“Be fearful when others are greedy and greedy when others are fearful,” is one of Warren Buffet’s most famous maxims. It is this strategy combined with shrewd analysis and long-term thinking that has made the ‘Sage of Omaha’ one of the world’s greatest investors and also one of the wealthiest.
Even as the US stock market currently booms, there is one sector of it that is being stalked by fear: the cinema exhibition business. This was most apparent when shares in AMC Theatres dropped a staggering 27% in just one day this week. The fall came after the shares in the world’s largest cinema chain had already been trading at the bottom of their 52 week range, but are now at the lowest level since the company was listed on the New York Stock Exchange (NYSE) in 2013.
While it may have had the steepest drop, AMC was not alone in facing a slide in its share price. Here is how other cinema-related shares slumped this week: Cinemark (CNK -4.6%), Regal Entertainment (RGC -3.9%), Eros International (EROS -4.7%), Reading International (RDI -2.7%) and IMAX (IMAX -8.5%).
Fear & Loathing on Wall Street
What is behind this sudden fright? AMC had issued guidance on Q2 earnings that it would record a net loss of USD $178.5 million to USD$174.5 million, even though revenue was up at least 57% year-on-year. The earnings were short of analysts’ expectations but the loss was due to a one-off USD $202.6 million pre-tax impairment charge related to its investment in cinema advertiser National CineMedia.
The fact that AMC would have to sell a stake in NCM and that the sale would incur costs was well known, but that was the price AMC was prepared to pay for merging with Carmike and overtaking Regal as the largest cinema chain in the U.S. So there was more at work in regards to AMC’s declining stock price, most of it relating to skittish and/or un-informed analysts. The company tried to counter any jitters over the health of its largest shareholder, the Wanda Group, by spelling it out; AMC is not affected by parent company Wanda’s financial problems, as all of its loans are secured and acquisitions completed.
Sure, the reviews for “The Emoji Film” were terrible and the North American box office is down 3.3% worldwide during the second quarter (4.4% in the U.S. alone), but Europe was stronger, validating AMC’s decision to invest in Odeon and Nordic to smooth out regional box office fluctuation. Even as attendance flatlines or declines in the U.S., AMC has proven adept at extracting more from each cinema goer with higher food and beverage (F&B) spend, as well as gradually increased ticket prices tied to premium formats (IMAX, Dolby Cinema, 4DX) and comfy recliners.
The ‘Imminent’ Launch of PVoD
What really troubles Wall Street is that Hollywood studios might start releasing their films via premium video-on-demand (PVoD) day-and-date with cinemas and that this could cause cinema attendance to dwindle. “Boutique” investment firm MoffettNathanson was most explicit about this threat:
We continue to expect at least one of the major studios (either Universal, Warner Bros. or Fox) to grow frustrated enough by waiting to reach a mutually beneficial deal with exhibitors and move forward with their own PVOD press release by 4Q 2017, if not sooner.
They had perhaps been reading the New York Times article that predicted that “multiplex movie executives with deep knowledge of the landscape say the first quarter of next year is the target,” for Hollywood studios to start a PVoD service. Except there is one problem with this article – it was written back in September 2010. Seven years on, the launch of such a service is apparently still just around the corner.
But even if/when Hollywood studios do test the water with PVoD there is little to suggest that it will hurt cinema going. The death knell for cinema has been rung many times over by home entertainment technologies: radio, television, VCR, cable channels, HBO, VOD, piracy, YouTube and Netflix. Yet it keeps coming back from the dead time and time again, like a B-movie axe murderer. “Can we please kill the talk about the death of movies?” New York Times film critic A.O. Scott recently pleaded:
Yes, it was a dreary summer. The box office was weak and the big Hollywood releases were weaker. Critics were grumpy. Audiences seemed indifferent. There was so much good television. And so the band struck up the funeral march, as it does every year, and the obituaries circulated on social media. Cinema is dead. (Again.)
That was in September of last year. Plus ça change, plus c’est la même chose…
The Disruptor and the Disrupted
There is no avoiding the perception that the cinema industry is about to be disrupted – which is actually true, but not in the way that most analysts predict. Theatre stocks may be trading low, but other companies are similarly feeling the heat from disruption, actual or perceived, whether it is General Motors vs. Tesla or Walmart vs. Amazon. So who is, or will be, the disruptor for cinemas?
Since the Screening Room and its ilk have yet to demonstrate that they can launch a product, never mind disrupt the movie industry with it, the stock reply is usually Netflix. But the fallacy of this point is increasingly becoming clear. Not just are Netflix films like “Beast of No Nation”, “War Machine” and “Okja” failing to impress, but rival Amazon Studios is winning Oscars and plaudits while still respecting the theatrical window. As Patrick Corcoran of cinema trade body NATO recently observed, “Netflix is disrupting television, it’s not disrupting the movie business.” Amen.
The cinema industry is undergoing a shift – call it ‘disruption’ if you will – as the switch to digital projection is superseded by a second wave of investment in further improving the experience of watching movies out of home. Everything from premium formats to recliner seating, from enhanced food and alcohol offerings to data analytics, is all coming to the fore. This is pushing up both prices, customer spend and ultimately revenue, so that even if attendance isn’t growing, more money is flowing into the coffers of cinemas.
