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Saving the Silver Screen in the Streaming Age
Part 1 of a four-part series: Exhibitors face significant financial challenges necessitating extensive restructuring.
Movie theaters are a key piece of Americana, but due to changes in consumer behavior (catalyzed by television), a theatrical product that hasn’t evolved to meet these changes, and an ill-conceived debt-laden expansion strategy, major theatrical exhibitors are uniformly on the verge of bankruptcy. The necessary decisions are easy; the intestinal fortitude is not.
Read Time: 13 minutes
“Theaters are dead”
So proclaim the talking heads from all sides - critics, podcasters, even industry insiders. We’re living in the Streaming Age, after all, in which content is abundant and consumable on demand everywhere.
One of the major victims of this abundance is the now lowly movie theater; the once hallowed structure that exists as a talisman of an earlier, simpler time, when cars were still luxuries and the American dream was unironic (and still white as Wonder bread).
No, actually, that’s not correct. The Streaming Age did not catalyze, nor does it necessitate, the demise of the theater.
This halcyon institution was, in its heyday, the dominant form of distribution technology for delivering films (on actual film) to consumers. And, like all technologies, it was displaced by newer, different, and not always better technologies.
Movies were, at one point, the dominant form of filmed narrative content, but they’ve become a little less dominant every year for the last 70 years:
As Byrne Hobart notes:
“Theatrical releases will still be around for a long time as marketing events, just as video game retailers kept doing midnight release events well after gamers had mostly switched to downloading. But the theater model has been permanently impaired by the growth of streaming, which has created more ways to release a movie and meant that IP owners who also have streaming services have a stronger bargaining position with other distribution channels.”
Or perhaps famed movie critic AO Scott, who just announced that he’s retiring from the job:
“I’m tempted to say that the sky is still falling, or falling again, and that it’s the same old sky. The death of cinema is almost as old as cinema itself. In 1935, the German critic Rudolf Arnheim declared that film as an art form had died with the coming of sound, and that what followed the silence was mere commercial propaganda, a bastardized form he prophetically called “television.” After the war, television killed movies all over again, and even when a technological villain wasn’t apparent — the VCR, the internet — things were always bad. Frank O’Hara’s poem “To the Film Industry in Crisis” appeared in 1957. Two decades later Pauline Kael asked “Why Are the Movies So Bad?” The End Times have a way of turning out to have been golden ages all along.”
So no, streaming did not kill the movie theater, but there’s no arguing that theatrical exhibition has been in persistent secular decline for 70 years.
The theatrical film business going away - not when a Super Mario Bros movie can open to the largest (non-inflation adjusted) animated film release in history - but the question we’re most interested in is what it would actually take to reverse this decline; to ensure that it is not, in fact, permanent.
This series is, then, an exploration of how the cinema may continue to survive, and perhaps even thrive, in this Streaming Age.
I’ll place my bias upfront - I’m a massive fan of cinema. In the two years prior to the pandemic I saw 50 films in theaters per year, but since then all of my favorite theaters in LA have shut down and, frankly, I’m a bit pissed that their owners have done such an incredible job taking their businesses for granted. So I’m going to spend the rest of this series attempting to correct past mistakes and offer a future for theaters that looks not quite so bleak.
Secular declines, especially of the “permanent” variety, are not altered by minor adjustments; there is no “small fix” for the theatrical product. No, what Exhibitors must accept if they want to regain any modicum of relevance (let alone profits) is that the status quo is death.
They need to remake their businesses with difficult, fraught, courageous changes to the businesses many of them have run for decades. And for the sake of clarity, when I say Exhibitors hereafter I’ll be specifically referring to the Big 3 of AMC, CineWorld, Cinemark, both because they collectively own more than 50% market share and because their needs (and those of the industry) are quite different than a small exhibitor.
Broadly, Exhibitors need to adopt four major strategies for their collective turnaround:
Significantly restructure their bloated P&Ls to enable further investment (and, you know, survive).
Adopt modern pricing practices to both expand current demand and improve ARPU.
Actually build a direct (digital and analog) relationship with customers to help alter their behavior.
Reimagine “cinematic content” to capitalize on the major shifts in consumer demand in the current age.
Shrinking to Grow
“I’m concerned about the health of the chains for sure. I don’t see them going away. This is an opportunity for them to restructure their debt, reorganize and right size the amount of theaters. They need to make the consumer experience better.” - Paramount CEO Brian Robbins
In case you haven’t been closely following post-pandemic indebtedness sagas of the Big 3 Exhibitors, things have not been going well!
