Cineworld faces a bleak future – investors should stay away
Weighed down by crippling debts and with consumers tightening their belts, Cineworld's future does not look bright, says Rupert Hargreaves.
The best investors carefully analyse the probability of certain outcomes to establish the perfect price to pay for an asset. When it comes to Cineworld (LSE: CINE), I think the company’s outcomes are pretty binary at this stage: it will either fail under the crushing weight of its enormous debts or it will continue to bumble along and tread water.
This conclusion might seem harsh, but in my view, it does not have a lot of options at this stage.
The state of Cineworld’s balance sheet is the most pressing issue. Net debts totalled $4.8bn (£3.9bn) at the end of 2021, up some $500m (£407m) from 2020 (excluding leases). To put that into perspective, the stock’s current market capitalisation is just £352m.
It is highly unlikely the business is going to be able to get out from under this crushing debt without some kind of restructuring. Financing costs amounted to $900m in 2021 while box office revenue for the period totalled $956m. These numbers suggest the business is only just generating enough money to keep its head above water.
There are multiple threats to Cineworld’s recovery
In the best-case scenario, Refinitiv broker estimates suggest the firm will earn $140m in 2022, with losses of $31m. If the business hits this target, it might be able to start chipping away at its debt, assuming analysts have factored rising interest rates into their calculations (Cineworld has a range of hedges and currency swaps in place).
But a lot can happen in a year and the company is already asking its creditors for breathing space.
One of the many legal fights Cineworld has become caught up in over the last couple of years is with former investors of Regal, a US movie theatre operator. Cineworld paid $23 per share to snap up the corporation, but US investors have successfully argued that this undervalued the enterprise. To placate the litigants, Cineworld agreed to pay $170m to these investors in September last year. However, with cash reserves dwindling, management had to ask for an extension to the initial deadline to repay the remaining balance.
There’s another big legal elephant in the room. The firm is battling a near-$1bn damages award after it abandoned its $2.1bn takeover of Cineplex in June 2020. Management is in the process of appealing the ruling, but this is yet another threat to the company’s existence.
Even if Cineworld does manage to wrangle its way out of the court award, it still has plenty of other creditors to deal with, suggesting further battles down the road.
The cost of living crisis could wipe out the company’s growth
On the other side of the equation, cinema-goers are returning to the company’s theatres and that’s a positive. Still, when I look at the City’s revenue and income projections over the next two years, they do not fill me with confidence. Cineworld is going to struggle to earn enough from its customers to pay down debt and reinvest. And this is assuming customers do not cut back on spending due to the cost of living crisis.
Reports emerged last year that Cineworld had raised its prices by 40% since the economy reopened to try and recover some of its losses. The price of a single adult ticket is now above £10 with the price rising to more than £16 for the top of the range 4DX experience. Are people going to keep paying £20 (without popcorn and drinks which could set you back another £10) when they’re watching every penny? I’d rather subscribe to Amazon Prime for £79 a year with Prime Video, free delivery, music streaming and photo storage for free.
When I consider all of the above, it’s clear to me that the odds are stacked against Cineworld.
Even in the best-case scenario, where the company returns to profit next year, it will still face an uphill struggle to reduce debt and convince consumers to keep spending.
All of this suggests that the odds of Cineworld recovering to its former glory are very low and its odds of continuing to struggle are very high. Management has reportedly been looking at options to raise cash, including a public offering of its US business. With interest rates on the up, raising more money could become a pressing issue for the enterprise, although unfavourable market conditions may put pay to any IPO ambitions.
The company is running out of options. Investors may be better off staying away.