Plan to Build More Theaters Signals Industry Desperation

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When is an industry really in trouble? When its most frugal company not to mention the largest commits to spending more money than it can readily borrow.

Regal Cinemas Inc. recently told analysts that it will spend almost $200 million on movie-theater construction this year, although it only has $130 million available under its bank lines. The company hopes to raise $50 million to $100 million from the sale and leaseback of theater properties.

That doesn’t leave much room to maneuver. Regal, like other heavily indebted theater companies, can’t expect to raise more money in the equity or debt markets until the new movie theaters prove themselves.

“Liquidity is going to be very, very tight going forward,” said Bishop Cheen, an analyst at First Union Securities Inc. in North Carolina.

The prospect is sobering because of Regal’s profile. The Tennessee-based company is the world’s largest movie exhibitor, boasting 4,413 screens at the end of 1999.

The company says it expects its liquidity position to bottom out at about $50 million in early summer. Although Regal has trimmed its future construction plans, it still expects to spend another $100 million in 2001.

Regal was a renowned penny-pincher before its 1998 acquisition by two leveraged buyout companies, Kohlberg Kravis Roberts & Co. and Hicks, Muse, Tate & Furst Inc. for $1.2 billion.

The company was founded in 1989 by Michael Campbell and Neal Melton, two former grocery-store managers who were cost-vigilant. On business trips, Regal employees were allowed just $15 a day for meals, and the two co-founders shared a motel room until 1993, the year Regal sold shares to the public.

Over the next five years, Regal grew rapidly by acquiring 11 other theater chains. But in 1996, competitors began building “megaplexes” with as many as 30 screens, turning the entire industry on its ear. Moviegoers began bypassing perfectly good multiplexes with six to eight screens, to flock to the new venues with stadium seating and other amenities.

As Campbell, Regal’s chairman and chief executive told Variety last year, “A lot of theaters built five years ago are obsolete already.”

Shrewd sale

By early 1998, Campbell realized that Regal wouldn’t be able to sustain its earnings growth rate that had wowed Wall Street with a 43 percent annual improvement from 1993 through 1996. Regal accepted the $31-a-share offer from KKR and Hicks Muse, which turned out to be a great decision for shareholders. Since that time, any number of theater companies have gone begging, as prospective buyers have recoiled from the capital investment needed to build megaplexes.

KKR and Hicks Muse have each invested $500 million in Regal. Their goal: To capture as much as 25 percent of the U.S. cinema business, from Regal’s base of less than 10 percent of the nation’s screens in 1997. The LBO firms merged a smaller company, Act III Theatres Inc., with Regal in August 1998 and accelerated the building campaign.

KKR and Hicks Muse retained Regal management, but some of the old caution was sacrificed in the race to gain market share.

Capital expenditures climbed to $427 million last year as Regal added 869 new screens. The new construction boosted Regal’s market share to 12 percent of the nation’s estimated 36,000 screens.

Based on industry data, Regal garnered just 9 percent of the box-office revenue and 11 percent of admissions in 1999. Regal said its movie admissions rose by 8 million, or 6 percent, last year.

At what cost? Theater operating expenses rose $49 million, or 25 percent from the previous year, and interest payments increased by $48 million, or 58 percent (including the results of Act III Theatres for all of 1998).

Meanwhile, business at Regal’s pre-1998 theaters declined in markets where new theaters opened, reducing admissions by as much as 15 million in 1999, Regal told analysts. The company said that loss of business reduced Regal’s earnings before interest, tax, depreciation and amortization by $35 million.

Mega-challenge

The pressure is intense to make the new theaters work. But some analysts have begun to question Regal’s ability to draw enough patronage in markets where it faces another megaplex. Also, the definition of markets has changed as megaplexes have demonstrated an ability to attract moviegoers from greater distances.

In a recent teleconference, Standard & Poor’s Corp. analyst Heather Goodchild said she is paying closer attention to the theater companies’ competition for patrons within a 10-mile radius, instead of traditionally smaller “zones.”

Stiff competition may even prompt new theaters to turn to discounting. Regal has cut ticket prices to $3.50 at a 13-screen theater in North Bergen, N.J., even though the movie-house is only about three years old and offers stadium-style seating.

Regal may have picked some bad sites. Projects are now being reviewed more carefully, according to analysts at S.G. Cowen Securities who visited the Knoxville headquarters in November. Regal officials didn’t return calls.

The overall returns on investment have been much lower than Regal expected, says Cowen analyst John Maxwell. Instead of a 25 percent to 30 percent return, the new theaters were probably lucky to see 15 percent in 1999, he said. Nevertheless, he changed a “hold” recommendation on Regal’s high-yield bonds to “buy” in November, after bids on 9.5 percent senior subordinated notes drifted to about 68 cents on the dollar.

“We just thought at this point, Regal’s bonds yield close to 17 percent,” Maxwell says. “We don’t see the scenario where (things) get much worse.”

The same can’t be said for several others in the industry. The Mann Theatres chain was put into Chapter 11 bankruptcy last year by a leveraged buyout firm. (Mann Theatres has since emerged from bankruptcy.) Another LBO-backed company, United Artists Theatre Co., has no obvious source of funds for its next coupon payment to bondholders, due in April.

First Union’s Cheen predicts that it will take two or three years for the industry to right itself. “I think there’s more pain to be had before it gets better. We’re not at bottom yet.”

Kathryn Harris is a columnist for Bloomberg News.

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