Turns Out Your Home Town Theater Is Across The Country

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Investment Highlights

Alternative Programming: Carmike views alternative programming as an exciting business venture that is expected to bring in additional revenues as it is implemented more widely. Alternative programming refers to concerts, plays, ballets, and sporting events that would take place during the day while the majority of theater seats are empty.

Mergers and Acquisitions: Carmike has aggressively pursuing complementary M&A opportunities, hoping to achieve the ongoing goal of 300 locations and 3,000 screens. This quarter, Carmike completed the acquisition of 24 locations totaling 234 screens from Digiplex, expanding their footprint by four states.

Digiplex Team Integration: After the successful acquisition of Digiplex, Carmike brought on several Digiplex team members to Carmike. This poses as an exciting opportunity for Carmike to integrate innovative ideas and help propel them through a successful 2015 fiscal year. Most notable of which is Bud Mayo, who will serve as Carmike’s president of Alternative Programming.

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Business Description

Carmike Cinemas (NASDAQ: CKEC) is the fourth largest movie theater company in the United States. The company operates nearly 290 theatres with 2,900 screens across 41 states. Carmike strategically seeks small to mid-size non-urban markets with populations of fewer than 100,000 people to open new locations due to the belief that they provide a number of operating benefits such as lower operating costs and fewer alternative forms of entertainment. Carmike Cinemas primarily generates revenue from admissions and concessions along with additional revenues from on-screen advertising sales, a couple of restaurants, and theater rentals. Admissions accounts for about 63% of Carmike Cinema’s revenue and Concessions and other services account for about 37% of the revenue.

Recent Stock Performance

A: Carmike’s stock began a rapid recovery after they announced the proposed sale of screenvision to National CineMedia Inc.(NCM) for $375 million. Carmike claimed that this acquisitions would be extremely beneficial and it is likely the capital raised from the transaction would be used to fund mergers and acquisitions.
B: Shortly after Carmike announced the sale of screenvision to NCM, the Department of Justice filed a civil antitrust lawsuit seeking to block National CineMedia Inc.’s $375 million acquisition of Screenvision LLC. This had a traumatic impact on Carmike’s stock price as it was rumored the capital raised from the sale would be used to fund a merger and acquisitions ventures, which are the primary components of Carmike’s growth strategy.
C: Carmike’s stock saw another decline after Sony Picture’s experienced a cyberattack from alleged North Korea. The interview, a highly anticipated comedy to be released in theaters, controversially made fun of North Korea and Kim Jung Un, sparking a cyber-attack and media frenzy regarding the release of the movie. Carmike, along with other movie theater companies, decided not to premier the movie in theaters for the safety of their guests.
D: A continuation of the cyber-attack that impacted the market, industry, and Carmike. This dip occurred when The Interview was actually released in select theaters and online. The dip occurred because there were continual threats towards people who dared watch the film, and once it was realized nothing happened, the sock recovered.

Chairman of Board Dies: Alan Hirschfield, Carmike’s chairman of the board since 2002, died on January 15th. Hirschfield served as an independent director of Carmike since April 2002, and was also a member of its Audit and Executive committees. Carmike’s CEO David Passman commented on how Hirschfield was a valuable member of their team and the company has yet to appoint a replacement. The stock price fluctuated slightly as news of Hirschfield’s death circulated, falling approximately 5%. Since the announcement, Carmike has gained about 3% back from the initial market response.

Analyst Recommendations: The vast majority of analysts have recommended a buy for Carmike Cinema’s because they still believe that the company is in the perfect environment for continued M&A operations. Between analyst recommendations on various services, there is a high amount of analysts that have a buy or hold rating, with only one recommendation to sell. The bulk of price targets range from $36 – $40 a share. Yahoo finance posted a mean target price of $36.35 and a high target price of about $40. Some analysts have downgraded the stock from a strong by to a buy over the last few months, largely due to the cyber-attack against Sony Motion Pictures and the impact it had on the industry.

Third Quarter 2014 Results: Carmike’s total operating revenues for the third quarter were $162.2 million, down slightly from $164.2 million in the prior year. Admissions revenue was $100.2 million versus $102.3 million in quarter three of 2013. Despite the decline in top line revenue due to the industry box office shortfall, partially offset by contributions from their recent acquisitions, Carmike again achieved success with its concession and other revenues, which rose this quarter to $62.5 million from $61.9 million. On a per screen basis, admissions receipts experienced the decline that was relatively in line with the industry’s 13% drop. Total attendance fell 5.8% to 14.3 million, a decline of 16.7% on a per screen basis. Average admissions per patron increased 3.4% to $6.98. The modest price growth reflects an increase in the premium showings, nominal ticket price increases and the company’s expanded presence and more mid-sized markets. Average concessions and other sales per patron increased during the period, rising 6.4% to $4.35, aggregate per patron spending rose 4.5% to $11.33.

Future Outlook: Carmike continues to maintain a strong balance sheet with the financial flexibility to target attractive merger and acquisition opportunities. They also have brought several members of the Digiplex team to Carmike, with hopes to inspire fresh ideas and help propel them through a successful 2015 fiscal year. Carmike views alternative programming as an exciting opportunity with significant upside that will prove extremely beneficial as it is implemented throughout their national footprint. Alternative programming accounted for nearly 10% of Digiplex’s annual revenue, considering Carmike is far greater is size, management believes that over the upcoming quarters substantial revenue contributions will be seen. Carmike’s management estimates that revenues will increase in the high single digits for the 2015 year due not only to the integration of alternative programming, but also several high profile movie releases. Analysts predict a 12% growth rate for Carmike, which is only slightly behind the industry prediction of 14%.

