REP properties (NYSE: EPR) the story of investing since the start of the pandemic has been heavily punctuated by fear, uncertainty and doubt. Fear of what was then thought to be a permanent abandonment of cinema. Uncertainty about whether post-pandemic entertainment patterns would last forever prefer the remote control. Doubt that the company would remain a going concern despite its large cash and cash equivalents position.
The company not only survived the pandemic in its aftermath, it emerged with a record cash position, increased its monthly dividend payout, and has now embarked on back-to-back cash redemptions of designed experiential assets. to diversify its rental income stream and transition from repossession. to growth.
The collapse of Cineworld (OTCPK:CNNWQ), Regal’s parent company, surprised theater bulls following what has been an extremely strong year for cinema. But the second-largest movie theater chain in the United States after AMC Entertainment (AMC) was burdened with debt from its parent company. Regal was acquired by Cineworld in a $3.2 billion leveraged buyout deal and already filed for bankruptcy once in 2001. Basically, its parent company was hugely overleveraged and unnecessarily acquiring. Indeed, he was actually faced with a $1 billion in breach of contract lawsuits payment for its discontinued acquisition of Cineplex of Canada.
EPR common stock has fallen sharply on the news from just over $55 to $42 at the time of writing. As a result, Regal’s Chapter 11 news essentially erased just over $1 billion in value from EPR. That’s grossly excessive with Regal’s total rental revenue of just $45.9 million for the six months to the end of June. So even if you assumed a worst-case scenario of Regal closing each of the just under sixty that it leases from EPR, the market cap retracement would still be incredibly disproportionate. Of course, bears would be right to point out that Regal’s collapse rekindles fears that AMC, EPR’s largest tenant, may also collapse. AMC is also highly leveraged and struggling to find new sources of liquidity. Both form EPR’s top 2 tenants, highlighting their overall importance to financial performance.
Regal Chapter 11 Brings Material Uncertainty But Is Manageable
Regal is currently in discussions with its creditors and owners regarding the restructuring of its liabilities. The most likely impact will be the reduction in rents granted by the EPR to avoid closures. Theaters are usually quite difficult to reallocate, but EPR’s Regal properties are well located and will likely be held until Chapter 11. There will also most likely be a discount of up to 15% on total rental income by Regal.
This would of course have a negative impact on financials which were on the verge of a broader shift from recovery to growth, but would certainly not justify the move we have seen so far. Regal will have approximately two months to accept or reject each lease with the total closure of several Regal but non-EPR sites in Irvine, Anaheim Hills and Calabasas already announced. We should hear about more closures in the coming weeks.
Regal represented 14.4% of total revenue for the first half of fiscal 2022, compared to just 5% for the same period a year ago, as pandemic-era deferred rent was likely still in place for the over-indebted company. With revenue of $610 million over the last twelve months, the company could see about $14 million erode. This represents 2.25% of the total rental income. Assuming this decline in revenue declines dollar-for-dollar on the adjusted FFO per share, the higher dividend payout would still be protected, but with some risk that the forecast revised up to between $4.39 and $4.55 be revised downwards.
The EPR is still halfway through its capital expenditure forecast of $500-700 million, which was completed at an 8% cap rate. As capital spending was expected to increase in the second half of this year, there is a risk that this will be delayed as the company deals with the fallout from Regal’s bankruptcy. Lower growth expectations in the meantime on the back of this may also have played a role in the current retracement of EPR common stock.
Theaters might face an uncertain future, but they still have one
The EPR has been one of my main holdings since the pandemic hit. I have no qualms and believe the management faced worse a few years ago. Regal’s collapse is not a damning indictment of cinema, its parent was simply too over-leveraged and always looking for more growth for no reason. In this, Cineworld’s failure to complete the Cineplex takeover and its collapse could end up being good in reducing customer concentration and accelerating EPR’s diversification strategy. Cineworld’s unwarranted expansionism was simply wrong.
EPR held cash and cash equivalents of $168.3 million at the end of its last reported quarter, with no balance drawn on its $1 billion credit facility. This will lay the groundwork for further value-creating redemptions and stability in the face of endless entropy. The bearish warnings that cinemas are dead are overblown, the current retracement is a giveaway and I am a buyer at these levels.