IMAX - National CineMedia Inc. Post-Deconsolidation: The Numbers Don't Justify Its Price Tag

2023-10-20 12:22:52 ET

Summary

• NCM LLC's bankruptcy hints at challenges in the cinema advertising industry due to COVID-19, digital content, and streaming platforms.
• NCMI's investment outlook has been altered by NCM LLC's Chapter 11 filing, with a high valuation but uncertain accuracy.
• NCMI's reduced stake in NCM LLC presents both challenges and potential benefits, but its current performance is not reassuring.
• Based on the sector's P/S ratio, NCMI's implied fair value appears to be around $38.07 million, which seems significantly lower than its current market cap of approximately $365 million.
• I rate NCMI a "sell" due to concerns about its ability to generate adequate revenue post-deconsolidation and its seemingly inflated valuation.

Following NCM LLC's bankruptcy, National CineMedia, Inc. ( NCMI ) has assumed a managerial role for NCM LLC. NCM LLC has been a prominent player in the U.S. cinema advertising industry. The recent bankruptcy suggests that cinema-based advertising has faced setbacks, likely influenced by the challenges of the COVID-19 pandemic, an increasing transition to digital content, and the rise of streaming platforms. I believe the repercussions of NCM LLC's Chapter 11 filing have notably altered NCMI's investment outlook. When examining NCMI from a valuation perspective, based on the recent quarterly results, it seems to carry a high valuation. However, it's essential to note that Q2 2023 marked the first quarter after NCM LLC's deconsolidation, which could impact the accuracy of these valuations. The latest quarterly data shows NCMI much to demonstrate to its investors. I believe their recent performance isn't reassuring, leading me to lean towards a "sell" recommendation for NCMI to reflect my bearish bias at this juncture.

Business Overview

NCMI serves as a holding company, acting as both a manager and a partial owner of National CineMedia, LLC (NCM LLC), which stands as a leading advertising platform in the US. NCM LLC delivers video and digital marketing solutions to its clientele through various channels, including On-screen and Lobby Advertising, as well as Digital Online and Out-of-Home platforms, all strategically located within movie theater lobbies.

The core programming includes branded content, Noovie original content, and paid advertising sold via direct and programmatic channels. NCM LLC's "Audience Accelerator'' program extends cinema advertising campaigns to online and digital/mobile channels like OTT-connected devices and mobile platforms, targeting moviegoers more precisely through partnerships with entities like ATM.TV, TROOH Media, and Ziosk, NCM LLC also deliver movie-centric advertising in additional venues like restaurants, convenience stores, and college campuses.

The recent bankruptcy of NCM LLC highlights financial difficulties. The failure of NCM LLC to fulfill its debt commitments suggests that traditional revenue avenues from cinema-based advertising are under strain. This may be attributed to several factors, including the impact of the pandemic and a marked shift in consumer behavior towards digital content, coupled with the challenges faced by the cinema industry in the streaming era .

Breaking down NCM LLC's Chapter 11 and NCMI's Implications

On the surface, NCM LLC's decision to file for Chapter 11 seems alarming. However, the aim was not to signal an end but to ensure continuation. Filing for Chapter 11 was a strategic step for NCM LLC to address its financial challenges and is typical for companies looking to position themselves for a stronger future. The Restructuring Support Agreement (RSA) and the Up-C structure allowed for a mechanism where NCM LLC's units can be redeemed for NCMI's public shares. In essence, it offers flexibility, providing liquidity for unit holders. Thus, equity dynamics here are key. Initially, NCMI's substantial 45.8% stake in NCM LLC represented significant influence and potential profit-sharing. However, post-restructuring, this was slashed to 13.8% . In my view, this reduction represents a double-edged sword.

On the one hand, NCMI has lost significant control and will now partake in a smaller chunk of NCM LLC's profits. But, on the brighter side , NCMI's reduced stake comes with a silver lining: a cleaner balance sheet for NCM LLC devoid of cumbersome debts. This debt reduction is, in my opinion, the restructuring's crowning jewel. The ability to convert debt into equity strengthens NCM LLC's balance sheet and removes the shackles of interest payments. This is a classic case of short-term pain for long-term gain. NCMI may have lost some control, but they've potentially set NCM LLC on a more sustainable and growth-oriented path.

However, it's essential to recognize the potential downside for NCMI, notably the decline in NCMI's now separate revenues from NCM LLC, owing to its reduced stake in NCM LLC. Still, this isn't the end of the story for NCMI. The fact that NCMI continues as NCM LLC's manager suggests that operational influence remains intact, at least for now. But, for the foreseeable future, NCMI's managerial role should continue benefiting NCMI. Thus, for NCMI, it's a classic case of having a smaller slice of a potentially larger pie. While there might be short-term repercussions regarding reduced profit-sharing, the horizon could be promising if NCM LLC leverages its post-restructuring strength. If NCM LLC can effectively harness the potential growth opportunities the restructuring has unlocked, NCMI stands to benefit despite its reduced stake.

