MOODY'S ASSIGNS B2 RATING TO CARMIKE CINEMAS' PROPOSED SR SUB NOTES; BANK DEBT RATED Ba3
Moody's Investors Service assigned a first-time B2 rating to the proposed $200 million of senior subordinated notes due 2009 to be issued by Carmike Cinemas, Inc. (Carmike), and Ba3 ratings to Carmike's combined $275 million of bank facilities, including an amended $200 million revolver due 2002 and a new $75 million term loan due 2005. Net proceeds from the new notes and term loan will be used to redeem existing notes and to repay borrowings under the company's revolving credit facility. The senior implied rating for Carmike is Ba3, and the rating outlook is stable.
The assigned ratings reflect the company's high operating and financial leverage, as adjusted for the company's considerable long-term operating lease obligations; large capital expenditure requirements to upgrade its comparatively older theater base and support an aggressive expansion strategy, including risks associated with shifting from a predominantly acquisition-driven to a new build construction growth model; related expectations of negative free cash flow over the next several years; and potentially increased competitive risk as industry players continue to consolidate and accelerate the build-out of new markets. The ratings also recognize certain general risks associated with the theatrical exhibition industry, including slow growth of ticket sales and attendance, high dependence on relationships with film studios, box office risk, and seasonality of film product.
Positive considerations supporting the assigned ratings include the company's large size and geographic diversification, with no significant theater-level dependencies or regional concentrations; strong presence in small, ex-urban markets which today are predominantly non-competitive film zones; and relatively strong operating performance, including above-average EBITDAR margins and returns on assets. The ratings also incorporate generally favorable industry trends, both at present and as expected for the near term, as well as the recent contribution of junior capital in the form of Goldman, Sachs' $55 million 5.5% preferred interest, notwithstanding the cash-pay nature of dividends related to the same.
The B2 rating for the senior subordinated notes also reflects their effective and contractual subordination to a large amount of actual and permitted bank debt, as well as other senior obligations at the company's operating subsidiaries. However, it is noteworthy that bondholders will benefit from upstream subsidiary guarantees (on a senior subordinated basis), which thereby precludes potential structural subordination issues that would otherwise be relevant to the rating decision by virtue of their holding company status. The senior subordinated debt rating also factors in the distinctly tighter covenant package, relative to other recent market transactions in the sector, that serves to better protect bondholders in a distress scenario.
Carmike has pursued an aggressive strategy of acquiring and developing theaters in "secondary markets" that have largely been ignored or exited by the larger theatrical exhibition chains. The company estimates that it is the sole or dominant provider in approximately 83% of its markets, a significant factor contributing to its successful historical and projected future operating performance, as well as the assigned ratings. The small size of Carmike's markets, coupled with its relatively low number of screens for its large theater base, is reflected in the company's universally low metrics pertaining to admissions, revenue and cash flow on per screen and theater bases, which in some instances lag those metrics for larger market participants by more than 50%. However, its "only game in town" strategy has thus far enabled the company to negotiate good deals with the film studios and concession vendors, resulting in comparatively high gross margins notwithstanding the partially offsetting impact of lower average ticket prices. Lower real estate prices and build-out costs associated with its smaller markets, coupled with a well-integrated MIS backbone and industry-low overhead, facilitates the generation of positive operating income which is able to fully cover proforma interest, a rarity in the rated exhibitor universe.
While this strategy has worked well for the company to date, future growth plans include a concerted shift from acquisitions to construction, with significant development of new theaters planned over the next few years. Many of these new builds will occur in new markets, which entails considerably greater levels of risk as success depends on the careful selection of untested sites. Carmike will also undertake a large-scale retrofitting and upgrade of its existing aged theater circuit, which Moody's suggests may potentially be exposed to competitive entrants during the interim period as lower population densities only partially insulate these assets. A large component of these assets consists of older, less efficient theaters that the company has acquired over the last several years. Some have been converted to discount houses as a means of extending their useful lives prior to expiration of their operating leases. Several of the company's underperforming theaters have been targeted for closure over the near term, as reflected in the company's anticipated $33 million fourth quarter charge to account for the discounted value of future minimum cash payments related to existing leases. Many other theaters will likely be similarly targeted over the next few years, which could potentially entail additional cash payments for early lease cancellation. Management will be challenged to effectively control these simultaneous initiatives and grow the company's cash flow in the absence of any meaningful losses and/or market share erosion in order to maintain the assigned ratings.
Although Carmike has a highly leveraged balance sheet, it is on the low end of its rated peer group, nonetheless. As of 9/30/98, total debt adjusted for long-term operating leases approximated 5.7x pre-rent cash flows. Pre-rent cash flow is expected to cover proforma interest and rent expense approximately 1.7x. Moody's expects that the company will continue to spend heavily on capital expansion, which will preclude the ability to reduce debt outstandings over the intermediate term. The company should have good liquidity, however, as a large portion of its revolving credit facility is expected to be undrawn at closing.
Carmike Cinemas is one of the largest domestic motion picture exhibitors with 468 theaters and 2,658 screens in 36 states. The company has its headquarters in Columbus, Georgia.
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