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The Cineplex Inc. Merger Investors Would Love to See

I was in the audience this past weekend, one of the millions around the world catching Wonder Woman, the latest comic book character to come to the big screen.

Generating US$103.1 million between Friday and Sunday, Wonder Woman set a record for the largest opening for a female director. More importantly, for Cineplex Inc.  (TSX:CGX), it got the summer blockbuster season off to a promising start.

Cineplex’s business is based on getting quality content at the theatres to drive revenue. Wonder Woman’s success is a welcome surprise given some predictions for its opening weekend were as low as US$65 million.

So, you can expect decent numbers when Cineplex reports its second- and third-quarter results in August and November.

Of course, Cineplex is transforming into an all-encompassing entertainment company, not just a movie theatre chain, so you can’t just look at the box office to determine its future earnings.

Stock is expensive

Fool.ca contributor Chris MacDonald thinks Cineplex’s stock is way too expensive at more than 40 times trailing earnings.

“I believe Cineplex’s valuation will remain under pressure from intense competition for consumer dollars in the entertainment industry,” MacDonald wrote May 31. “New streaming platforms and technological breakthroughs with the quality of in-home movies and media, in general, have provided significant headwinds to the cinema chain business around the world, and Cineplex is no different.”

The above argument is not a new one.

My grandfather ran Famous Players theatres in the 1960s; even then, some in the media were predicting the demise of the movie theatre. They said the same thing when VHS came out.

People don’t want to stay in their homes to access entertainment, at least not all of the time.

CEO is a smart cookie

Ellis Jacobs is an excellent CEO who’s been in the business for a long time and understands its ups and downs. That’s why he’s diversifying Cineplex’s revenue streams beyond its 78% box office market share in Canada.

For instance, to counter the in-your-home argument, Cineplex brought out a digital store where you can buy and rent films at home and on the go using your mobile device.

Outside the theatre, it’s got a significant advertising business, it distributes arcade games across North America and is building a network of family entertainment centres across the country.

The merger investors would love to see

The last item on its growth agenda, which ties into my merger scenario, is The Rec Room, Cineplex’s 60,000-square-foot, $10 million answer to a fun night out.

A combination video arcade, restaurant, and bar, it’s a larger version of Dave & Buster’s Entertainment, Inc. (NASDAQ:PLAY), a U.S. company whose motto is “Eat. Drink. Play. Watch.”

With 94 locations in the U.S. and two in Canada, Dave & Buster’s 2016 revenue was slightly more than US$1 billion with US$239 million EBITDA and an average year one cash-on-cash return for each of its stores of 47.2% — higher than Cineplex’s version of adult entertainment.

Bottom line

Without accounting for synergies and cost savings, the two businesses would have $2.8 billion in annual revenue (Dave & Buster’s numbers are converted to Canadian dollars in this section) and $323 million in operating profits. Also, it would have $750 million in long-term debt, or just 11% of the two companies’ combined market cap.

The combination would give Cineplex an excellent entry into the U.S. market beyond what it’s already done with its amusement distribution, and Dave & Buster’s would get a good operating partner to expand beyond the two units here in Canada.

Both Cineplex and Dave & Buster’s have strong management teams, so I’m not sure who would run things, but together I think they could become a global force in the entertainment industry.

Investors would love it. I doubt it will happen.

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Fool contributor Will Ashworth has no position in any stocks mentioned.

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