Less means more for Euro circuits

Upgrades expected to open up plexes for Hollywood pics

LONDON — Vue Entertainment’s $215 million takeover of German circuit Cinemaxx heralds a fresh wave of investment in Europe’s cinema sector, which could help unlock the potential for box office growth and cut costs for distributors.

The merger of the U.K.’s No. 3 chain with the Teuton No. 2 is the most significant deal in European exhibition since Odeon joined with UCI in 2004 to create the region’s largest loop.

“For a Hollywood studio focused on delivering the big numbers for their big movies, it’s very important to know that there are quality cinema operators who can match their investment,” says Rupert Gavin, CEO of Odeon UCI.

According to Vue CEO Tim Richards, it’s just the start of a continent-wide shake-up in ownership, which will result in the emergence of three or four major pan-European circuits.

“The landscape in the next 18 to 24 months is going to change very materially,” Richards says, adding that the fragmented cinema sector in continental Europe is ripe for the kind of consolidation, and consequent upgrade in audience experience, that took place in the U.S. a decade ago.

Far from being wary of exhibitor power being concentrated in fewer hands, the Hollywood studios welcome that concentration. The benefits of consolidation are evident from the robust U.K. market, where Odeon, Vue and Cineworld control 75% of the business, and box office has risen consistently on the back of substantial exhibitor investment.

“We have invested $50 million in our U.K. cinemas this year, and $150 million over the past four years to keep them up to date and in pristine quality,” Richards says. “Our distribution partners appreciate that. The studios are excited that we’re going into new markets. Sometimes they even call us up and say, ‘Please look at this country or that country, they need help.’?”

After paying $31 million for the U.K.’s Apollo chain in May and completing the Cinemaxx deal, Richards says he’s already lining up more acquisitions in other territories.

In both Germany and Italy, for example, some 50% of the market is still made up of old-fashioned theaters, with less deep-pocketed owners, Gavin says. “There are many factors that determine box office growth, but having up-to-date cinemas is definitely one of them, and consolidation and investment can play a part in unlocking this potential.”

With the emergence of bigger chains, the emphasis now is on such exhibs and the Hollywood studios working together to protect the value of the theatrical window, rather than clashing over booking terms. “The world between exhibitors and distributors has changed over the past five years,” says Cineworld CEO Steve Wiener. “There are no more fights on Monday morning. We’re even doing co-operative advertising with distributors now, where we each put something into the pot.”

Gavin notes that exhibs are providing muscle to the marketing through their databases and presence on social networks.

Meanwhile, the Hollywood studios are looking to cut back on international distribution costs. Dealing with fewer, larger circuits reduces the expense and headache of supplying hundreds of smaller operators, and making sure they are reporting the correct figures. For example, one studio suspended its dealings with a chain in the Baltic States after belatedly discovering, thanks to a tip from a rival exhib, that the circuit was under-reporting its ticket prices.

But the danger is that the current box office slump in certain territories could deter, or at least delay, the fresh investment that their cinemas urgently need to reverse this decline.

Spain is the most chronic example; its economy in a tailspin, crippled by youth unemployment that tops 50%. While it’s true that film exhibition is a counter-cyclical business, thriving as affordable escapism in tough times, the crisis in Spain is so profound that even the box office has been dragged down 12% this year, with no end to the spiral in sight.

In May last year, the U.K.’s Cineworld agreed to buy Spain’s fifth largest chain, Cinesur, for $23 million as a launch pad for future acquisitions in the territory. The deal collapsed in September when Cinesur’s parent filed for bankruptcy protection. But Wiener now reckons he dodged a bullet.

“We would have had a very hard road if we had bought it,” he says. “We had a very simple plan, to buy a platform for Spain and expand from there. But it’s a difficult situation there; no one knows where the bottom of the market is going to be.”

Wiener warns not to expect any aggressive moves by Cineworld into continental Europe in the immediate future, though the circuit is planning to add 25 new theaters in the U.K. over the next five years. “We’re publicly traded, and that means I can’t spook the shareholders. We’d have to see the European economy doing better before we could do anything,” he says. “Unfortunately in some European countries, and particularly in Spain, they have invested nothing for so long that it would be cheaper to go in and build new cinemas than to upgrade the old ones.”

Germany, by contrast, bounced back in 2011, albeit only by comparison to several previous years of decline. The entry of Vue, along with Odeon UCI’s ambition to grow its market share, means that further Teutonic takeovers are likely, which should help to drive additional growth.

“In Germany, you have three players with 40% share, and in Italy you have two players with 40% share, so there’s a way to go in both countries,” Gavin says.

With 2,200 screens across the U.K., Ireland, Spain, Portugal, Italy, Germany and Austria, Odeon UCI, which is owned by private equity fund Terra Firma, is already twice the size of its nearest pan-European rivals, including the new Vue/Cinemaxx combo (1,100 screens in the U.K., Ireland, Germany, Denmark, Portugal and Taiwan), Pathe Gaumont (1,000 screens in France, the Netherlands and Switzerland), and the fast-expanding Cinema City circuit (900 screens in Israel, Poland, Hungary, Czech Republic, Romania, Bulgaria and Slovakia).

Gavin says he’s not seeking another major takeover — although the group’s German arm was reportedly one of the bidders for Cinemaxx, which would have catapulted it from third in the German market to first.

Odeon UCI acquired eight smaller clusters of cinemas in the past year: three in Italy, two in Spain, two in the U.K. and one in Ireland, adding nearly 400 screens total.

“Our focus is to be No. 1 or No. 2 in each country, then we can get economies of scale,” Gavin says. “We see more opportunity in picking up four sites here and five there, particularly ones that have been unloved by their previous owners, where we can see an immediate upside to improving them.”

Simply putting the Odeon UCI name over the door is a move that can deliver an instant profit for Terra Firma. If Odeon pays four or five times EBITDA (earnings before interest, taxes, depreciation and amortization) for a handful of rundown theaters, but Terra Firma values Odeon at twice that figure, then the acquired cinemas immediately double in their book value when they become part of the group.

While Odeon prefers to buy shabby circuits which it can upgrade to add value, Vue targets acquisitions that match the quality its own existing theaters. “We’ve got 90% stadium seating, and we would only look at acquisitions of comparable quality,” says Richards. “Cinemaxx has 100% stadium seating, beautiful cinemas, incredibly well maintained. They’ve spent a lot of money, and there’s a lot of pride in making sure it’s the best run chain in Germany. We don’t look at Cinemaxx as an acquisition, it’s two companies coming together to exchange best practices.”

On a smaller scale, Austrian exhib Cineplexx, owned by Germany’s Constantin, bought Slovenia’s Planet Tus in July, having previously expanded over the past two years into neighboring Croatia, Serbia, Montenegro and Macedonia Ultimately, Gavin says, consolidation across Europe is inevitable. “The amount of investment now required in the cinema sector is quite large to keep up with all the technological developments and all t
he innovations in service, and there are fewer people with the capital and expertise to move with the times,” he says. “You’re not going to get that investment from single, family-owned cinemas in small towns.”