Cineworld’s (CINE) picture palaces may have been shuttered in recent months, but a drama is unfolding off-screen. The group announced after market close last Friday that it had pulled out of its plans to buy Canadian chain Cineplex (TSX:CGX). The $2.3bn (£1.8bn) debt-financed deal was announced in December, and had originally been expected to complete during the first half of 2020.
Cineworld explained that it had “become aware of certain breaches” by Cineplex “of the arrangement agreement relating to the acquisition”. The group added that “a material adverse effect has occurred with respect to Cineplex”. Those issues, and “Cineplex's unwillingness to cure the breaches”, caused Cineworld to terminate the agreement with immediate effect.
Yet Cineplex has vigorously denied Cineworld’s allegations, arguing that these stem from “an outbreak of illness and act of God (Covid-19)”. Cineplex said that such scenarios are “explicitly” excluded from the definition of a material adverse effect within the acquisition arrangement. Cineplex believes Cineworld is suffering from “buyer’s remorse” – and that its claims represent an attempt to back out of the deal in light of the coronavirus pandemic.
Cineplex intends to start legal proceedings against Cineworld, seeking damages for what it perceives to be the latter’s breaches of the deal agreement and failure to follow through with the transaction. Cineworld in turn will defend any suggestion that it has not complied with its obligations. It has also reserved its right to seek damages from Cineplex.
The acquisition had been expected to add 165 cinemas to Cineworld’s portfolio, with 1,695 screens – creating a leading North American operator. It was expected to be double-digit accretive to both earnings and free cash flow in 2021.
However, as broker Jefferies noted, “the world has changed”. While analysts here had previously “liked” the deal, cancellation “improves Cineworld's short-term liquidity prospects” by reducing burn. They thus see “no deal” as good news for the group – and although litigation will “be a distraction”, Jefferies reckons that “damages may only be limited to deal fees incurred”.
At the end of May, Cineworld revealed that lenders had agreed to waive the leverage covenant attached to its credit facility for the June 2020 testing date. The leverage covenant at the December 2020 testing date also rose to a net debt/cash profits multiple of nine. In a bid to secure additional breathing space, the group said it had agreed the terms of $110m in additional liquidity through an expansion of its revolving credit facility – as well as securing approval to apply for government loans.
