GABRIEL LOWENBERG. Special to The Globe and Mail, Published Wednesday
What does it mean to be a value investor? The general assumption is that value investors search for assets with intrinsic values not properly recognized by the market. In other words, the shares are selling at a discount to their true worth. But occasionally, I see value in different ways, even in pricey stocks.
Using traditional metrics, for example, Cineplex Inc. is expensive. It trades above its American peers, based on trailing and forward price-to-earnings, and cash-flow multiples. The exhibition industry is mature, with declining revenue, and is confronted by intense competition from new sources of entertainment. In Canada, Cineplex – already the market’s dominant player – cannot consolidate any more.
So where is the so-called value?
I will answer in one word: management. Smart management is worth a premium because it has a habit of producing rabbits out of hats. Allow me to make my case.
In 1999, Onex’s Gerald Schwartz and Anthony Munk partnered with film executive Ellis Jacob to form Galaxy Entertainment, aiming to grow in untapped markets. In 2001-02, Onex, with Oaktree Capital Management, bought the defaulted debt in Loews Cineplex at a huge discount and converted it into equity and new notes in the restructured company. I call that smart management.
Effectively, $500-million (U.S.) of debt, purchased at steep discounts, was erased during Loews Cineplex’s Chapter 11 in the United States and Canada. Onex emerged with the Canadian theatres, after selling the U.S. assets with its partners for $2-billion. Smart move? Check.
In 2005, with Mr. Munk’s help, Mr. Jacob orchestrated the takeover of Cineplex’s major rival, Famous Players. Another smart move. Then Cineplex purchased 26 Empire theatres from Empire/Sobeys. Today, it controls almost 80 per cent of the Canadian market.
If you go to the cinema, you may also have noticed that ticket prices have not increased meaningfully in years. That, too, spells opportunity.
And there’s more – the 70 million annual moviegoers that Cineplex is actively working to monetize. Let me explain.
You are probably aware of Scene, the rewards program with Bank of Nova Scotia that now boasts more than seven million members. Through Scene, Cineplex allows customers to earn and redeem points with the likes of Telus, SportChek, Swiss Chalet and Milestones, etc.
What you may not know is that two months ago, for $10-million, Cineplex bought 80 per cent of World Gaming, a fantasy sports company. Although the company’s precise business model is not set in stone, the general intent is to stage live online gambling tournaments in theatres across the country.
The American model is instructive. At three major U.S. exhibition chains – Regal, AMC and Cinemark – gamers pay $120 to play the online game Minecraft in a series of weekly sessions at the theatre. In doubt about the eyeballs? There are 100 million registered Minecraft users; for movie theatres, this has huge potential for growth.
So Cineplex has made a modest investment in what, for now, is a small business. But think about the upside. Imagine if every multiplex devoted a few screens every weekday and weekend to fantasy gaming – combat games, virtual reality simulations, professional sports, etc. As the audience grows, so will the payouts, revenue and profitability.
In the United States, Web-based fantasy sports gambling is exploding. This year, FanDuel and DraftKings will pay out nearly $3-billion in prizes. That’s the payout: Imagine what they must be keeping.
One important caveat: There are legal risks surrounding the sports fantasy category. Certain U.S. jurisdictions, including New York and Nevada, regard them not as games of skill, but of chance – that is, gambling – and are seeking to regulate, tax appropriately or shut them down, as they may be using loopholes to circumvent the intent of the law. Never a good thing.
But my Cineplex argument is that smart management is creatively looking for ways to put bums on seats and optimize revenue. Yes, smart management is expensive, because investors reward companies that anticipate the future and capitalize on it. But in time, I firmly believe that what seems like an expensive equity will look cheap.
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Gabriel Lowenberg is CEO and President of Lowenberg Investment Counsel, Inc. (LICi), an independent wealth investment management firm based in Ottawa, which owns Cineplex and Onex for the benefit of its clients.