Small Cap Value Report (Fri 18 Aug 2023) - EMAN

Good morning from Paul!

I'm a bit preoccupied this morning, as I have to accompany a loved one to hospital shortly for a routine operation. So I might have to find a quiet corner there are do some more updating of this article later, so please bear with me. Although looking at the state of the market, everyone's probably hiding under the kitchen table, trying not to look at your computer screens! There's not much news today either.

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Red (thumbs down) - means we see significant, or serious problems, so anyone looking at the share needs to be aware of the high risk.

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Everyman Media (LON:EMAN)

Down 2% to 59p (£54m) - Trading Update - Paul - AMBER/RED

I’ve been increasingly negative about this cinema chain, because it has failed to demonstrate that it can make any genuine profits, trumpeting meaningless EBITDA figures instead. The pandemic disruption can be allowed for, but that's over now, so it should be profitable now (but isn't).

As you can see, since it listed, positive investor sentiment gave way to a hammering in the pandemic, but a failure to regain traction since. It’s just not a very good business model in a nutshell.

New Banking Facilities - maybe I’m missing something, because the banks are happy to lend substantially relative to the market cap -

Everyman Media Group PLC (AIM: EMAN) is pleased to announce that on 17 August 2023 the Group agreed a new three year loan facility of £35m with Barclays Bank Plc and National Westminster Bank Plc, extendable by a further two years subject to lender consent. The facility ensures that the Group is soundly financially structured and well positioned to take advantage of opportunities moving forwards.

The new facility replaces the existing £25m Revolving Credit Facility and £15m Coronavirus Large Business Interruption Loan Scheme ("CLBILS") held with Barclays Bank Plc and Santander UK Plc.

We’re not told anything about the terms though. Debt is getting a lot more expensive these days of course, so I wonder if EMAN is generating a sufficient return on investment to justify rolling out more sites?

Trading Update - for the 26 weeks ending 29 June 2023.

It’s in line with expectations -

Trading continues to be in line with expectations and the Board remains confident that the financial performance of the Company for the full year ending 28 December 2023 will be in line with market expectations1.

1 Current market forecasts for the year ended 28 December 2023 are revenue of £94.4m and Adjusted EBITDA of £17.2m.

As I’ve mentioned before, the trouble is that this is a capital-intensive business - opening new sites is very expensive, and the fit-outs then have to be expensed through the P&L each year with a heavy depreciation charge - which reflects the expected use & life of the capex from eg. wear and tear.

This remains the case, with Canaccord’s spreadsheet (many thanks) translating adj EBITDA of £17.2m into a profit of…. nothing! Actually it’s an adj loss before tax of £(0.9)m.

Paul’s opinion - remains negative. I cannot see the point in rolling out a format that doesn’t make a profit. Remember the above forecast is for the full year, so that takes into account the expected H2 weighting to film releases. Barbie & Oppenheimer have been good in July it says.

The only bull case I can imagine is if there are benefits from increased scale in future. In that case it might make sense to roll out more sites.

This share seems to me a worrying example of how fixated with EBITDA the city, and the banks, have become. It’s not real profit in a capital-intensive company, although you can argue it’s a proxy for cash generation if the business were to stop expanding, and if you ignore things like finance costs and tax (which have to be paid out as cash in the real world, so why ignore them?).

There’s also maintenance capex to take into account. Cinemas get a lot of customer wear and tear, as does any site that has large numbers of people going in and out, spilling drinks and popcorn everywhere, constantly rustling crisp packets and sweet wrappers, and coughing, and lighting up their mobile phones during the film. etc.

It’s useful to be reminded of this famous quote every now and then, which I just looked up on google -

Warren Buffett: "The tooth fairy does not pay for CAPEX. We have to account for it to assess a company's true earnings power." The same point applies to sales and marketing expenses. Both CAC and CAPEX are real cash out the door up front, which is the worst type of expense.

For me, any retail/hospitality type roll-out investment (ie where you’re investing in the upside from growth in site numbers) has to move into proper profits (PBT) by the time it’s got to say 40-50 sites. If it’s not profitable by that size, then it probably isn’t a very good business model. Look at how profitable the bowling companies are, each extra site loads on more profit, they’re cash generation machines. Compared with that, EMAN’s numbers are almost a joke.

I’d be happy with EBITDA if the site fit-outs were modest, and funded by landlord contributions (as for example XP Factory (LON:XPF) [I hold] is doing). But EMAN’s site fit-outs seem very expensive, leading to the need for borrowings, and EBITDA is completely consumed by the depreciation and finance charges.

Another drawback is that the big capex obviously has to be done up-front, before the business knows how a site will actually perform. Front-loaded, heavy expenditure, with uncertain payback - not the best  business model. Also once a lease is signed, the tenant is locked in, regardless of how well or badly it performs. So many multi-site businesses collapse because of a small number of really bad leases signed at the top of the market, that they can't get out of, and landlords seem less inclined to agree to CVAs these days, to let tenants off the hook.

Despite all my misgivings, with the banks clearly viewing it positively, and trading in line, I don’t suppose I can justify staying at RED, which we normally reserve for companies where something is badly wrong. But I’ll keep a moderately negative view, at AMBER/RED. It’s a nice format, with a premium seating and food offer, but it doesn’t make a profit!