A Slow Fading to Red Ink Blurs The Outlook for Movie Theater Chains

The balance sheets of U.S. theater exhibition companies are hemorrhaging red ink at a rate that makes other movie industry disasters like Ishtar, Heaven’s Gate, and 1942 look like hits. “There was a lot of expansion when the industry was going strong, but now these aggressive building schedules have come back to haunt operators,” says Stan Campbell, who operates six theaters and is president of the National Association of Theater Owners’ (NATO) Colorado and Wyoming branches. How bad is bad? Four of the eight largest U.S. theater operators have filed for Chapter 11 bankruptcy protection this year. In August, reorganization requests came at a particularly rapid rate with Carmike Cinemas Inc., the third-largest operator in the U.S., United Artists Theatre Co., and Edwards Theatres Circuit Inc. all filing for bankruptcy. In October, GC Cos. Inc., owner of General Cinema Theaters, followed them into Chapter 11. The bankruptcy filing of Mann Theatres Inc. in the first quarter showed that the industry’s problems are not confined to the largest players. Mann is ranked as the industry’s 40th largest chain. But the industry’s troubles start at the top. Regal Cinemas Inc., the largest operator with 4,493 screens at 418 sites, has requested relief from its bank lenders, although it hasn’t filed for Chapter 11 protection. Other operators have reported problems to the extent that more bankruptcies are expected by the end of the year. Some theater operators point the finger at the dearth of hit movies this summer as the immediate cause of companies getting hit by bankruptcies. With a burgeoning number of screens, the industry needed a big jump in attendance rates to break even. And while attendance rates did go up – the hike is expected to be about as much as last year’s 6.7% increase in admissions – it wasn’t a dramatic enough increase to keep all operators in the black. “This isn’t an industry where one-year attendance jumps 30%, and 30% the next year,” says Michael Florin, an entertainment analyst at Gerard Klauer Matheson in New York. Balance this modest increase in attendance against the increase in the number of screens and you get an idea of the industry’s problem. In a three-year period ending in 1998, the industry added more than 6,400 screens, about a 24% jump, according to NATO figures. Thousands have been added since then. One factor driving the industry’s expansion was the shift from multiplexes to megaplexes. Just as the invention of multiplexes – theaters with more than one but fewer than 12 screens – threatened the existence of the previous generation of single-screen theaters, the rise of megaplexes has threatened the profitability of some multiplexes. Megaplexes typically offer digital sound, stadium seating, and as many as 30 screens per theater. The exhibition industry’s easy access to capital in the early 1990s set off an expansion frenzy that led to today’s glut of megaplexes. Led by AMC Entertainment Inc. and quickly followed by competitors, the industry embarked on a building schedule that created too many screens at too many locations. “It was a mistake trying to be all things to all people,” says one movie chain owner. “I know how to sell popcorn. I don’t know how to sell hamburgers and alcoholic drinks,” says this industry executive as he ticked off two businesses some multiplexes have tried to enter. A good vehicle to shed bad leases “This industry isn’t going to get healthy until we drop down to around 27,000 or 28,000 screens,” says Michael Florin. In his view, the older multiplexes with 12 screens or less are dragging down the results of their owners. “One thing that the bankruptcies will certainly accomplish will be to give the operators a way to get out of their worst leases. They’ll be blood-letting, but when these companies emerge from Chapter 11, they’ll be leaner and stronger,” Florin says. Last year, outgoing NATO president Bill Kartozian sent a warning to the industry at the annual “ShowEast” trade fair. “I would urge caution and prudence in further expansion,” he said. By 1999, however, the damage had been done. According to one industry source, the industry’s overbuilding resulted from two things: easy access to capital and financial investors coming into the industry. “Private equity money and people who didn’t know the industry, pure financial investors like these funds and others, stretched the exhibition companies too thin and now they’re getting lousy results,” said one distribution executive. Another industry source also touched on the theme of investor greed. “You can’t reinvent this business. These are companies that can be leveraged up to four times earnings. With these financial buyers aiming for leverage at 10 or 12 times what they put it, it just made for a shaky house of cards.” The extent of the industry’s losses last year was estimated by Morgan Stanley Dean Witter & Co. at about $15 billion. Among the biggest losers in the industry’s decline are two of the nation’s largest buyout firms, Hicks, Muse, Tate & Furst and Kohlberg, Kravis, Roberts & Co. Together they took Regal private in May 1998 and combined it with other theater assets. Like other operators in the industry’s race for expansion, the buyout specialists hoped to outgrow their competitors and profit from the resulting dominant market share. But now, each firm has a paper loss of about $500 million on their stakes, according to media reports. Both companies declined to comment. While some theater executives have blamed the poor quality of last summer’s films for at least some of the industry’s ills, others blamed management. “The fish rots from the head down,” said Milt Daly, COO of Crown Theatres. He laid the responsibility for the industry’s condition on bad decisions by management at the affected companies. Prospects for m&a activity as a result of this state of affairs present a mixed picture. On the one hand, the problems at the larger firms are not confined to the top tier of players. As a result, few theater chains have a war chest of cash for acquisitions. Stock prices had been generally weak to moderate before this recent spate of bankruptcies. So, most theater owners won’t be able to get a lot of bang out of their stock as potential currency. But while it might not come from the ranks of theater owners, some observers don’t rule out the possibility of consolidation. “You could get a situation where someone from outside the industry buys a number of these facilities and manages to turn the businesses around,” Florin says. He also mentioned that there had been rumors that McDonald’s Corp. might enter into some kind of cooperative agreement with AMC Cinemas. Anschutz angles for United Artists And in Denver, Phillip F. Anschutz, a billionaire investor, has filed a plan to take control of United Artists. In the wake of United Artist’s default on its debt in April, Anschutz paid about $65 million for about 21% of a $440 million outstanding loan to the company. This made him the largest single lender to the company. The plan awaits approval by the courts. If the Anschutz plan and other reorganization proposals at other faltering chains succeed, they will allow theater owners to get out of some of the unprofitable leases that have dragged down results. But even in an environment in which theaters have extra-wide seats arranged in tiers, stadium style, and digital sound, one theater owner says that the exhibition business is still in some ways a mom-and-pop industry. “People from outside the industry have learned the hard way that there is a limit to audience growth and a limit to how big you can grow some of these chains,” says this source. He added that he believes you can’t reinvent the theater business. But he did see an upside after the contraction. “We’re going though a down cycle. The companies that survive will be stronger, and you’re going to have a more manageable number of screens.”