When it comes to the UK cinema market, private equity rules with the swagger of King Kong on Skull Island. However, the big beasts of the financial world will hope to enjoy a smoother journey when travelling to foreign soil than their cinematic counterpart.
There are three major cinema groups in the UK. With Terra Firma behind Odeon, Blackstone supporting Cineworld and Doughty Hanson’s acquisition of Vue Entertainment in late 2010, the asset class has a golden touch for the UK’s silver screen.
When Real Deals spoke to Terra Firma chairman Guy Hands in early 2011, he stated his belief that Odeon was the “only pan-European cinema chain”. However, Doughty-backed Vue’s recent takeover bid for German cinema chain Cinemaxx threatens that claim. The deal has already been approved by majority shareholder Herbert Kloiber, who holds an 84.6 per cent stake. Promisingly for both players, Hands also opined that the cinema market in continental Europe is still fragmented, with plenty of room for consolidation, saying it is “where the UK was around eight to ten years ago”.
Beyond there being plenty of space for acquisitive growth, there are other reasons why private equity is an avid supporter of the sector. Cinema has remained the only segment of the leisure market to thrive during the downturn as cash-conscious consumers seeking a night out turn to the big screen for its contained cost. Furthermore, with DVD piracy so difficult to stamp out, Hollywood studios depend on box office sales to ensure big profits for their features. Consequently, it is the studios themselves that take the lead (and the cost burden) on major advertising and marketing campaigns to ensure those vital ticket sales.
Then there are the juicy margins to be made on popcorn, snacks and beverages. The mark-up on popcorn is typically around 90 per cent, and to ensure cinema-goers buy their movie fodder in the theatre (rather than the Tesco Express next door), an increased and improved food and drink offering is creeping in. Odeon recently introduced franchises including Costa Coffee and Ben and Jerry’s to several of its sites.
However, as with any internationalisation, much care needs to be taken over understanding the local culture and tastes of the new market. And in Germany, it is often noted that cinema-goers have a somewhat eclectic taste in films. This year, French feel-good comedy The Intouchables, concerning the unlikely relationship between wealthy tetraplegic Phillip and out-of-pocket, ghetto-born hired help Driss, brought in record audiences throughout Germany (and much of continental Europe). By contrast, the film has yet to make it to the UK after it was slammed by US critics, including Variety, which described it as offensive due to its leaning towards “Uncle Tom racism”.
According to Tim Richards, chief executive of Vue, this isn’t a problem. “If we were going into a new market and starting from square one there would be some concern. However, when buying the top company in the country, you know what you’re getting.”
Digitisation has transformed the business of cinema, enabling owners much more flexibility and efficient control of their screens. Richards points out that by next month, Vue’s UK sites will be 100 per cent digital.
A report from the European Commission in 2009 highlighted the slow pace at which continental Europe had adopted digital cinema technology. And Cinemaxx is no different. Despite boasting stadium-style seating throughout the entire chain – ensuring every viewer has a perfect sight line, a key differentiator for Vue cinemas – Richards concedes that only a third of Cinemaxx has digital screens.
“It will be fully digital within the next 12 months,” he notes. Fortunately, Vue is not shy when it comes to paying out large sums for the refurbishment and modernisation of its sites. The company has spent over £100m (€127.5m) in the last four years on new screens, technologies and even reclining red leather VIP seating. “We’ve spent £30m this year alone,” adds Richards.
The gargantuan spend on ensuring the highest quality and most technologically advanced cinema offering may be painful for Vue’s spreadsheet-trained private equity backers, but with other major competing forces in the market, it is vital to deliver an attractive level of differentiation.
Furthermore, if Cinemaxx’s remaining 15.4 per cent shareholders accept Doughty’s offer of €6.45 per share (a 45 per cent premium on its closing price on 9 July), then it will have pulled off a seriously impressive deal. The offer represents six times historic Ebitda. Late last year the company was trading at a meagre €3.30, although even this was almost three times the level seen two years prior. When compared to the Kinepolis Group in Spain and Brussels, which has seen shares trading well above €50 for several years at a 6.8 times Ebitda multiple, Cinemaxx feels cheap.
Growing acquisitively across Europe is now firmly on the cards for both Vue and Odeon. However, for Vue, this growth strategy will be predicated on choosing wisely. “We are only looking at high-quality assets,” asserts Richards, who claims the chain has already had to turn down several approaches from sellers.
Through careful selection, Vue can become a major force across Europe, and when the Cinemaxx takeover is complete it will soon be snapping at Odeon’s heels. Perhaps the right cinematic metaphor for private equity’s European approach is of James Bond – using cutting-edge technology and a certain ruthlessness with the intention of making a killing.