Theater Contraction is Inevitable

I have been openly short and down on the movie theater business on Stocktwits since May 2017. I’ve been asked by a number of people both online and in real life about why I have this opinion so I am going to detail my basis for the theory that will, in my opinion, lead to the title of the article.

My landing on movie theater companies was due to a couple of situations. I had already made 650% earlier this year on National Cinemedia, (NCMI), June $10 puts, (this was detailed in my posts on Stocktwits real time), which made me wonder if the advertising revenue in theaters dropping maybe was the canary in the coal mine for the whole industry. I was also short a number of Mall REITS and I was looking for a second level to the trade, something that wasn’t so prevalent in the headlines. What I discovered became  my current biggest position, owning puts on Regal (RGC), and Cinemark (CNK).

(For all intents and purposes if I refer to being “short” I am referring to being long puts, which as you most all know typically appreciate in value as the underlying equity depreciates in value.)

I thought that Regal and Cinemark’s charts should look just like Mall REIT charts, all basically a downward funnel towards the bottom right of whatever chart you look at, however what I found wasn’t anything at all like that. (This is as of May 2017 btw, and all these stock quotes are estimated).

Regal had gone from $21~ a share to about $22 from 5/1/16 to 5/1/17, so not only did it fail to look like an ugly Mall REIT chart it went up nearly 5% for the preceding 12 months. Cinemark was even more shocking, it went from $35~ a share to about $43.50 a share in the same time frame, which is a gain of almost 25% that 12 months! That was my first indication that I was ahead of the masses on the trade, and it made me look much more closely. I also reviewed IMAX and AMC too, but I felt that their balance sheets were stronger than Regal’s and their stocks had already been punished more than Cinemark’s or Regal’s which led me to start with Regal puts.

After careful review of Regal’s balance sheet, they had an estimated shareholder equity position of -$800m, they had declining box office attendance, a lot of debt, and a 17.9% ownership of the common stock in NCMI. I felt that Regal’s ability to handle any rocky spots financially was the lowest of all it’s peers so Regal became my main target.

My first purchase was $20 Oct puts in early May, Regal was almost $22 a share then, and the puts were only $.85. I added Jan $17.50 puts for $.50, (now @ $3.30), on an up day for Regal in June, then once I felt like the wheels were partially coming off just a few weeks ago I added Jan $15 puts for believe it or not $.35 a share. In the past week when Regal spiked up a bit I took off between 30-50% of each of those three put positions and rolled most of the funds into Cinemark $25 puts for March, and $12.50 puts for Regal for both Oct and April expiration.

With regard to my Cinemark holdings, I bought March $30 puts for $.85 in mid August, and just last week added the March $25 puts from my Regal proceeds. The profit from my original Regal positions have netted me what is now close to a free roll, meaning almost my entire theater short position is from the profit on those first 3 batches of Regal puts.

Now if you made it this far you are going to get the good stuff…The fundamental reasons why I loved this short to start and love it even more now are…

  1. Malls and strip malls have less traffic than ever, and lots of theaters are in these places. Not good.
  2. There is an epic assault on the theater concept, Amazon Video, Youtube, Netflix, Apple TV, Hulu, and on and on. The movie goer has a finite amount of time and money and the theater has more competition than ever.
  3. Raising ticket and concession prices is an unsustainable model. You cannot simply raise prices on a decreasing audience indefinitely, see Economics 101 at your local college.
  4. Regal owned 27,600,000~ shares of NCMI at the end of Q2. This position has lost $57,408,000 just since the end of Q2 on June 30th! This will wipe out about a whole quarters profits and they need to address this instead of burying it on a 10-Q!
  5. Cinemark owns even more as of their last 10-Q, 27,871,862 shares. That means Cinemark has lost $57,973,000~ just this quarter on it’s NCMI holdings.
  6. Both Regal and Cinemark will have to quantify these, at the moment, on paper losses and if you look at what happened to AMC when they quantified their NCMI losses I am expected a 20-25% drop in a day for Regal and Cinemark when they do that.
  7. Some of my reasons were technical on the charts. Both Regal and Cinemark would find little support if they did break through their recent lows in my opinion and that is exactly what has happened.

 

In closing I wanted to say that I literally have two net short positions in my portfolio, and they are the two ones mentioned above. I am an optimist, I am a cup half full type of guy. I have numerous long positions, and if you look at my original posts of Stocktwits I accurately called a number of bullish situations too. This movie theater situation is just a Goldilocks scenario to be short in my opinion. In five years will there be more movie theaters or less? Can theaters be profitable enough to pay 4%+ dividends like they do now? Will the average family fork out $60-100 for a trip to the movies when they can get an entire month of Netflix for ten bucks with all you can eat and drink at home?

I know that there might be a pop, or even a run up in RGC and CNK, and this may turn into a bad trade. The only thing I may be missing is the timing, for without any question in the world, Movie Theater contraction will occur, it is a certainty. Good luck out there-

 

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