A CINEMATIC IPO IN T&T… READ ON!

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A Firstline Securities Limited Blog by: Jonathan Wilson

Summary

CinemaONE Limited (CINE1) is offering ordinary shares via an Initial Public Offering (IPO). A successful IPO will make CINE1 the first listing on the SME or Small- to Medium-sized Enterprise Market on the Trinidad & Tobago Stock Exchange (TTSE). This blog includes a quick overview of the company, the key risk drivers from our perspective and a valuation and general recommendation on the shares.

Description                                                                                                               

Offer, Company & Fundamentals Summary

Valuation

We classify CINE1 as a growth stock for two reasons: it has a clear objective to expand and its offer price against key fundamentals strongly suggests that attractiveness of the price depends heavily on expectations of success for said expansions. This classification contrasts with value stocks where investors seek a “cheap” price for the same expectations.

Our valuation approach comprised, in large measure, discounted cash flows of the condensed projected financial statements within the prospectus. We put much less emphasis on comparables valuation using multiples, because we consider listed local companies as materially different in terms of size, core business and years in operation.

Comparables Summary

The vast majority of the Trinidad & Tobago Composite Index is in the Financial Sector. With that caveat in mind, we compare the Select Ratios from the Description section earlier with the index and a range based on select listed companies whose segments are loosely similar to that of CINE1.

Discounted Cash Flow Summary

Between the projections below and the 2017 Management Discussion & Analysis, we choose to work from the 2019 forecasts and beyond with additional assumptions and analysis to estimate the intrinsic value. It is not unusual for such forecasts to be overly optimistic: CINE1 projects tripling its net profit margin and more than doubling its operating margin within four fiscal years. As below described, we can make assumptions to take such biases into account instead of re-projecting statements directly.

Our general process was as follows:

1. We approximate the Free Cash Flow to Equity using the Net Cash Flow projections and take the Dividend Payout as it is.
2. We assume the expansion plan is accomplished in 4 years by 2022, after which CINE1 achieves a steady-state growth rate that ranges from 1% to 2%. Our less likely, worst-case scenario was an 8-year expansion.
3. We calculate for both measures of cash flow and in both scenarios the implicit annual rate of return that investors demand if entering at the TTD 10.00 offer price.
4. We put these required returns into context based on market data available about government yields (as a minimum return), the expected liquidity (or cost when buying and selling CINE1 shares on the TTSE) and other risk premia such as the small size of the company relative to the first tier listings.
5. We use this context for using ranges of all the above assumptions for various estimates of CINE1 value.

Valuation Summary & Recommendation

Our estimated range of CINE1 shares at IPO is TTD 7.81 – TTD 11.15. We consider the offer price of TTD 10.00 to be relatively high for a fair price. Thus, while there is ample room for return, more often than not, we think investors will have overpaid for those returns.

We classify CINE1 as a growth stock; thus we can recommend it only for long-term investors and or (diversifying) aggressive growth allocations to local equity. The offer price is materially above our core estimate of intrinsic value; the short-term risk of capital loss or at least above-market-average liquidity risk as well as the lack of value investment opportunity leads us to recommend that the average investor instead considers better established local companies for similar return opportunities but for relatively less risk.

History 

CINE1 operates in Trinidad & Tobago, offering differentiated and innovative digital cinema entertainment in multiple, premium movie formats. CINE1, formerly Giant Screen Entertainment Holdings Limited (GSEHL), was incorporated for licensing and deploying the first IMAX theatre in the Caribbean and entering the cinema exhibition market in Trinidad with patented IMAX and IMAX 3D technology.

On June 8, 2010 CINE1 entered into an exclusive 15-year IMAX License Agreement with IMAX Corporation, and two additional 5-year renewal periods for a total licensed period of 25 years. CINE1 also executed a 15-Year Lease Agreement with Home Construction Limited (HCL) to locate the IMAX Trinidad theatre in the heart of Port-of-Spain within the upscale One Woodbrook Place (OWP) urban development project. CINE1 initiated construction of the IMAX theatre in early 2011; the theatre was opened to the public in August 2011 as the Digicel IMAX, following the successful execution of multi-year title sponsorship agreement with Digicel Trinidad and Tobago Limited. Thus, CINE1 launched successfully: the first large format IMAX movie theatre in the Caribbean, with the region’s largest screen (72ft wide by 40ft high).

After 3 years of profitability, CINE1 expanded into a multi-cinema screen or multiplex venue at OWP. In 2016 (fiscal 2017), CINE1 launched its luxury, designer theatre format branded Gemstone. CINE1’s Gemstone multiplex offers in-theatre dining inclusive of cocktail, wine and beer service combined with convenient push button seat side service. Gemstone facilities are equipped with digital projector systems, surround sound and fully reclining seats. Its location is one floor above the IMAX Trinidad at OWP. This fiscal 2018, CINE1 recently introduced the first 4D theatre in OWP. Through partnership with one of South Korea’s media conglomerates, CGV Limited, this brings environmental elements such as motion, wind, mist and light rain to the cinematic experience.

Business Model

CINE1’s strategy is to target high-traffic locations, such as malls and plazas, in demonstrated strong movie-markets and to construct premium, differentiated movie theatre multiplexes with a minimum of 5 to 8 screens. CINE1 plans to match available space and market demographics to deploy the most appropriate, innovative formats of premium cinema such as IMAX, Gemstone, 4DX and others in its new theatre development projects.