Valuation Perspective

As a potential investment, NCM LLC stands out as a premier cinema advertising company in the U.S. It functions as a central hub for advertising and content delivery for its affiliated cinema operators. However, it doesn't operate theaters directly. Instead, it has established partnerships with several prominent U.S. theater chains. Notably, its founding members encompass industry giants such as AMC Entertainment (AMC), Cineworld Group ( CNNWQ ) (owner of Regal Entertainment), and Cinemark. At the core of the relationship between NCM LLC and other companies, such as IMAX ( IMAX ) and Cinemark (CNK), is NCM LLC's pivotal role in cinema advertising. NCM LLC seamlessly weaves advertising into the theater experience. In return, theaters receive a portion of the advertising revenue. In my view, this model benefits theaters, providing an additional consistent revenue stream. Furthermore, these collaborations afford NCMI exclusive rights to market and showcase advertisements during pre-show programming, which is a strategic move, as it ensures a captive audience for advertisers.

NCMI's Q3 2023 report reveals structural and financial changes. Most strikingly, after the deconsolidation of NCM LLC on April 11, 2023, there was a marked shift in NCMI's revenue recognition. NCMI's advertising revenue sharply declined by 89.4%, highlighting the extent of NCMI's dependence on NCM LLC's advertising revenue in the past. However, this decline isn't merely a reflection of poor performance. Instead, it is primarily due to a change in accounting for NCMI's revenue from NCM LLC, especially given NCM LLC's filing for Chapter 11. While this drop in advertising revenue may initially seem alarming, it's important to understand the broader context. While advertising revenue took a hit, the management fee reimbursement increased by $7.7 million in the same quarter. This fee, recognized by NCMI for managing NCM LLC, had previously been a less significant contributor to NCMI's top line. I believe that this management fee, although possibly not as lucrative as the earlier advertising revenues from NCM LLC, could provide a more consistent and predictable revenue stream for NCMI going forward. But evidently, NCMI, with the deconsolidation of NCM LLC, fundamentally altered its revenue accounting structure.

Hence, from a valuation standpoint, NCMI seems poised to receive only the "management fee reimbursement" components. The $7.7 million figure over the 79 days post-deconsolidation shows NCMI's estimated annual revenue rate of around $35.58 million. Pricing this at the sector's P/S ratio of 1.07 results in an implied fair value for NCMI of $38.07 million. In contrast, when focusing on NCM LLC's Q2 2023 revenues of $64.4 million and annualizing that number, we infer an estimated yearly revenue of $257.6 million. Using the sector's 1.07 P/S ratio, the fair value is around $275.63 million. However, considering NCMI owns only 13.8% of NCM LLC, its fair value, based on NCM LLC's valuation, would be close to $38.04 million. Therefore, I believe the numbers suggest that NCMI's current market cap might be inflated, which hovers around $365 million.

NCM's internal projections reveal an anticipation of $275.6 million in revenues for 2023, with aspirations to escalate this number to $552 million by 2027. When utilizing the company's forecasted numbers in conjunction with the prevailing sector P/S multiples , I've derived a valuation considering NCMI's CAPM discount rate. This valuation is then averaged with the present values of implied evaluations. Based on this assessment, NCM is again potentially valued higher than its intrinsic worth. Lastly, even if you just look at NMCI's book value , it just has assets of $43.4 million, with liabilities of $62.7 million and a negative equity of $19.3 million. So, Considering the current data and valuation methods used, it seems prudent to recommend a "sell" rating for NCMI at this juncture because I can't seem to justify its current $365 million valuation. The disparity between the actual numbers and the present market perception is too wide to ignore. However, I don't rate it a "strong sell" simply because this is the first quarter since its deconsolidation, so we're still operating with limited information regarding the new NCMI.

Conclusion

The recent bankruptcy and subsequent restructuring of NCM LLC have undeniably influenced National CineMedia, Inc.'s stance in cinema advertising. Although NCM LLC's move to file for Chapter 11 successfully addressed its debt, it's evident that NCMI's investment profile has felt the repercussions. This is particularly evident when considering the inherent challenges cinema-based advertising faces. The Q2 2023 results for NCMI highlight a marked transformation in its trajectory following NCM LLC's deconsolidation. Given the recent changes and the unpredictable nature of the cinema advertising environment, it would be wise for investors to approach NCMI cautiously. Relying on annualized revenue figures for a comprehensive evaluation might provide a partial picture. However, from what is presented, I'd argue the data paints a bearish outlook on NCMI post-deconsolidation. NCMI's revenue figures and reduced stake in NCM LLC raise valid concerns regarding NCMI's present valuation, and for now, I infer that NCMI might struggle to generate sufficient revenue to substantiate its current valuation. Therefore, I maintain a conservative perspective on NCMI. This is why I rate NCMI a "sell." This rating reflects the substantial overvaluation of NCMI post-deconsolidation.

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