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Market Musings - December 30, 2017

We continue our blog series: Market Musings, Volume 1, Edition 18, giving our (hopefully not too random) thoughts on recent goings-on in the markets. Today, we present Drive-By Analysis: National CineMedia (NCMI) Edition.

Today, we present a brief look at National CineMedia (ticker NCMI). As of the end of Q3 2017, NCMI owned 48.8% of National CineMedia, LLC ("NCM LLC", i.e., the operating company), which sells movie theatre advertising under long-term exhibitor services agreements (“ESAs”) with NCM LLC's founding members (American Multi-Cinema, Inc. and AMC ShowPlace Theatres, Inc., wholly owned subsidiaries of AMC Entertainment, Inc. (“AMC”), Regal Cinemas, Inc. and Regal CineMedia Holdings, LLC, wholly owned subsidiaries of Regal Entertainment Group (“Regal”) and Cinemark Media, Inc. and Cinemark USA, Inc., wholly owned subsidiaries of Cinemark Holdings, Inc. (“Cinemark”)) and certain third-party theater circuits, referred to as “network affiliates” under long-term network affiliate agreements, which have terms from one to twenty years (average of approximately 19 years remaining as of September 28, 2017).

When one of the founding members acquires additional movie theatres, these can be added to NCM LLC's active advertising client roster (and such founding member will receive additional units of the operating company in exchange), however the applicable founding member must also make so-called "integration payments" (make-whole amounts) so long as alternative (i.e., non-NCMI) advertising agreements remain in place for such theatres. This is further explained in NCMI's Q3 2017 10-Q filing, page 11, as follows:

Integration Payments and Other Encumbered Theater Payments—If an existing on-screen advertising agreement with an alternative provider is in place with respect to any acquired theaters, the founding members may elect to receive common membership units related to those encumbered theaters in connection with the Common Unit Adjustment. If the founding members make this election, then they are required to make payments on a quarterly basis in arrears in accordance with certain run-out provisions pursuant to the ESAs (“integration payments”)... The integration payments will continue until the earlier of (i) the date the theaters are transferred to NCM LLC’s network or (ii) the expiration of the ESA. Integration payments are calculated based upon the advertising cash flow that the Company would have generated if it had exclusive access to sell advertising in the theaters with pre-existing advertising agreements. The ESA additionally entitles NCM LLC to payments related to the founding members’ on-screen advertising commitments under their beverage concessionaire agreements for encumbered theaters. These payments are also accounted for as a reduction to the intangible asset. During the three and nine months ended September 28, 2017 and September 29, 2016, the Company recorded a reduction to net intangible assets of $6.9 million, $0.7 million, $11.6 million and $1.5 million, respectively, related to integration and other encumbered theater payments. These payments received from AMC related to their acquisitions of theaters from Carmike and Rave Cinemas and from Cinemark related to their acquisition of theaters from Rave Cinemas. During the three and nine months ended September 28, 2017 and September 29, 2016, AMC and Cinemark paid a total of $4.6 million, $0.7 million, $6.1 million and $1.7 million, respectively, in integration and other encumbered theater payments (as payments are made one quarter and one month in arrears, respectively). If common membership units are issued to a founding member for newly acquired theaters that are subject to an existing on-screen advertising agreement with an alternative provider, the amortization of the intangible asset commences after the existing agreement expires and NCM LLC can utilize the theaters for all of its services.

As seen from the stock chart above, NCMI shares are down substantially from the February 2007 IPO initial trading level of ~$26 and are off over 50% just in the past year. In addition, over its history NCMI has paid out $8.90/share in dividends, meaning total shareholder return has been minus 40% over the past ~11 years. Thus, to put it mildly NCMI has been a terrible investment. The main reason for the recent stock decline appears to be poor attendance for the domestic movie industry in 2017 and the worry that NCMI may have to cut its $0.88 per share annual dividend (the dividend yield is nearly 13% currently).

So how safe is the dividend? Below is the statement of cash flows for NCMI for the first 3 quarters of 2017:

From the cash flow statement, we find that NCMI on a consolidated basis generated approximately $85 million in operating cashflow (ex-working capital changes), spent $8 million on capex and made $102 million of distributions to shareholders and founding members (the holders of NCM LLC equity). This means that FCF after all distributions was negative $25 million for the period, which amount was made up with proceeds from sale and maturities of marketable securities. Looking at the most recent balance sheet, though, NCMI cannot go to the "marketable security well" any further, as these have run down to just under $4 million. Furthermore, NCMI's net debt is quite high, at $880MM, or around 4.35X expected adjusted OIBIDA of ~$202MM (down ~12% versus 2016) on the low end of the company's guidance range, so it would be prudent to pay debt down with money saved from a potential dividend cut. Below is NCMI's most recent balance sheet:

As a caveat to the above discussion, however, it should be noted that NCMI's most important quarter is Q4 each year, so it is possible the company could make up some of the $25 million post-distribution FCF shortfall for the first 9 months of 2017 with a strong final quarter. Per the company's most recent Form 10-K filing, in 2016 NCMI on a consolidated basis generated positive $41 million in post-distribution cashflow (ex-working capital changes) for the full year, including positive $31 million in Q4 of 2016. (Note that it is difficult to accurately assess how much of this cashflow actually belongs to NCMI, due to the substantial noncontrolling interest in NCM LLC held by the founding members.)

If NCMI were to suspend its dividend, the company could use the resulting ~$56 million additional annual cash to pay down debt. Below is the schedule of NCMI's debt maturities as of the end of Q3 2017 (from page 15 of the Q3 2017 Form 10-Q):

From the above, we learn that the company has $270 million of term debt maturing in just under two years. The weighted-average interest rate on the term loans as of September 28, 2017 was 4.0%. Clearly, it would be prudent to try to reduce this debt balance as much as possible prior to maturity, since NCMI may end up having to pay a higher interest rate by late 2019 should its financial performance continue to lag (as it has this year).

Assuming a dividend suspension in order to lower leverage, is NCMI currently attractively valued? NCMI's market cap now stands at $539 million (as of November 2, 2017, 78,501,468 shares were outstanding), meaning NCMI's enterprise value (or EV) is $1.42 billion, or 7X 2017 expected OIBIDA. Assuming a pre-dividend (but ex-working capital change) FCF number for 2017 of around $60 million (or $20 million less than 2016) attributable to NMCI (i.e., after deducting FCF belonging to non-controlling interests), the shares now yield 11% versus its market cap. Adding back around $55 million in NCMI interest payments for 2017 results in a FCF + Interest yield of 8% versus its EV. In either case, assuming the company can adequately deal with its debt maturities (an important assumption, to be sure), NCMI's valuation appears attractive in a ZIRP environment.

Finally, we note that hedge fund Standard General has taken a 13.25 million share (~17%) position in NCMI recently, including purchases close to current market price levels (source here):

For more information on Standard General, please see its Wiki entry here and website here.


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