Cineplex (CGX.TO) – Merger Arbitrage – 7% Upside

Current Price: C$31.70

Offer Price: C$34.00

Upside: 7%

Expected Closing: Q2 2020

Investor Presentation

This idea was shared by Raphael.

 

This is a bit of a va banque play on the NA cinema industry consolidation.

Second largest cinema operator in the world Cineworld is acquiring Canadian cinema industry leader Cineplex for C$34/share in cash (7% upside). Shareholders of CGX have approved the transaction last month, so the remaining conditions include blessings from competition regulators (US and Canada) and two ministers of Canada (Heritage and ISED).

• Offer was announced in mid-Dec’19 and the companies expect the closing between March 23 and June 30, 2020.
• Shares have traded very tight until about the 27th of Feb (widened to 3%). This has happened due to poor annual results release of one of the peer operators Cinemark, which has put pressure on the CINE.
• On the 4th of March it was announced that release of the latest James Bond movie will be delayed until November due to Coronavirus outbreak.
• A day later short seller Hindenburg Research released a series of tweets saying that the market is underestimating the risk of the deal being cancelled or amended.
• As a result of two above mentioned events CINE has fell 20%, while the merger spread increased from 4% to 13%.
• Mar 6 – CINE has released an update saying that they don’t see “any material impact on our movie theatre admissions due to COVID-19” and that despite the delay of James Bond release, other studios plan to release their movies on time. Nonetheless, the company also noted that in case the virus situation worsens, it plans to take certain measures such as “capex postponement and cost reduction”, which might be a hint related to the CGX acquisition. Interestingly, after this announcement CINE share price barely moved, while the spread shrunk to 7%.

 

Further points

• One of the main points of short sellers is that by making this acquisition CINE is overleveraging itself. However, pro forma leverage (net debt/EBITDA) of the combined company stands at about 4.8x, while the leverage of the largest cinema operator AMC Theaters is about 6.3x.
• According to the merger agreement, outbreak of an illness is not considered as a materially adverse effect (which would allow to cancel/amend the transaction).
• Financing should not be a problem as it seems that CINE has already raised the required C$2.3bn.

 

Other points to consider

• Spread to pre-announcement price stands at 24%, however in case the deal breaks, CGX would likely fall considerably lower.
• CINE has not the best reputation and a history of lying/overstating the facts to the investors. So the actual situation of their business (attendance) could be much worse than implied in the most recent update.