Film Exhibition: Cannibalisation Risk Lower Versus QSR. Visibility Of Better Ad Rate For Inox

Management Meet Update Institutional Equities Cinepolis 19 September 2017 Film Exhibition: Cannibalisation Risk Lower Versus QSR. Visibility Of Better Ad Rate For Inox Mexico-based Cinepolis, which is the world s fourth largest film exhibitor with ~5,000 screens (most of which are in Latin America), started operations in India in 2009 and currently has 311 screens in 43 cities under the brand names: (1) Cinepolis (219 screens) (2) Cinepolis VIP (12 screens) and (3) Fun Cinemas (80 screens). We had a meeting with Mr. Devang Sampat, business head (strategic initiatives) of Cinepolis recently to understand his take on the Indian industry, the company s growth plans and points of differentiation vis-à-vis players like PVR and Inox Leisure. From our meeting there were two key takeaways: (1) Mall growth is very anaemic with no signs of pick-up limiting the supply of screens. (2) There is scope for narrowing the large gap (~50%) in advertisement revenue per screen that exists between Inox Leisure and PVR as Cinepolis with a smaller and, in our view, a slightly weaker locational footprint commands better rates that Inox Leisure. We came away with the feeling that while other consumer discretionary segments like Quick Service Restaurants (QSR) are facing a decline in revenue per store (see Exhibit 1) because of substitution (many alternatives exacerbated by introduction of online food ordering mobile applications) and cannibalisation (following rapid store expansion by various players), the multiplex industry will see revenue per screen hold up, if not improve (that has been the trend, see Exhibits 2 & 3) in the foreseeable future. This should result in improved margins/ RoIC. As indicated in our sector initiating coverage report, Indian Film Exhibition Sector- Oligopolistic Business In Its Infancy, entry barriers are formidable (as top players have locked in mall space in key locations/cities) and there are no substitutes (at least as of date). The revenue per screen is also holding up/improving as multiplexes are weaning market share away from single screens and more of the population is moving into the middle income bracket. Cinepolis highlighted that while ATP & SPH of its core Cinepolis brand is in line with that of industry leader PVR (~Rs200 and ~Rs85, respectively), PVR enjoys higher advertisement revenue/screen because of better location and perception. Cinepolis advertisement revenue per screen is between that of PVR s (~Rs4.4mn/screen,FY17) and Inox Leisure s (~Rs2.2mn/screen). As regards Fun Cinemas, incremental screens are under management contracts where it pays no fixed rentals but takes a consultancy fee plus incremental revenue share. But unlike Mukta Arts (Faster Expansion Planned In Film Exhibition), it is not going for any capex. In our film exhibition coverage we have a buy on Inox Leisure and accumulate on PVR. On our estimates, Inox is trading at a 38% discount to the FY19E EV/EBITDA multiple of PVR. Our primary thesis for being more bullish on Inox is that it would partly bridge the gap on F&B SPH and ad revenue per screen (which were 14% and 40% lower respectively vis-a-vis PVR in 1QFY18) thereby fostering faster EBITDA growth. Key points of differentiation vis-à-vis PVR and Inox Leisure: Cinepolis highlighted that: (1) It brings the expertise of successfully running 5,000 screens worldwide, which is not the case with Indian peers. (2) It has a customer-focused mindset which takes care of their needs by bringing the best technologies such as RealD-3D, 4DX and IMAX to India much earlier than others while other players have shareholder-focused mindset. (3) The company has the design expertise of 5,000 screens which helps it to make the best utilisation of mall space allocated to it. (4) It has pioneered the gourmet food concept in India under the banner of CoffeeTree rather than selling just packed foods like samosas and chips. Capex strategy: Capex per screen in the core brand is at ~Rs25m which is in line with that of industry. Cinepolis stated that it expects a payback period of four years at EBITDA level. The company stated that it added 50 screens last year which were all under the Cinepolis banner and that over the next two years 60% of the expansion will be under its Cinepolis banner and the balance 40% under its Fun Cinemas banner. The company also stated that it has the highest inventory of screens as it has signed >500 screens, but the development of these screens is dependent on several external factors like pace of mall development and licence approvals. As regards acquisitions, the company stated that it will look at all potential acquisitions if they are available at the right price. On industry-wide screen expansion, the company highlighted that building 200 screens is achievable in the coming years as construction of 30 malls (~150 screens) is possible and the remaining screens can be single-screen conversions. Content cyclicality: Cinepolis stated that although Bollywood has been performing poorly in recent years, it has been balanced with some good regional and Hollywood content and its average footfalls/screen remained constant at ~1,20,000 admits/screen/year over a period of time and a similar trend is expected in the coming years as well. NOT LISTED Sector: Film Exhibition Girish Pai Head of Research girish.pai@nirmalbang.com +91-22-3926 8017 Devanshu Bansal Research Associate devanshu.bansal@nirmalbang.com +91-22-3926 8179