CINE1 employs a range of marketing activities: including a mix of above-the-line and below-the-line marketing. For the former, CINE1 leverages its sponsor relations, particularly those of Digicel Trinidad and Tobago, its title sponsor, and Atlantic, its educational sponsor. CINE1 further focuses on specific movie marketing that effectively captilalises on the Hollywood studio budgets and media impact of blockbuster titles, their stars, directors and producers. CINE1 also uses social media and in-theatre dress-up campaigns, movie awards and other marketing and PR to push a movie title. CINE1 is also actively in the process of establishing a rewards program to enhance customer intimacy.

CINE1’s marketing campaigns are extended to and solidified by a strong focus on in-theatre custom service. The majority of CINE1’s current staff of 54 persons is actively engaged in customer-facing operations. (Note that as of September 30, 2017, staffing was 16 and 49 between corporate and support, respectively.) Support staff has been professionally trained and educated in the tourism and hospitality industries. Services include online ticketing and barcode scanning. Key metrics and data analytics are used for quality control.

Purpose of the Offer & Use of Proceeds

The specific purpose for the IPO offer is as follows:

1. Launch the 4D movie theatre experience in Port-of-Spain, increasing the movie screens to six at CINE1’s anchor site in OWP.
2. Expand Gemstone into Gulf City Mall, San Fernando, potentially combined with another differentiated movie experience.
3. Deepen customer appeal through use of high-impact movie theatre technologies, strong and integrated IT platforms and a myriad of social media connectivity.
4. Capture 10%-15% market share in target markets and more rapidly grow the overall business.
5. Emerge as the first SME listing on the TTSE and benefit from the reduced 10% corporate tax rate [applicable for 5 years].
6. Spread share ownership and anchor CINE1 as a community asset within each market that CINE1 operates.

CINE1’s minimum required net proceeds for the IPO listing on the SME exchange is TTD 13,000,000. Where the minimum is not raised by CINE1 prior to the Closing Date, inclusive of any extensions and such extensions not to exceed 90 days from the Opening Date or commencement of the distribution [September 17, 2018], then the IPO Offer and distribution shall cease and the funds raised shall be returned to subscribers.

CINE1 estimates that it will receive net proceeds from this SME offering of approximately TTD 30,183,737, after deducting estimated brokerage commissions and advisory fees and other offering expenses. These proceeds will be used to at least triple the current screen count of CINE1 from 6 to over 18 screens and to geographically diversify CINE1’s operations with the launch of two additional sites. One will be located in Trinidad & Tobago, and the other is intended to be developed in a USD-denominated destination, where negotiations have reached a “very advanced stage”.

Dividend Policy

CINE1’s dividend policy is to distribute to shareholders cash in excess of operating requirements, at the discretion of its Board of Directors. CINE1’s total annual dividend payout percentage shall be equal to a minimum of 30% and a maximum of 50% of profit available for distribution (PAD). Per its policy, we think the PAD definition (see Prospectus page 18) effectively equals Free Cash Flow to Equity.

Key Risks

Please read the Risk Factors of the prospectus on page 24, if nothing else. We summarise our considerations and the prospectus’ below.

Regional and Local Macroeconomic & Business Cycle Risks

• A prolonged economic downturn and or reduced consumer spending in the entertainment industry;
• A devaluation of the Trinidad & Tobago dollar or worsening constraints in the availability of United States dollars, effectively increasing or hampering capital expenditures for new theatre development projects
• Increasing interest rates or tightening covenants in bank debt agreements, restricting CINE1’s ability to borrow and invest.
• Accelerated or above-average inflation that can negatively impact CINE1’s operating margins.
• Real estate development restrictions or constraints related to permitting, licensing, construction material supply and construction labour, all of which may vary based on the country or municipality.

Industry & Idiosyncratic or Company-Specific Risks

• A lack of motion picture production and poor performance of motion pictures would have a negative effect on film attendance. Similarly, the success of CINE1’s IMAX theatre is directly related to the availability and success of IMAX films for which there can be no guarantee.
• CINE1 is subject to uncertainties relating to its future expansion plans, including its ability to identify suitable site locations.
• Deterioration in relationships with film distributors could adversely affect CINE1’s ability to obtain commercially successful films.
• CINE1 faces competition and the introduction of new, competing products and technologies could harm CINE1’s business. Similarly, an increase in the use of alternative film distribution channels, such as home theatre video and the internet, and other competing forms of entertainment may drive down movie theatre attendance and limit ticket prices.
• CINE1’s results of operations may fluctuate on a seasonal basis and may be unpredictable.
• The loss of services of one or more members of CINE1’s leadership team could adversely affect CINE1’s business, results of operations and its ability to effectively pursue its business strategy.
• Terms of leases and lease renewals are subject to uncertainty or unfavourable renegotiations.
• As on the macro level, long-term debt financing may not be attainable on favourable terms, and may restrict one’s ability to fund current and future operations and restrict one’s ability to enter into certain transactions.

Market Sentiment & Liquidity Risks

• The successful oversubscription of the National Investment Fund in August 2018 suggests that the market has appetite for investment in general. On the other hand, NIF bonds were especially well marketed and carefully structured for the masses to be successful. Second, CINE1 is a straightforward business that may attract the average investor, but its business lacks the qualities of a good “story stock” where an IPO tends to excite most investors to get carried away without much due diligence.
• Liquidity risk refers to the ease of trading shares. We expect CINE1 to trade with a bid-ask spread similar to the higher end among those on the TTSE; these ranged from 4% – 8%. For example, if CINE1’s strategy performs, then it will be difficult to participate in the secondary market without paying about that spread higher than the market price. Conversely, it will be difficult to sell the shares against unfavourable news without giving up at least that much value to a potential buyer.