However, a recliner leather chair or reserved seating is not seen as particularly ‘sexy’, even if it has the remarkable effect if increasing attendance while at the same time reducing seating capacity in cinemas. But make no mistake, this is disruption.
Lack of Long Term Thinking
The best thing for cinemas would be if PVoD actually launched, because it would then rapidly become clear that such offerings will not kill off the theatrical experience any more than VCRs or piracy did. Given that it is uncertain if and how PVoD might launch – since Hollywood studios are divided and Disney has outright ruled it out – exhibitor stock prices are stuck in a limbo where the slightest downward trend in box office has an outsize negative effect on the share price. We can dub this effect the PVoD fear amplifier. It doesn’t even matter that “Star Wars: the Last Jedi” is likely to lift the overall annual box office at the end 2017, because too many analysts aren’t even looking that far ahead.
This is where Warren Buffett, or more appropriately his company Berkshire Hathaway, comes in. His company has a long track record of investing in solid but un-glamorous businesses which he considers under-valued. This type of value investing is based on the idea of intrinsic value, rather than current valuation of quarterly results. It is beyond the scope of this article to analyse Buffett’s investment strategy in detail, so read up on it here if you want to know more.
Two driving principles are Buffett’s maxim that “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” He is also strict about about sticking to his ‘circle of competence’ of investing in businesses that he understands. What Buffer looks for when he invests in companies like Coca-Cola is:
…businesses with durable, competitive economics — the moat — and rational, honest management. He then looks for a good price and takes advantage of opportunities when others are fearful.
This is why Buffett sat out the dot-com boom of the late 1990s, preferring to invest in insurance companies instead of pet food delivery. Although he attracted criticism at the time for failing to keep up, when the Internet 1.0 bubble burst he was proved right yet again. He subsequently invested in Apple when everyone thought the shares had peaked, but this week his investment gained him USD $1 billion in a single day.
AMC or Regal?
Wouldn’t buying a cinema chain be too, well, frivolous for an business veteran who likes to acquire railroads and insurance companies? Not if you look at it as a hospitality or brick-and-mortar business. Also, Buffett is not averse to getting close to Hollywood. In 2015 Berkshire Hathaway bought 4.75 million shares in 20th Century Fox for around USD $160 million.
There is thus a strong case that having survived as a business for over 100 years, cinema is set to survive any potential PVoD introduction. That shares in U.S. exhibitors are significantly under-valued by short-term thinking and that the quiet revolution that the cinema sector is undergoing by investing to make it a business offering premium service and hospitality is likely to ensure long term returns. This is why it would be surprising if Buffett was not already weighing an investment in the cinema business, whether he goes ahead with it or not.
So which would be the better cinema company to invest in? While it is the world’s largest cinema chain and its shares have lost the most value, it is unlikely that Berkshire Hathaway would invest in AMC. This is for the simple reason that the majority share of the exhibitor is owned by a Chinese company with an unpredictable leader, who promises to build studios and hotels only to turn around and sell them when the investment climate sours. AMC is a very solid and well run U.S. company with good leadership, but Wanda head Wang Jianlin is not Murdoch and it is unlikely Buffett would be comfortable with such an investment.
The Case for Regal
On the other hand, the argument for buying or taking a significant stake in Regal is more than just the fact that it is not AMC. A detailed and strong case for the fundamental soundness of Regal as a business was made this week on Seeking Alpha by Michael Boyd in ‘Regal Entertainment: Two Thumbs Up.’ It is worth reading in full, but the key points are that the cinema chain has a strong dividend yield, significant cash generation, it is not over-leveraged, and that Regal has a sensible and honest leader in CEO Amy Miles, a fact Buffett might cherish the most.
Regal itself seems caught in a bind, because it is too big to be acquired by another cinema chain like CJ CGV or Cinepolis without taking on excessive debt, yet it seems unwilling to expand overseas. Regal has instead chosen to grow its U.S. footprint with small but strategic acquisitions like Santikos. This means that, unlike AMC, its fortunes are more closely tied to the ups and downs of the U.S. box office, though Regal is attempting to mitigate that by driving F&B and ancillary revenues hard.
The biggest issue with Regal is that the company is controlled by Phil Anschutz, who has 74% of the voting B class shares, though only 27.8% of A class shares, even after selling off USD $303 million worth of shares a year ago. Having built up the business since the company was forced to undergo Chapter 11 in 2001, Anschutz is unlikely to relinquish control of his company while the shares are trading as low as they currently are. The issue is whether Buffett would be prepared to own a minority share of the business, which has a market cap of USD $2.86 billion. For someone who spent USD $35 billion to buy Burlington Northern Santa Fe Corp. (a railroad company) an outright purchase is not inconceivable, particularly if the Regal stock keeps trending lower.
The only other factor against Buffett buying Regal? Omaha, Nebraska where Berkshire Hathaway’s headquarter is based has two Marcus multiplexes but no Regal or AMC. Perhaps he prefers the popcorn and recliners at Marcus.