We are positive on the film exhibition sector (see sector report Indian Film Exhibition Sector- Oligopolistic Business In Its Infancy). We believe that: (1) Indian multiplex industry is an oligopoly (top four players control ~70% of screens) and will remain so as entry barriers are quite formidable and there are no substitutes. This industry s structure will deliver steady revenue growth, and improve margins as well as RoIC over a long period of time. (2) PVR and Inox Leisure (the two large players) can deliver in the next 10 years at least 5%- 10% volume/footfall growth (new screen-driven, attracting both single-screen and new generation customers) per year, respectively, with a rise in realisation of 4%-5%. This will result in revenue CAGR of 10%-15% with PAT growing a tad faster. Structurally, expectations of a rise in relevant customer households which can afford this type of entertainment (currently at 8%-11% of total, in our view) are going to drive demand. Same store/screen sales growth (SSG), in our view, will be realisation-led at 4%-6%. We believe that: (1) These players deserve premium valuations, considering the longevity of earnings compounding and good RoICs. (2) Expensive M&A activity in the past five years and consequent weak return ratios are a small price to pay for achieving consolidation in a nascent industry. Over the long run, as organic growth predominates, the benefits of a better industry structure will far outweigh the price paid. We believe the stranglehold over retail real estate (and slow pace of its expansion) will be the key drivers of positive industry dynamics. This will lead to a steady increase in capacity, solid pricing power and a high occupancy rate. The key risk to sector earnings tends to be the volatility induced by success of content. This is a very difficult thing to predict. Some movies may look great on paper, but may turn out to be duds at the box office. But increasingly the content risk is being lowered as Hollywood and regional movies (both in their original and dubbed versions) are able to command a greater share of GBOC. Other points discussed Business model and revenue-sharing contracts: Fun Cinemas - Cinepolis acquired 83 screens of Fun Cinemas which were spread across 24 properties in December 2014. As on date, out of 83 Fun Cinemas screens, ~30 screens have been brought under the Cinepolis brand and it has gone for management contracts for ~30 new screens which keep the number of screens under the Fun Cinemas banner to ~80. The company highlighted that it plans to bring most of its single-screen conversions under the Fun Cinemas banner. In such contracts, the exhibitor pays consultancy fee plus an incremental revenue share. Unlike Mukta Arts which goes for small capex on its properties, Cinepolis does not do any capex and only provides consultancy services and its brand name, similar to a franchise agreement. As regards its core Cinepolis (219 screens) and Cinepolis VIP (12 screens) screens, it follows a business model similar to Inox Leisure and PVR. Advertisement revenues and role of external agencies: Cinepolis stated that advertisements in cinemas only account for 1% (Rs6bn) of total advertisement budgets of companies (which is ~Rs500bn) and stated that external advertisement agencies like Khushi and Interactive act as influencers when advertisers approach them for advertisement slots. Cinepolis stated that its advertisement revenues are driven by an internal team as well as external agencies and also stated that it now sells advertisement slots for its complete portfolio of screens and there are no differential rates for Fun Cinemas screens and Cinepolis screens (advertisement rates for Fun Cinemas were below advertisement rates for Cinepolis earlier). Currently, advertisement revenues and other revenues account for 15% of overall revenues. For PVR's advertisement revenues being abnormally high, Cinepolis stated that location and perception are the two main reasons for PVR being able to command higher rates. It mentioned that PVR has a strong location advantage in the form of its greater presence in key mall properties of Mumbai, Delhi and Bengaluru which creates a bigger brand perception for PVR and PVR s advertisement revenues are a reflection of that. As regards Inox Leisure, Cinepolis stated that it was earlier working with Khushi and Interactive only, but it has now expanded to all available players which it believes is a step in the right direction. Points of differentiation with PVR and Inox Leisure: Cinepolis stated that: (1) It brings with it the expertise of successfully running 5,000 cinema screens worldwide. (2) It has a customer-focused mindset which takes care of customer needs by bringing the best technologies such as RealD-3D, 4DX and IMAX (much earlier than others) to India. The company mentioned that its revenues are extremely high during the release of 3D movies. The company also stated that its occupancy rate is as high as 70% for its 4DX screen at Viviana Mall in Thane since its inception and masses have loved it. (3) It has the design expertise of 5,000 screens which helps in making the best utilisation of mall space allocated for cinema exhibition. An example of this expertise is the vinyl flooring under the seats which helps in easy washing of food stains when compared with carpet flooring. This helps provide a feeling of freshness to its patrons. The company also highlighted that it was the first one to launch recliner seats globally.(4) It was also the first one to introduce gourmet food under the banner CoffeeTree in India rather than the usual packed foods like samosas. 2 Cinepolis