Cineworld (owner of Regal Cinemas) just emerged from bankruptcy with a restructuring agreement that “would be expected to reduce by $4.53 billion the indebtedness of the group’s subsidiaries…and would do this principally by a debt-for-equity swap” that would significantly dilute current shareholders. This debt load emerged primarily from its highly levered acquisition of Regal Cinemas and its highly expensive ($1B) failed acquisition of Canada’s Cineplex Inc that was aborted in 2020”.
Cinemark has not (yet) filed for bankruptcy but is similarly managing $2.5B in debt and several billion more in ongoing rent obligations to landlords.
And then there’s AMC, the world’s largest exhibitor, which has performed better than its competitors, though that’s faint praise indeed:
AMC has thus far avoided bankruptcy solely because it became a meme stock (that Everest peak above) and leveraged this newfound status to raise significant capital ($228.8M) for reducing its debt load, but not enough to keep it from its (inevitable) Chapter 11 filing. A sampling of encouraging words from their latest annual report:
“To remain viable beyond the next twelve months, the Company will require additional sources of liquidity, reductions or abatements of its rent obligations and/or significant increases in operating revenues and attendance levels”
“Ultimately, if operating revenues and attendance levels do not normalize and we are unsuccessful in restructuring our liabilities, we would face the risk of a future liquidation or bankruptcy proceeding, in which case holders of the Company’s Common Stock and AMC Preferred Equity Units would likely suffer a total loss of their investment.”
“We have a substantial amount of indebtedness, which requires significant interest payments. As of December 31, 2022, we had outstanding approximately $5,140.8 million of indebtedness ($4,949.0 million aggregate principal amount) and $58.8 million of existing finance lease obligations. As of December 31, 2022, we also had approximately $4.8 billion of discounted rental payments under operating leases (with a weighted average remaining lease term of 9.4 years).”
“we must use a substantial portion of our cash flow from operations to pay interest and principal on our indebtedness, which reduces or will reduce funds available to us for other purposes such as working capital, capital expenditures, other general corporate purposes and potential acquisitions”
That is, the largest theater chain in the world must, in tandem:
Successfully renegotiate its rents
Somehow increase revenues with attendance in permanent secular decline
Manage debt and future rent obligations totaling approximately $10B and with operational runway of less than 12 months.
The Exploding Balance Sheet
To better understand how these obligations weigh down exhibitors, let’s take a quick look at AMC’s balance sheet to unpack their operating income:
First things first - the pandemic very clearly decimated AMC’s business, driving that $4.1B loss in 2020, but even before then the business was in trouble, with a 2.5% and 4.9% operating margin the two years prior. Revenue last year was still down 28% from 2018 levels, which has improved variable costs slightly in the period. For every $100 of revenue, AMC has variable costs of about 34%, broken down as:
$28.10 (down from from $31.32 in 2018) to Distributors
$5.57 (from $4.96) for concessions.
AMC (and all Exhibitors), like hotels, airlines, or other comparable businesses with massive fixed cost bases, are highly sensitive to any perturbations to topline revenue, and it’s these fixed costs that have triggered three straight years of more than half a billion in annual operating losses. Compare across the two periods:
2018: $3.21B (58.9% of gross revenues)
2022: $3.15B (80.6% of gross revenues)
These costs are, well, fixed! Such businesses require significant amortization across demand in order for the company to remain solvent.
The reality is that Exhibitors have (a) done nothing to increase total demand nor (b) fundamentally improved their monetization efforts in order to deal with these fixed costs.
I’ll cover both of these failures in future installments in the series, but let’s focus for now on the costs themselves. The major two contributors here are both tethered to the physical theaters:
Rent is now 22.7% of gross revenue (up from 14.6% in 2018)
Operating costs (primarily tied to actual operations of the theaters) are now 39.1% of gross revenue (up from 30.3%)
With demand severely impaired and impossible to immediately regain, this ~60% fixed cost base is, frankly, untenable, especially when you factor in the non-operating costs:
Interest payments have increased from 6.3% of gross revenues in 2018 to 9.75% in 2022, and this is after the company was able to pay off $72M in debt primarily from its meme stock-driven public offering.
We can take this further and look at the company’s interest coverage ratio - effectively the company’s ability to manage its outstanding debt. Generally investors view a ratio of 2+ to be healthy and 3+ to be ideal, meaning that the company shows operating income that is at least double the debt interest payments outstanding. Anything below a 1 means that the business does not currently possess the capital from operations necessary to meet its debt obligations.
Well…AMC saw its ratio in the last five years peak at 0.8 (in 2018), bottom out at -11.5 (in 2020), and currently sits at -1.4. As their 10-k made explicitly clear - they simply don’t have enough capital given current demand to meet their obligations, making default essentially a foregone conclusion at this stage.
