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Cineworld highly leveraged following Regal acquisition

The cinema operator has been subject to recent increase in short interest and broker downgrades
September 26, 2019

A recent increase in short seller activity in Cineworld (CINE) shares, coupled with consensus broker forecast downgrades, has caught our attention. Disclosed short interest has increased by 2 per cent over the past month to 7.6 per cent, while Bloomberg consensus forecasts for the current financial year have been trimmed by 3 per cent over the same period and 8 per cent over three months. The cinema operator’s debt burden has increased dramatically since it acquired US cinema chain Regal Entertainment, which completed at the end of February 2018. This, coupled with recent weak performance, looks like cause for concern.

IC TIP: Sell at 241.3p
Tip style
Sell
Risk rating
High
Timescale
Medium Term
Bull points

Second-largest cinema company globally
Synergies with Regal

Bear points

Recent run up in short interest
Broker downgrades
Questionable subscription service
Competitive market

The $3.6bn acquisition of US-based Regal Entertainment by Cineworld has made it the second-largest cinema chain in the world – currently with 9,494 screens across 786 sites – but also highly indebted. Factoring in Regal’s debt, the deal cost Cineworld $5.8bn in total. This was funded by a $2.3bn rights issue at 157p, along with $4.1bn of debt raised. Net debt increased from $378m at the 2017 year end, to $3.73bn at the end of 2018. This took the group’s net-debt-to-adjusted-cash-profits ratio from 1.5 times to a towering 4.0. Net financing costs meanwhile increased from $10m in 2017 to $171m in 2018, which means interest cover dropped from 16.5 times to just 2.9.

Cineworld has been selling assets and leasing them back in order to try to cut debt. Two sale-and-leaseback transactions were completed during the first half of 2019 across 35 US-based sites for a total of $556m, allowing Cineworld to repay $550m on a US-dollar-denominated term loan. However, with companies now having to report debt-like lease liabilities on their balance sheet, it’s easy to see how cosmetic some aspects of such transactions really are. While net debt excluding leases was down from $3.95bn to $3.36bn at the half-year stage, including lease liabilities net debt hardly budged, dropping marginally from $7.08bn to $7.01bn.

The US is now Cineworld’s largest market, representing three-quarters of pro-forma revenue generated in 2018, compared with 15 per cent from the UK and 10 per cent from the rest of the world. But the US is a highly competitive entertainment market, and Cineworld’s success is largely dependent on blockbuster releases, which can be unpredictable. At-home entertainment, such as video streaming, is becoming increasingly popular and could discourage consumers from heading to the cinema. Cineworld is also pushing a subscription service, where customers pay a monthly fee and can see an unlimited number of films. But analysts worry this service has continued to “lag”, and similar models of subscription services, such as Moviepass in the US, have ultimately proved unsuccessful.

On a more positive note, the continued integration of Regal is going to plan, with $150m of synergies expected to be achieved, which is better than the $100m expected when the deal was first announced. At the half-year results in August, Cineworld reported a weak start to the financial year, with admissions down 14.4 per cent to 136m, while box-office sales were down 14.9 per cent to $1.29bn. This contributed to an 11.1 per cent drop in group sales to $2.15bn on a pro-forma basis, which accounts for the timing of the Regal entertainment deal. More worryingly, US revenue fell 13.8 per cent, which management attributed to the timing of major film releases.

Cineworld (CINE)   
ORD PRICE:241.3pMARKET VALUE:£3.3bn 
TOUCH:103-103.2p12-MONTH HIGH:325pLOW:206p
FORWARD DIVIDEND YIELD:6%FORWARD PE RATIO:9 
NET ASSET VALUE:243ȼ*NET DEBT:$7.01bn* 
Year toTurnoverPre-taxEarningsDividend
 (£bn)profit (£m)**per share (p)**per share (p)
20160.811134.719.0
Year toTurnoverPre-taxEarningsDividend
 ($bn)profit ($m)**per share (ȼ)**per share (ȼ)
20171.112822.312.3
20184.755527.215.0
2019**4.551731.317.2
2020**4.754232.718.0
% change+4+5+4+5
Normal market size:     
Beta:0.41    
*Lease adjusted, includes intangible assets of $6bn, or 438ȼ a share
**Peel Hunt forecasts, adjusted PTP and EPS figures
£1=$1.24