Mon 02/01/2021 12:47 PM
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The middle-market movie theater industry is one of the industries hit hardest by the Covid-19 pandemic because its central feature is an in-person experience. Many industry experts anticipate that the industry will not start to recover until a vaccine is widely available and a large portion of the public feels comfortable in a crowded setting. But even then, the industry will have to adapt in order to survive. Continue reading as our Americas Middle Market team analyzes the middle market movie theatre industry and the impact from Covid-19 and Request a Trial for access to our coverage of thousands of other stressed/distressed debt situations as well as access to the linked documents.

The movie theater industry was already slowing prior to the onset of the pandemic, but stay-at-home orders forced studios to quickly pivot to releasing content on streaming services amid high demand for content. Domestic box office total reported revenue from 2020 declined 80.3% year over year to $2.2 billion, according to data from analytics firm Comscore. The shift in consumer behavior is likely to stick even when pre-pandemic life resumes.

“Our expectation based on what we see is you’re not going to see attendance back to normalized levels for two years, but at reduced capacity from pre-covid levels,” said Russell Mason, a director at Houlihan Lokey. He added that he expected that attendance “will be down 20% from historic levels from competition like streaming. The pandemic has accelerated that trend.”

Smaller movie theaters are likely to face a period of restructuring and consolidation as 25% capacity at many theaters is not sustainable for cash-intensive business with high fixed costs, said Robert Feinstein, managing partner of the New York office of Pachulski Stang Ziehl & Jones.

Between the pressure that the Covid-19 pandemic has caused and the market share that streaming services have squeezed, many middle-market theaters may simply fold, Eric Wold, senior analyst at B. Riley Securities, said. “I think you're [going to] see probably a lot of smaller chains that don't make it through. Maybe decide they don't want to deal with the added burden and headaches of kind of post-Covid world,” Wold said. “You could see some of these smaller chains[] fold up or potentially be acquired by some of the larger ones once the large ones get a little more stability.” With capacity utilization concerns swirling and consumer behaviors remaining a question mark, less-efficient chains could force the industry overall to become efficient, he added.

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Colin Adams, senior managing director at M-III, agreed, adding, “It should be the case that companies with better balance sheets are the consolidators. But the question is, What are you consolidating to? The environment for these businesses appears to be reduced pricing power and lower volumes. Why are folks buying? What is my investment thesis if I am a consolidator in the exhibition business?”

Also driving uncertainty around near-term consolidation is a lack of recent deals in the space and no indicated market clearing price, Cynthia Nelson, a senior managing director in FTI Consulting’s corporate finance and restructuring segment, pointed out. “I think consolidation is inevitable though - and we're going to see fewer screens in the future. But when that actually happens, it’s still very uncertain,” Nelson said.

In addition to increased competition and reduced capacity, middle-market movie theaters are also grappling with a lack of access to capital markets that larger chains have access to. Without the revenue to entice lenders, smaller theaters are left with fewer avenues of survival.

“I don't think they have the same access to capital that the larger players do, for the most part,” said Nelson. “They probably have founder-owners, and they're just not able to necessarily raise the capital as quickly or easily as some of the others.”

Art Penn, founder and managing partner at PennantPark Investment Advisers, agreed, adding that larger chains are able to “access capital more efficiently because loan buyers are forced to deploy,” whereas “middle-market investors tend to be a bit more thoughtful and in less of a rush to deploy capital.”

Government Funds Provide Relief … for Now

Some middle-market movie theaters will also receive support from the Covid-19 Relief Bill that former President Donald Trump signed into law on Dec. 27, 2020, which earmarked $15 billion in funding for live venues, independent movie theaters and cultural institutions. Eligible entities will have gross revenue earned during the first, second, third or fourth quarter in 2020 that is at least a 25% reduction from gross earned revenue during the same quarter in 2019.

However, several market experts said that the government funding was just a temporary fix on a long-term problem, particularly because the funding is specific and defined. Funding “will help to bridge theater operators, but it is unclear what it is bridging to,” Houlihan Lokey’s Mason said.

