March 31, 2023
Amid today’s most uncertain sectorial and economic climates, then if financing is not conventionally via the banks, then to which alternative financing sources might cinema operators look? Happily, EFA Partners sheds some timely as well as most helpful light.
Most may feel that 2022 has presaged exhibition’s long-term viability as our sector began rebounding well. There will of course be little need for any year-in-review, here, since such has already been covered many times over – suffice to say that there were good indicators that movie-going is here to stay. Still, it’s difficult to argue any long-term clarity with so many industry variables at play. 2022 also experienced general economic uncertainty highlighted by rising interest rates, inflationary pressures, and recession fears, leading, in turn, to worries by financiers that consumers may have less disposable income for discretionary items such as movie-going.
Given the general economic uncertainty, then banks have today become even more cautious to the extent that many won’t consider lending to exhibitors until there is more post-pandemic analysis. Also, if they do lend, then proceeds may be only for working capital with no proceeds for growth projects. Exhibitors seeking capital for theater-upgrades, new-builds, or acquisitions may continue exploring with banks; however, they could, concurrently, be considering alternatives such as specialty lenders, real estate investment trusts (REITs) and specialty financiers of equipment. Such financiers can often provide more flexible terms; provide proceeds for growth-projects, and, in some instances, shareholder-distributions, too. Now, while these options do tend to be more expensive, bank interest rates have generally risen more than those for alternative loan sources, thus potentially making them more attractive.
Many banks remain in ‘wait-and-see’ mode when it comes to theatrical exhibition and demand more months of results before moving forward. A major part of this conservatism stems from loan-approval processes that only consider historical financials rather than also taking projections into account. So, while your bank manager may seem optimistic, the reality may be that obtaining approval from credit committees could be more uphill. Banks do like real estate, however, so that those with owned-properties could be looked upon more favorably. Conversely, many banks won’t even pursue loans that don’t have real estate as collateral. Also, if loan-approval is received, be mindful that the amounts may be lower than anticipated and the allowed uses of proceeds may be limited e.g., loan amounts may be capped at 50-65% of real estate values or at less than twice the annual EBITDA and with loan proceeds only for working capital rather than growth projects. In addition, loans may need personal guarantees from owners and may include loan covenants, such as prohibitions on owner-distributions and caps on the amounts of allowable capital expenditures.
Specialty lenders have become a more prevalent financing alternative in the past decade, and may differentiate by offering more funds (and potentially up to 4x EBITDA), providing the same for growth, and even funds for shareholder-distributions. And while more expensive than banks, the interest-rate gap has recently decreased since internally these groups are funded differently than banks and so do not necessarily raise their rates quite as much whenever there are general increases in the interest rate environment.
Like banks, these groups seek mature companies rather than early-stagers; however, unlike banks, they look for growth plans and loans can include future growth-lines to be drawn for new projects or acquisitions. Certain specialty lenders offer ‘dividend recaps’ which provide funds for owner-distributions which can be advantageous for owners seeking personal funds while not wanting to sell all or even portions of their businesses. Specialty lender loans are also often interest-only; so that, while the interest rates may be higher than banks, the actual payments may be lower since, by contrast, banks require significant amortization.
Lastly, most loans can be prepaid with little or no prepayment premiums after two-to-three years. At that time, they could be repaid with less expensive bank debt but, meanwhile, exhibitors could have taken advantage of current growth plans.
REAL ESTATE INVESTMENT TRUSTS (REITs)
REIT financing is an expansion method used by many exhibitors. Some utilize REITs for constructing new venues, while others seeking owner-distributions or extra funding for other projects have utilized REIT financing via the sale and leasebacks of owned properties. Again, while costlier than banks, REITs provide financing for up to 100% of the property’s value compared to the banks which have typically hovered around the 50-65% range. Unlike banks, REITs allow funds to be used for any business need and/or for shareholder-distributions.
Until recently, REIT cap-rates were much more expensive than bank interest rates but that isn’t necessarily the case currently. Whilst cap-rates have increased, they haven’t increased as much as bank interest rates. Also, particular REITs have since become more creative with their financing – and with some offering options to repurchase the property at predetermined times in the future, while others may offer mortgages rather than sale/leasebacks.
SPECIALTY EQUIPMENT FINANCIERS
Most exhibitors have used equipment-financing as a tool to grow their businesses. Many equipment-vendors offer financing options as do the equipment-finance units of banks. And while these can be relatively inexpensive options during good economic times, similar to banks, many of these have become more conservative.
Other groups to consider are specialty financiers of equipment which are more expensive but can pursue financing for more complex situations. Some of these are mandated to work with operators willing to pay higher rates until their business situations stabilize. This financing can be advantageous for growth projects when other equipment financiers seem uninterested. Similar to specialty lenders, prepayment penalties can often be limited so financing could be repaid with less expensive options in, say, two-to-three years. Additionally, while financing proceeds are typically for new equipment, these groups can also consider financing for used equipment which can be advantageous for companies currently needing capital.
Given the current uncertain climate, then many exhibitors may look to pursue expansion later rather than nearer-term and, for such ones, relationship banks could be good sources for financing. However, for exhibitors that do view the current environment as an expansion opportunity, alternative financing sources should be explored to take advantage of current growth opportunities. Also, to note that certain alternative sources can provide funding for shareholder dividends for owners seeking distributions.
While alternative funding-sources can be typically more expensive, again the rate-gap has decreased since bank interest rates have significantly increased recently. The flexibility of alternative financing sources therefore could be beneficial in the current market.
ABOUT EFA PARTNERS
Over the past 18 months, EFA Partners has closed over a dozen transactions for theaters and other entertainment clients, including construction, equipment financings, re-financings, and M&A as sell-side advisors. With well over 100 financiers contacted, this has provided the team with a good feel for the current lender-mindset.