Shares in cinema operator Cineworld (CINE) registered heavy losses in early trading after the firm announced it had offered C$2.8bn (£1.6bn) to buy Cineplex, Canada's largest chain of cinemas.
If the deal gets the go-ahead from investors Cineplex shareholders will receive C$34 in cash for their shares, a mighty 42% premium to their closing price on Friday.
In addition to the price premium, investors are also concerned about the effects on Cineworld's balance sheet and debt. Buying Cineplex would see the UK company take on $2.3bn, or £1.7bn, of extra debt.
That would mean pushing net debt to $5.6bn (approximately £4.19bn), tipping its gearing level to four-times earnings before interest, taxes, depreciation and amortisation (EBITDA), presuming the deal completes quickly.
By mid-morning the shares had recovered some of their losses but the stock remained 2.5% in the red at 201p.
CRITICAL MASS
Cineworld’s board argues that the opportunity to acquire Canada’s largest operator is too good to miss given how stable and attractive that geographical market has been.
Box office revenues have grown just under 2% a year on average over the last five years, thanks to an average 3.5% annual increase in ticket prices.
Cineplex had a 75% market share of box office revenues at the end of September 2019. The Canadian cinema market as a whole was worth C$1bn, or £575m last year.
Together with the Regal acquisition in 2018, the Cineplex deal would make Cineworld the biggest cinema operator in North America with a combined 8,900 screens across the US and Canada.
Interestingly 20% of Cineplex’s revenues last year came from its fast-growing Digital Media business which creates content and analyses data for bank ATMs, touch-screens in fast-food restaurants, shops and shopping malls, and offers large-scale digital displays for advertising.
HUGE COSTS SAVINGS
As well as betting on the strength of the Canadian market, Cineworld also sees huge cost savings for the combined business. Management believe that by implementing its operational best practices it can improve the customer experience and extract around $120m, or roughly £90m, of cost efficiencies by the end of 2020, with a further $130m (£97m) by the end of 2021.
Using its in-house technology platform, sales channel and online customer ‘interface’, as well as features like its Unlimited subscription deal and reserved seating, Cineworld management is confident that it can improve customer loyalty and increase takings.
Using its enlarged scale and relationships, it also believes that it can increase advertising revenues and at the same time negotiate better terms with its key suppliers to improve Cineplex’s margins.
However, with the Regal acquisition still weighing on the balance sheet and the refurbishment programme soaking up cash there are many who question the timing of the Cinexplex deal.
Russ Mould, investment director at AJ Bell, suggested that the management team at Cineworld is either ‘very good at shrugging-off market concerns or they don't realise they are walking further into the lion's den.’
Large amounts of debt can be a corporate killer if trading conditions deteriorate.