Frederick Hill, a managing director in FTI Consulting’s Strategic Communications segment, said that the bill is clearly geared toward those businesses that have been hit harder. However, he said it is important to consider the intent of lawmakers - the goal was likely to keep these businesses open for the time being, but they are not likely concerned with who ends up opening said businesses.

Between vaccine rollouts, consumer behavior, studios and production, and the individual financials of any given theater, it is almost impossible to say whether the legislation is the solution lawmakers hope it is, Hill said.

“This isn’t intended to be permanent, it’s intended to kind of get through a phase to a better time,” Hill said.

While it is difficult to assess how the stimulus will affect credit opportunities, Hill said the extra cushion could make businesses that are not currently viable for investment more attractive.

Movie Theater-Production Studio Symbiosis

The industry is not likely to disappear altogether because streaming does not generate the same level of revenue as movie theaters do. The same box office results simply will not be achieved without large studios bringing their content to the big screens, which is one reason why filmmakers and studios are hoarding content until a later date - they need the money theaters offer.

Even as the virus spread, consumers still found ways to enjoy movies in a communal setting at drive-in theaters, said Paul Dergarabedian, a senior media analyst at Comscore.

“The success of drive-ins to me was the most encouraging sign to theatrical exhibition - that people, despite having so much content available at home, were finding a way to go see a movie on a big screen,” he said.

Smaller cinemas with less revenue, however, subsequently have less pull with the studios that the industry relies on. The situation presents a Catch-22 for theaters, as film exhibitors rely on content that will motivate consumers to come to theaters and studios rely on theaters to realize revenue that is not achievable in streaming alone.

“Movie theaters are absolutely in very tough circumstances, but they also need the studios to provide them with great content, great movies,” Dergarabedian said. “Within the studios they have to look at, With a truncated marketplace, how am I going to earn back those dollars for a very expensive production?”

A More Expensive Future Existence?

Movie theaters are likely to incur higher fixed costs than prior to the onset of the pandemic because they will need to purchase and maintain items such as plexiglass shield protection barriers for seats and personal protective equipment, or PPE, for staff, among other items, and spend more money on cleaning so that moviegoers feel safe, Bradford Sandler, a partner at Pachulski Stang Ziehl & Jones, said.

On the flipside, lease-related fixed costs could come down amid pressure in brick-and-mortar retail rents, and capital remains relatively accessible and low cost for many borrowers.

According to B.Riley’s Wold, the survival of many middle-market movie theaters thus far is also partially due to supportive sponsors, lenders and landlords as evidenced by the number of debt raises, lease negotiations, amendments to facilities and covenant waivers as the market faltered. However, that flexibility is still contingent upon the market’s future and the consumer’s ability to go to a movie theater, which is evident as larger chains take steps to ensure they have the liquidity and capital to sustain themselves in the meantime. “They've been pretty amenable. I think as long as there is a belief and hope that things can start getting back to normal this year, I think they've been willing to kind of be flexible,” Wold said.

Landlords have also been generally flexible with their movie theater tenants throughout the pandemic, either granting tenants a percentage rent deal or deferring rent. William Snyder, a partner at CR3 Partners, said it is likely landlords will continue to be open to various ways of paying rent because they are realizing the significance of having movie theaters, which tend to be anchor tenants, open. “After being in this for almost a year, they totally get that they don’t want these screens dark. I think landlords are becoming very, very understanding of keeping these stores open,” Snyder said.

Still, landlords are going to want quality-credit tenants, Mason asserted. If a movie theater chain “has an over-levered balance sheet and there isn’t a path forward, they’ve deferred rent for nine or ten months, at least in more desirable locations they’ll have competition that’s approaching landlords.”

One legal source added, however, that while landlords might have been lenient at the beginning of the pandemic, this year will likely bring more REIT filings, which should have a “trickle-up effect to middle market movie theaters.”

--Millie Dent, Ellen Schneider
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