ) was to allegedly get rid of being undercut on price by Screenvision.
Shamrock is likely to look for another exit as soon as possible. It is too soon to take stock of who might be an alternative buyer. Most likely such a sale will be held off until the next round of musical chairs in North American exhibitor ownership (will Cinepolis buy Carmike, will CJ GVC buy Cinermark, will the Chinese buy the Canadians?), given the interdependencies of exhibitor-advertiser relationships.
Interestingly Screenvision has throughout the merger process allegedly hedged its bets in terms of pursuing certain strategic options that only make sense as a stand-alone entity rather than a merged half of a bigger NCM, at least according to industry insiders that we’ve spoken to. This is not to say that Screenvision did not believe in the merger, but perhaps they were less convinced about its inevitability.
Given all this, Screenvision will still have to up its game significantly in the near future. It is not just that it is smaller than NCM but that with the exception of a few notable strategic moves, it is perceived in some quarters as the less innovative of the two. Screenvision will have to double down on Avis’ old motto about “We try harder”.
Calling off the merger of NCM and Screenvision will have little impact for the four largest US cinema chains who are stake-holders in the two entities. It is the smaller chains that have the most to gain because they can continue to play one off against the other. The end of VPFs and the phasing out of stand-alone advertising projectors also means that cinemas will be more in charge of their infrastructure, which makes switching contractors less cumbersome.
Both NCM and Screenvision are countering this by embracing more 360-degree approaches to utilising all opportunities inside and outside the cinema complex; targeting everything from electronic displays to smartphone apps. Yet their biggest challenge is to get cinemagoers (particularly Millennials) to embrace the pre-feature block of adverts (and trailers) as something that enhances the cinematic experience rather than an intrusion of yet more advertising into their lives.
The Canadian cinema advertising major, the third largest cinema advertising company in North America after NCM and Screenvision, is suddenly looking a whole lot more interesting with the merger of #1 and #2 called off. While there are fewer synergies cross border than domestically, the fact that the North American cinema market is counted as one does weigh in its favour, so it would not be as far fetched as trying to fuse cinema advertising in, say, Japan and South Korea.
NCM is unlikely to go after Cineplex Media – though it would face fewer regulatory hurdles if it did so, albeit in two countries – but a merger between Screenvision and Cineplex Media should not be ruled out. What speaks against it is that it would require a level of initiative from SV Holdco that they did not have to muster for the proposed merger with NCM. In this situation it is more likely that a private equity group buys out both Screenvision and Cineplex Media from their respective shareholders and merges the two.
One of the things that was never clear in the proposed merger between NCM and Screenvision is what would happen to their respective event cinema (a.k.a. alternative content) divisions. NCM had already spun-off these activities into the Fathom division but what Screenvision would do with its opera et al. transmissions was an issue that would apparently be decided after the merger. Most likely some of what Screenvision was doing would be absorbed into Fathom and other initiatives spun off.
As it now stand there will be more competition in the event cinema field in the United States and as with advertising, cinemas will have more choice, as will content owners who can shop around their product to multiple distributors. This is to be welcomed because the event cinema field is still relatively under-developed in North America compared to more mature markets such as UK, France and Scandinavia.
You would think that we might have listed television advertising as the winner, given that NBC and the other networks don’t have to worry about a larger NCM stealing away advertisers from them. The truth is that television networks are not worried as much about cinema as they are about cord cutters, Netflix and YouTube. While television advertising remains an enormous business in the United States, changes in technology and content consumption patterns worry those in the television business that rely on advertising, i.e. almost everyone other than HBO.
Television networks like Fox continuously complain that the introduction of HD increased their costs but did not result in more money from advertisers. Having tried and given up on 3D, they are now being told that they ought to embrace UHD (4K) television, though again it is unlikely that Ford will pay more for a spot in yet higher definition. Contrast this with the difference that digitisation has made to the cinema and cinema advertising industry.
Ditching 35mm and slide adverts for digital delivery and projection along with automated and dynamic programming is what enabled NCM and Screenvision to grow as much as they have in the last few years. Thanks to cinemas spending money on more comfortable seats and innovations like premium large format (PLF) auditoriums and alcohol served to your seat, they have a hope of audiences being lured back to the cinema, even if the quality and popularity of any year’s film slate cannot be guaranteed.
With NCM and Screenvision forced to go their separate ways, at least for now, there is hope that cinema advertising can continue to grow and innovate with renewed competition. It is worth remembering that advertising is as critical as popcorn and soda to the long term financial health of the cinema exhibition sector. While it is and will remain small compared to broadcast and programmatic online advertising, it will continue to occupy a profitable niche.
For now everyone can take comfort from the fact that 2015 is looking like a bumper box office year in North America (and likely worldwide). Yet just like sequels are an inevitability of the box office, so too will we see renewed efforts to reorganise the ownership of exhibition and cinema advertising operations in in the world’s largest cinema market.