Pre-pandemic, AMC (and other major exhibitors) were running at operating margins of sub-5%.
Post-pandemic these operating margins have imploded into the negative.
The theatrical business is predicated on massive fixed costs that must be buoyed with sufficient, consistent demand, which theaters no longer have.
As such, rent + opex + interest payments now constitute 70% of gross revenues.
Right-Sizing the Cost Structure
Altogether, we have a business in AMC that is fundamentally impaired both near-term and long-term, and though I’ve focused on one company, AMC is both the global market leader and represents the very issues faced by all Exhibitors.
For the theatrical business to invest in even base-level customer experience improvements, let alone paradigm-shifting investments required to actually grow demand, it first needs to survive, and this unfortunately means deep, painful cost-cutting. There are three primary areas to manage here:
Total operating expenses
The first is straightforward - whether through bankruptcy (as Cineworld has already done) or other mechanisms, the debt load and concomitant interest payments must be renegotiated. Straightforward is, of course, not easy, but I’ll leave the details here to the well-paid CFOs to wrangle with their creditors.
The second two pieces represent a flaw in the current operating model of the major Exhibitors today. Though the total number of screens in the US has (finally) started to fall, attendance per screen has been falling faster and steadily for three decades:
From the recent peak in 1989, screen utilization has fallen more than 50%, while total screens remain 75% higher. Even in this pandemic-ravaged period, the number of US screens has fallen just 5.3% in the last four years. More broadly, the US represents 4% of the global population but 18% of global screens.
Again looking at AMC because of their pole position, the company remarks that “50% of the U.S. population [lives] within 10 miles of one of our theatres”. In the last 5 years, AMC has shuttered 16% of its 2018 theaters and 13% of its 2018 screens, but because of new builds & acquisitions, net theaters and screens are down just 7% and 6%, respectively:
This is actually pretty well in line with the 1.6% annual decline in theater attendance the past several decades, but starting from a theater/screen base that was already overbuilt as of twenty years ago.
That is, AMC (and the industry as a whole) must accelerate its theater closures to actually “catch up to” current demand, on the order of closing some 20-40% of their current theaters in order to right size theater supply (and fixed costs) with current levels of demand.
Putting aside the inevitable litigation to come from large-scale lease-breaking, rents and Opex tied directly to theater operations simply must come down immediately if Exhibitors have any chance of rebuilding their business.
Theaters Actually Offer Value
Given these financial challenges and the clear need to shut down a substantial portion of national theater supply, one might ask a more fundamental question - why not shut down all theaters? Putting aside consumer demand for a moment, do theatrical releases still provide value to Distributors?
The pandemic offered an interesting (if unfortunate) natural experiment for a hypothesis that, with scaled streaming, perhaps theaters don’t actually matter. We can sum up the results of this experiment with a sampling of post-pandemic responses:
Warner Bros: “We have a different view on the wisdom of releasing direct-to-streaming films, and we have taken some aggressive steps to course-correct the previous strategy. We will fully embrace theatrical”.
Amazon: plans to produce 12-15 films/year that can be released in theaters
Apple: ready to spend $1B to produce movies that will be released in theaters
Netflix: Two $200M films (Red Notice and The Gray Man) seem likely to generate just $80M from their Netflix-only releases.
The broad takeaway? The revenues from theatrical are both meaningful and can’t be replaced by streaming alone.
But the value from theatrical goes beyond revenue - theatrical releases have meaningful, measurable impacts on streaming monetization of these movies as well:
Films of all genres see increasing returns in streaming value from box office revenues. Put differently, theatrical releases enable far greater marketing spends that not only boost theatrical revenues but also persist into elevated streaming consumption (and thus streaming revenue).
Taken together, the studios have found that theatrical releases:
Represent a currently irreplaceable direct revenue stream.
Provide secondary revenue boosts by increasing awareness and consumption of these films in the streaming window.
Theatrical exhibition is an essential piece of film industry history, but due to the home entertainment revolution over the past 70 years, theaters no longer represent a higher frequency consumer behavior. That said, there is still tremendous (business) value to be derived from the theatrical product, not just for Exhibitors but for Distributors as well.
The balance sheets of exactly zero major Exhibitors are tenable, caused primarily by massive over-investment in fixed cost real estate + operations that have exceeded available demand for several decades. Large, painful cuts must be made, and quickly, if AMC et al. wish to have the opportunity to revitalize their business in the coming decade.
In the next piece in the series, we’ll shift our attention from the balance sheet to the pricing of the current theatrical product. Even before investing in substantial product evolution, Exhibitors can extract significantly more value from present demand that can be further invested back into the product.