Reviews Generally Poor for Cinema Investors

Financial houses that poured hundreds of millions of dollars into movie theaters in the 1990s picked a lemon of a business, judging from the second consecutive year of earnings pressure in film exhibition.

Big-name outfits including Kohlberg Kravis Roberts & Co. (KKR), Merrill Lynch and Goldman Sachs & Co. are struggling with their investments, although at least three firms--Hellman & Friedman, MidMark Equity Partners and Wasserstein Perella & Co.--made big returns by either selling out as the sector downturn began or buying into the strongest companies.

“How they did depends on what they bought and when they bought it,” notes Dennis McAlpine, an analyst at New York-based Ryan, Beck & Co.

Typically, investment firms put up equity capital that is augmented by debt for a leveraged buyout. Because the underlying equity is relatively small, it mushrooms in value if the company prospers. The financial investors usually have board seats and typically hold their stakes for three to five years, after which time they sell out completely.

The worst bet among the spate of recent cinema buys was by private equity firm E.M. Warburg Pincus. WestStar Cinemas, which Warburg Pincus bought in 1996, landed in bankruptcy in September. The 357-screen WestStar includes the Mann circuit in Southern California.

But there are winners too. Big San Francisco-based leveraged buyout outfit Hellman & Friedman says its $85-million investment in Australian circuit Hoyts in 1994 grew to $170 million, after being liquidated in three steps between 1996 and 1998.

New York-based Wasserstein Perella racked up an even better return from leading a 1994 buyout of big-screen projection outfit Imax, which has defied the odds in the depressed cinema category. Wasserstein, which retains a 34.4% stake, figures it generated $20 for each $1 invested.

Imax is something of an exhibition hybrid as its main business is licensing and maintaining projection technology, though it has equity in seven of its theater locations.

“We had the benefit of getting in early enough and getting out early enough not to get swamped by the wave of capital pouring into the business,” said Matt Barger, senior managing director at Hellman & Friedman.

Paradoxically, the current downturn stems from the expansion in theater screens that resulted from the easy money flowing from investment firms. The number of U.S. screens mushroomed to 34,168 at the end of 1998, up from 23,000 at the end of 1987.

The investment firms, which mostly bought into the business in the mid-1990s when movie theaters were highflying stocks on Wall Street, were attracted by a history of steady, albeit slow-growth, cash flow. Another lure is that theaters take in cash from ticket and concession sales immediately but usually pay suppliers, such as Hollywood film distributors, on a delayed basis of 30 to 45 days.

Further, investment firms expected to squeeze more profit by clustering theaters or operating on a large scale for improved efficiency, and also by growing the high-profit area of food and beverage sales.

The slump in late 1997 was a surprise upset. Newly built megaplexes (20 or more screens) began draining audiences from multiplexes (six to 19 screens) of fairly recent vintage at a faster rate than expected.

At the top of everyone’s questionable list is United Artists Theatre Circuit, which an investment group led by Merrill Lynch Capital bought in 1992 and which has the oldest theaters of any major circuit. UATC, although private, disclosed in documents related to its debt that it incurred a net loss of $67.9 million for the first nine months of 1999 but generated $49.3 million in positive operating cash flow during the same time frame, which excludes noncash amortization charges that hurt net results.

The 2,050-screen circuit is shrinking because of closures, though the upside to downsizing can make it difficult to assess Merrill Lynch’s investment. UATC disclosed that it “received $4.8 million as a result of the closure or sale of 22 theaters [118 screens]” that had incurred $1.4 million in negative cash flow in the year prior, because of increased value of land and leases at antiquated theaters.

Some of UATC’s financial transactions may come under fire as it also disclosed that the Internal Revenue Service is auditing its 1995-97 tax returns. Merrill Lynch says the audit is not unusual for a company that underwent a leveraged buyout and it doesn’t expect any problems.

A huge yet-to-play-out investment is KKR and Hicks, Muse, Tate & Furst’s joint ownership of Regal Cinemas, the world’s largest circuit, with 4,239 U.S. screens created in a 1998 merger. Each investment firm holds a 46.3% stake.

Last summer, corporate credit rating agency Moody’s downgraded publicly traded Regal debt by $800 million in face value, reflecting eroding financials.

Nonetheless, Hicks Muse partner John Muse insists that the Regal investment will pay off in time. He says new theater construction is declining industrywide, which is a self-correction phenomenon that he predicts will help industry profits bounce back.

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Big-Screen Investments

Several big-name investment firms are faring poorly in the exhibition business because of the over expansion of theater chains. But a few got out in time--or invested in quality properties that haven’t suffered as much in the downturn. Investment firms and the chains they partnered with:

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Argus Capital

United Cinemas International (no screens)

* Formed joint venture with Prudential in December 1999 to build theaters in Central Europe with United Cinemas International. Expects to put in $25 million in equity for initial cinema construction.

*

Cypress Group

Cinemark USA (2,012 U.S. screens,

564 international screens)

* Bought 44% for $139 million in 1996. Cinemark explored sale in April but no deal materialized.

*

Goldman Sachs & Co.

Carmike Cinemas (2,716 U.S. screens)

* Invested $55 million in 1998.

*

Hellman & Friedman

Hoyts Cinemas (958 U.S. screens,

704 international screens)

* Doubled $85-million investment in 1994.

*

Hicks, Muse, Tate & Furst Inc.

Regal Cinemas (4,239 U.S. screens)

* Invested $500 million in 1997.

*

Kohlberg Kravis Roberts & Co.

Regal Cinemas (4,239 U.S. screens)

* Acquired 46.3% in 1998 and merged its Act III chain into Regal.

*

Merrill Lynch Capital Partners

United Artists Theatre Circuit (2,050 U.S. screens)

* Led $719 million buyout in 1992.

*

MidMark Equity Partners

Clearview Cinemas (260 U.S. screens)

* Put $2.5 million in New York City-area circuit in 1996 and sold for $12.9 million in 1998 to Cablevision Systems.

*

Soros Private Equity Partners

Euro Plex (no screens)

* Funding Pan-European start-up circuit.

*

SCP Private Equity Partners

CinemaStar Luxury Theaters (99 screens in California/Tijuana)

* Bought 75% in 1998 for $15 million.

*

Texas Pacific Group

Virgin Cinemas UK (300 screens in Britain/Ireland)

* Holds 30% stake in Virgin Entertainment, which owned British and Irish theaters from 1995-99.

*

E.M. Warburg Pincus

WestStar Cinemas (357 U.S. screens)

* Put up $45 million in 1996, three years before bankruptcy filing.

*

Wasserstein Perella & Co.

Imax Corp. (98 U.S. screens, 105 international screens)

* Financed 1994 buyout that yields 20-to-1 profit on investment. Still owns 34.4%.