Mergers and Acquisitions

Carmike’s primary growth strategy is an aggressive merger and acquisition plan in an attempt to grow to 300 locations with 3,000 screens, which they announced in May of the 2014 fiscal year. So far this year, Carmike has completed the acquisition of 24 locations and 234 digital screens from Digiplex. This acquisition also increased their footprint by four states. Dating back to 2011, Carmike’s aggressive merger and acquisition plan has led them to acquire and integrate 740 additional screens, over half of which was acquired within the last 12 months. In aggregate, these transactions account for more than 25% of Carmike’s total footprint today.

Also, Carmike reported that their recent acquisitions have put them on pace to achieve their goal of 3,000 screens by the time Star Wars Episode VII is released in the summer of 2015 and stresses that they are only going to be acquiring circuits of theaters rather than individual theater acquisitions because it takes just as much effort to acquire one theater as a circuit of theaters. Finally Carmike addressed the issue of financing the future M&A activity with cash rather than equity as they did with the recent Digiplex transaction. The $145 million will not be available to pay dividends but will be used to continue to take advantage of opportunities in the M&A environment until the M&A environment is no longer favorable for Carmike.

Along with the recent acquisition of Digiplex, Carmike has seen an opportunity that came with the acquisition of Digiplex and that is alternative programing and dine-in movie theaters. Dine-in Movie theaters have become very popular in the past year and have proved to be very popular with movie-goers. Carmike has recognized this trend and have already begun working on design and expanding dining and alcohol options in a large amount of their theaters. Digiplex has brought in a number of new ideas including alternative programming. Alternative programming is the presentation of non-Hollywood entertainment such as opera, ballet, concerts, and even sporting events, which can be booked for weekday times when most theater seats are empty. Digiplex has received 5% of its box office receipts from alternative programming for any given quarterly period and Carmike Cinemas is more than 13 times larger than Digiplex which is why improving success in this area can have a big effect in future revenue. For alternative programming to be a big factor in Carmike Cinema’s revenue they have decided to bring on extra management in this area and also to help expand the dining and VIP seating area which will incrementally pick up General and Administrative costs more than usual.

Economic and Industry Analysis

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The Movie and Entertainment industry relies heavily on movie production and distribution companies that distribute license rights and films. The relationship between theaters and these movie distributers are very important because the distributor decides which venues can show specific films, therefore the licensing for different films are done by a theater to theater basis. There is a high correlation between movie ticket sales, consumer discretionary spending, and the disposable income of American individuals. Ticket sales on average account for two-thirds of revenue while concession sales (food and beverage) is about 20% of the revenue and the remaining percentage comes from other sources including on-screen advertisements, facilities and concessions rental. The U.S personal consumption expenditures for movies and live entertainment are forecasted to grow at an annual compounded rate of 6% between 2015 and 2018.

The industry is dominated by three large movie theater companies; Regal, AMC, and Cinemark having about 70% of the market share. Carmike Cinemas currently holds 11% of the market share and is increasing as Carmike continues to acquire small movie theatre companies. The Market share is calculated by the number screens that each movie theater company currently owns and is the common way of measuring market share in this industry.

The movie industry has had many concerns in recent times due to stresses like movie piracy, which can have a dramatic effect on the profitability of movie theaters as more and more customers are partaking in the illegal activity of being able to watch them for free at home. Estimates indicate that preventing piracy by one week can increase a film’s box office grosses by as much as $10 million. Another threat to the industry is short theatrical release windows where the release time of movies in theaters and being available on other sources is decreasing. Viewing preferences also pose a threat to the industry, as younger audiences that are more tech-savvy enjoy watching movies in a personal environment rather than at the movie theaters. The industry was recently impacted by a cyber-attach on Sony pictures involving the release of a highly anticipated comedy entitled The Interview. As a result of the attack prior to its release, Carmike along with other movie theater companies elected to not premier the movie in theaters to ensure the safety of their viewers. This had a large profit impact on movie theater companies as millions of Americans rented the movie online rather than being able to view it in a traditional theater. Personal income and leisure time drive the demand of movie ticket sales and this depends on the movie theater company’s success on securing popular movies and selling high-margin food and beverages.

Box Office Performances

The top grossing titles that were released in the last quarter grossed over $1 billion in total and helped push Carmike through the year while the industry as a whole did poorly when compared to the record-performance experienced during last year’s third quarter. This quarter, Hunger Games: Mockingjay Part 1 hit theaters November 21st and has grossed over $330 million throughout its time in theaters so far. The Hobbit: The Battle of Five Armies, and Big Hero 6 all grossed over $200 million in box office receipts and Interstellar has grossed $185 million so far. Also in the third quarter, the late releases of Transformers: Age of Extinction generated about $100 million and Guardians of the Galaxy grossing $333 million.

2015 is projected to be another big year for the movies and entertainment industry. With highly anticipated titles such as Star Wars: Episode VII, The Hunger Games: Mockingjay Part 2, The Avengers: Age of Ultron, and Superman vs. Batman all being released throughout the year. Analysts believe that Star Wars: Episode VII has the potential the gross over $500 million during its time in theaters, with The Hunger Games: Mockingjay Part 2 just behind at $400 million.

Valuation Summary

I used the residual income model, which uses the current Book Value per share, an estimated growth rate, a required rate of return, and the return on equity. I received a price of $30.56 and received a mispricing of 14% undervalued. I used current price as of Monday 1/23/2015

Recommendation:

I recommend a hold of all 1700 shares of Carmike.

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