Lower screen capacity compared with peers: Cinepolis stated that it has 202 seats/screen against 230/250 seats/screen in case of PVR and Inox Leisure, respectively, as its back-to-back seating space is 1,200mm which is greater than the normal space of 1,000mm and in turn provides better legroom space to its patrons. Cinepolis stated that its footfalls are somewhere between that of Inox Leisure and PVR whose footfalls are 2,400 and 2,550 admits/screen/week, respectively.these numbers indicate that the occupancy rate for Cinepolis should be at least at par with that of PVR and most likely a tad better. Revenue segmentation: Box office/f&b/(advertisement revenues + other income) contribution is 60%/25%/15%, respectively, and stated that its EBITDA margin is in line with PVR and Inox Leisure when averaged out over a period of time. Cinepolis is fairly bullish on F&B revenues where it believes that going forward the SPH to ATP ratio will become 1:1 compared to 0.4:1 currently. Screen concentration: Cinepolis currently has 311 multiplex screens across India and it plans to take this screen count to 400 by the end of 2018. Currently, it has ~110 screens in North India, ~ screens in West India and ~50 screens in both South and East India (Exhibit 6). Cinepolis also stated that it is looking quite seriously at South India market as this is a lucrative market with higher occupancy level (~50%-65%) & F&B revenues and greater content options (Hindi/English/Regional). Cinepolis has lease rental contract periods similar to those of PVR and Inox Leisure. Rentals are ~17%-18% of total revenues and have a fixed 12%-15% kind of jump every three years. Premiumisation: For Cinepolis VIP, the company stated that these screens are comparable to PVR s Gold class and Inox s Insignia screens and it has 12 screens in Pune, Thane (Viviana Mall), Kochi and Mangalore and the ATPs vary from property to property and are in the range of Rs300 to Rs700. Mexico operations: It mentioned that Mexican market is a duopoly and, anecdotally, indicated that it has a 65% market share and the rest is with Cinemex. It mentioned that while ATPs are not that high relative to Indian multiplexes, the ratio of ticket price to SPH is 1:1 there and admits/screen are much lower and nearly half of that in India. Goods and Services Tax or GST impact: Cinepolis stated that there is no change on the ATP front and it is charging 15% GST on F&B because of non-clarity at this stage. Management and board of directors: Cinepolis India s Managing Director is Mr.Javier Sotomayor, and Chief Financial Officer is Mr.Rodrigo Perez. Mr.Devang Sampat is Business Head-Strategic Investments. 3 Cinepolis

1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 Present Institutional Equities Exhibit 1: QSR s Revenue/store is on a declining trend 45 Exhibit 2: Footfall/screen/year (in lakh) 1.70 40 35 42.5 40.2 37.1 35.3 36.1 1.60 1.50 1.40 1.58 1.55 1.44 30 25 20 24.0 22.9 Exhibit 3: Revenue/screen for Inox Leisure & PVR is on a rising trend (Rsmn) 38 36 34 32 30 28 26 24 22 20 Exhibit 5: Screen growth of top players 22.3 22.0 21.6 25.9 24.6 Jubilant Rev/Store (Rsmn) 32.9 31.3 25.9 26.3 Westlife Rev/Store (Rsmn) 35.2 29.5 37.0 27.7 PVR Rev/Screen (Rsmn) Inox Rev/Screen (Rsmn) 1.30 1.20 1.10 1.30 1.30 Exhibit 4: Overall multiplex screen growth over the years 2,500 2,000 1,500 1,000 500 - Source: Inox Investor Presentation, Nirmal Bang Institutional Equities Research Exhibit 6: Geographic screen concentration of top players 1.30 1.19 1.36 1.35 1.23 PVR Inox PVR Average fotfall Inox Average Footfall 1,075 1,225 1,350 1,500 1,630 2,134 2,225 2,343 FY10 FY11 FY12 Overall Multiplex Screen growth 700 600 500 445 454 462 467 474 477 491 524 551 557 569 579 587 597 250 200 197 238 206 400 300 200 0 361 365 372 377 393 320 193 205 110 413 420 425 440 446 292 236 468 476 481 303 311 150 50 130 110 99 99 22 72 50 50 PVR Cinepolis Inox Leisure 0 North South East West PVR Inox Cinepolis 4 Cinepolis

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