Exhibs roll dice

Digital dawn, slack stox stack odds vs. chains

Exhibs hitting the Las Vegas strip for ShoWest this weekend should head straight for the roulette wheel. It’s an apt symbol of the dizzying change and high stakes now facing the movie theater biz.

Though conventioneers will spend much of the week in the thrall of digital gadgetry and studio product reels, these are mere distractions from exhibition’s precarious hand.

Yes, box office receipts have climbed 7%-9% in each of the past few years. But it appears that the box office increases have benefited mainly the Hollywood studios, with theatrical results the locomotive for ancillary revenue streams.

While studios feast, the exhibs are leveraged to the hilt and hemorrhaging cash, with stock prices in the doghouse and bonds trading at pennies on the dollar.

Compounding their worries, the thousands of exhib execs at the annual confab, which runs through next Thursday, will also be eyeing the latest digital projection equipment –and wondering how they’re going to afford it.

Consolidation conga

As it struggles, exhibition still awaits some relief in consolidation as healthier groups survive and others fold. The larger, national circuits are especially susceptible; small regional chains face a bit less pressure. At least they don’t face debt loads in the hundreds of millions as do larger rivals.

Yet widespread combinations, anticipated for months, are taking longer than expected. Chains are reluctant to sell at historic lows, or to buy someone else’s old theaters.

“You would think that some of these companies would be ripe for the picking,” said one top distrib exec. “But there’s a losing formula out there.”

At ShoWest, “There will probably be more bankruptcy lawyers than M&A lawyers” added one Wall Streeter who follows the business.

The troubles are manifold:

  • Costs. Skyrocketing building costs have been well documented, and chastened circuits say they’ll exercise more discipline in the near future. But operating expenses — especially film rentals — have risen along with capital construction and infrastructure costs. Films tend to play off sooner (many pics reap 40% of their gross in the first weekend, up from 25% a decade ago), and they play in hundreds more theaters than they did a few years ago. That trend, plus a 25% increase in the average domestic gross during the 1990s, has boosted rental costs.

  • Interest-rate sensitivity. While many leisure businesses are vulnerable to rising interest rates, heavily leveraged exhibs face a bloodbath if rates increase. Judging by Fed chairman Alan Greenspan’s recent comments, a hike of three-quarters of a point during 2000 could be in the cards.

    Some examples: According to the most recent figures available, Carmike’s interest expenses for the quarter ended last Sept. 30 increased 42.6% to $9.7 million from $6.8 million in the same period in 1998. Execs blamed “a higher aggregate cost of debt” of 8.5% versus 6.6% in the year-earlier quarter.

    At Loews Cineplex, interest expense of approximately $51.3 million for the nine months ended Nov. 30, 1999, was $11.9 million higher than for the same period in 1998.

  • Cannibalization: That’s when newer theaters eat into business at older ones — and according to Schroder & Co.’s Scott Davis, the “decay factor” for older theaters is apparently worse than the industry expected. Incidentally, he also expects a second wave of closings of some new multiplexes that were built in haste and poorly conceived. Some may be the fruit of “ego building,” industry-speak for circuits entering already saturated markets to vie with rivals rather than building in untapped, but still potentially lucrative, areas.

  • Finger-pointing. Some exhibs blame Regal Cinemas, which spent hundreds of millions of dollars on new theaters, for raising the stakes and forcing its competitors into breakneck building. The company is backed by deep pocketed investment firms KKR and Hicks, Muse, Tate & Furst.

“There was too much capital available,” said analyst Christopher Dixon of PaineWebber. He and others said the big leveraged buyout firms believed that by consolidating the industry (Regal was combined with Act III, and the troubled United Artists almost joined the KKR/Hicks, Muse fold as well), they could pressure the studios to change the splits — the sliding percentage of box office gross shared by distributors and exhibitors. But that hasn’t happened.

Stadiums steep

Others say AMC’s early commitment to stadium seating forced rivals to spend up to $1 million per screen, up from the roughly $200,000 each non-stadium multiplex screen cost less than a decade ago.

“It now takes two or three years to absorb what were poorly made decisions a year ago,” Dixon said.

Ever since the watershed 1999 ShoWest, which wowed attendees with a digital “Star Wars” trailer, expectations have been mounting about cinema’s next wave. Most exhibs and distribs see a digital rollout within several years. But there’s no agreement about who’ll foot the bill, thought to be roughly $100,000 per screen.

The projectors alone are pricey, but a number of middlemen, expected to be out in full force at ShoWest, are devising leasing plans to lessen the pain. An army of tech players is hoping to drum up interest in new products — encryption software, inventory management tools and the like — billed as essential to digital film delivery.

While distribs appear to reap the obvious and immediate benefits of digital — saving film print costs — they claim exhibs will get their fair share down the line. With digital delivery, some see theaters as venues for a wide range of programming, from pay-per-view concerts and sporting events to corporate annual meetings.

“This isn’t just an upgrade,” said Steven Friedlander, distrib chief at Fine Line. “It’s a complete retrofit.”

As many chains cut back their expansion plans, some on Wall Street are saying the building boom peaked in 1999 and is headed down, although there will still be net additions of screens this year. Even if the hump in building is past, however, “financial results will continue sloppy,” said one fixed income analyst, as the debt that’s piled up continues to erode earnings.

UA’s troubles

United Artists is one of the industry’s biggest trouble spots. Its stock isn’t publicly traded, but its bonds are, falling as low as a nickel to the dollar this year. Wall Streeters say the company’s assets barely cover its bank debt and they continue to wait for the group to disappear from the scene.

Alan Gould of Gerard Klauer Mattison wouldn’t be surprised if the LBO firms came in to finish what they started. They may have had a bad run, but they initially invested at the top of the market for top dollar, when the megaplex building mania was just getting under way. Now it’s the bottom: a good time to buy.

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