Fitch Ratings: U.S. Movie Exhibitor Outlook Stable in 2007.

NEW YORK -- Though U.S. theater operators will continue to be pressured over the long-term by the rapidly improving home entertainment experience and the abundance of new media alternatives vying for the consumers' time, the promising film slate in 2007 should support another good year at the box office and should provide near-term credit stability for the sector, according to Fitch Ratings.

Fitch has a Negative Rating Outlook on several traditional media sub-sectors and the media industry in general going into 2007 due to secular challenges which have pressured stock prices and forced management teams to re-evaluate capital structure parameters. As exhibitors have limited room for financial engineering, Fitch expects that credit quality in 2007 will be driven by operating trends rather than financial policy revisions.

Longer term, Fitch believes that revenues and profitability of movie theatres could be increasingly challenged by factors that are largely out of managements' control. These secular challenges cause concern for Fitch as many of the operators maintain high debt levels combined with fairly high levels of capital expenditures to maintain property and equipment and to reposition their theater portfolios. In addition, the industry is highly susceptible to top-line volatility since theater operators are reliant on the movie studios for the quantity and quality of movie releases. These issues are somewhat mitigated by Fitch's expectation for improving operating performance in 2007, a generally healthy economic environment, ancillary revenue streams (or equity stakes) from screen advertising, and longer term opportunities presented by digitization of the film industry.

2007 U.S. Motion Picture Market:

After three years of flat revenue growth and a 5% drop in the box office in 2005, movie exhibitors are expected to experience an estimated 5% increase in box office receipts in 2006. This reflects an increase of about 2.5% in the average ticket price and moderate growth in attendance albeit not to pre-2005 levels. Looking into 2007, while Fitch anticipates softness in wider U.S. consumer spending, box office revenues are expected to be driven by the increased slate of franchise movies that have historically fared well at the box office. The 2007 line up includes several sequels to successful series such as 'Spider-Man 3', 'Shrek The Third', 'Pirates of the Caribbean: At Worlds End', 'Ocean's 13', 'Bourne Ultimatum', and 'Harry Potter and the Order of the Phoenix'.

Ongoing Industry Trends:

Theater industry experienced further consolidation in 2006 with the notable combinations of AMC Entertainment and Loews (all-equity deal) followed by Cinemark's bank debt-financed acquisition of the regional operator Century Theaters. Both of these deals reflect the operators' need to build critical mass. Considering the benefits of greater scale in the form of cost savings and negotiating power with movie distributors, developers and vendors, Fitch believes consolidation will continue through 2007 and beyond in the form of strategic, regional tuck-in transactions instead of major debt-financed acquisitions. Companies are also expected to reposition their portfolios by closing smaller theaters and opening larger ones such that industry theater counts should continue to decline while screens will continue to increase. The industry appears to be growing in a disciplined way, but Fitch recognizes the risks that supply could outstrip demand if screen counts grow more rapidly than attendance.

Movie exhibitors experienced perhaps the earliest wave of media leveraged buyouts (LBOs) and may be reaching the point where private equity sponsors start looking for exit strategies. Most recently, Marquee Holdings Inc, the holding company of AMC filed for a $750 million IPO in which the private equity sponsors will receive all the proceeds from the sale of their shares in this offering. Similarly, in the second half of 2006, Oaktree Capital, one of the original sponsors of Regal Entertainment Group, monetized its investment through a secondary equity offering in which all proceeds went to the seller of the shares.

Growth Potential in Ancillary Revenues and through Digital Cinema:

The movie exhibition industry is on the cusp of one of the biggest transitions in its history with the introduction of digital cinema. Out of the top four U.S. movie exhibitors, so far only Carmike has initiated a large scale conversion of its theater circuit which is expected to be completed by the end of 2007. The three largest exhibitors, Regal, AMC and Cinemark, have announced that their joint venture, National CineMedia (NCM), will serve as an agent to develop, finance and implement a digital cinema business plan. This industry wide transition is likely to take up to five years to complete.

Digitization is believed to enhance the theatrical experience with high quality image and 3D optionality, and provide greater programming flexibility in the form of sports, educational, religious, and music concert programming. Digital cinema may help minimize defections of some movie goers in the long term, however, Fitch believes it is unlikely that this potentially enhanced experience will enable the exhibitors' to charge higher prices.

The trend that will continue to affect the wider media universe in 2007 is the ongoing shift in advertising dollars from traditional media into non-traditional media, most notably the Internet. Over the last few years, theatre exhibitors through the NCM consortium have taken advantage of the shift away from traditional advertising media by selling increased amounts of ad space prior to a film's start. Regal, AMC and Cinemark have decided to sell a portion of their stake in NCM in an initial public offering expected to close in the first quarter of 2007. The net proceeds from the IPO are expected to be distributed to the three founding members. While Fitch expects other ancillary revenue sources could evolve over the years, the operators' ability to attract patrons, as well as financial policy decisions, will remain the main drivers of credit quality.

Liquidity, Covenants, and Recovery:

Solid financial performance should support stable or slightly improved liquidity for exhibitors in 2007. Liquidity will continue to be supported by solid working capital dynamics in the industry (working capital days are typically negative for theater exhibitors as companies carry limited inventory and sales are settled immediately making receivables very short while payables can be extended on traditional business practice terms). These features should allow exhibitors to reap the benefits of growth expected in 2007 without the risk of depleting working capital or overbuilding inventory. With the anticipated proceeds from the NCM IPO, financial flexibility should somewhat improve for Regal, AMC and Cinemark. To the extent possible under their respective credit facilities, these companies will likely accelerate returns of capital to shareholders, but Fitch expects some debt to be paid down.

Key covenants for major exhibitors (Regal, AMC, and Cinemark) include limitations on debt/leverage covenants, sale of assets / use of proceeds covenants and dividend restrictions. These covenants provide some protection for bondholders from financial policy revisions and financial distress.

In analyzing recovery values for theater exhibitors, the distressed enterprise value analysis typically generates a higher value than the liquidation value analysis due to the exhibitor's limited asset base. Recovery prospects for unsecured bondholders of movie exhibitors can be limited in some cases as several of the larger companies have secured facilities that encumber a significant portion of distressed enterprise value under financial strain, leaving little recovery for the subordinate claims of unsecured bondholders and other unsecured creditors.

Summary:

Fitch remains concerned about the traditional media industry's secular downward trend resulting from the proliferation of new or enhanced media alternatives ranging from video-on-demand (VOD), high definition DVDs and TVs to downloadable movies and various other web-based and mobile entertainment sources. The effect is exacerbated by the relatively short window between the theatrical release and the announcement and subsequent release of the movie in a retail format. The rise of the internet has also increased the threat of piracy and further simplified the pirating process. However, movie going remains the most popular and affordable entertainment compared to most sporting events, live shows, amusement parks, casinos, and other out-of-home alternatives. Despite the slowing economic growth in the U.S., Fitch expects movie theaters to show some resilience relative to the other forms of out-of-home entertainment as consumers may cut back their spending.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.