As talks take place to sell the chain, what is the future for the silver screen sector?
Emma Thompson and a pig attend the Nanny McPhee And The Big Bang world film premiere at the Odeon, West End, last year Photograph: Ian Gavan/Getty Images
Today, Odeon is the biggest British film business. Terra Firma insists that rather than selling, it would prefer to buy more cinemas abroad. So Bank of America Merrill Lynch is pursuing parallel strategies – running a sales process and helping Terra Firma to find about £600m of new debt for Odeon. "The priority now is refinancing to allow us to do a series of acquisitions," Gavin says. "We want to double the size of the company."
Hands told reporters last month that he would want at least £1.2bn for the business, and has given joint bidders BC Partners and Omers Private Equity a few weeks to agree a deal. Hands created Europe's largest exhibitor overnight in 2004, when Terra Firma won separate auctions for the Odeon and UCI chains for a total outlay of £650m. It was Hands's second investment after leaving Nomura bank to set up on his own.
No doubt, though, the big temptation is to capitalise on Odeon's success now rather than to defer pay day for five years. For Hands, who lost £1.5bn of his investors' money, £200m of his own wealth and a priceless chunk of credibility when the music company EMI was seized by its lender Citigroup earlier this year, selling Odeon would be the first milestone on the long road to recovery. "If you are Terra Firma you have to do a deal if you want some wind in your sails," says a banker involved with the cinema sector.
While offering Hands a way out of the EMI disaster, Odeon could also be said to have led him into it. Hands likes to think of himself as a transformer of whole sectors. At Nomura he became a pub landlord on an industrial scale, shooing out the old men and their warm beer to make way for clean, female-friendly décor and decent grub.
In 2007, justifying his decision to buy EMI, Hands said he had transformed cinema culture too. Unhappy with the numbers of managers attending premieres in Los Angeles, Hands said: "When we bought it, the management team really believed they were part of the film business. I had the difficult job of explaining to them that they were in the popcorn-selling business."
By ending the party lifestyle at EMI, Hands believed he could rescue the music business. It didn't happen that way, and there are those who say his influence in cinema has been less than revolutionary. Steve Wiener, the chief executive of rival number two chain Cineworld, says cinema operators have always known their balance sheet relied heavily on popcorn sales. "Anyone that came into this business and didn't realise up front that food and drink was very important didn't know what they were getting into."
Gavin has showbusiness pedigree – he has written a musical and is a West End theatre producer in his free time – but even he admits to feeling like an outsider. "Unless you've torn tickets in this business, how dare you have a view," he remarks wryly. Gavin doesn't describe Terra Firma's intervention in the manner of Hands's comment about popcorn sales - preferring to highlight the cinema chain's international growth as its main achievement.
The Odeon boss is open, though, about the need for a revamp at the ageing former music halls which house its town centre screens. The group has invested in multiplexes in Manchester, Newcastle and Liverpool, but not all its 100 UK cinemas are of the same quality. "We have now got a whole programme of going back to our legacy buildings to regenerate them," says Gavin. "They have become a little tired."
Odeon was not the first to convert to digital, arguably the most important change to the cinema industry for a generation. By replacing expensive 35mm film reels with what are essentially large USB sticks that plug into cinemas' computers, digital will save Hollywood studios billions. The 3D films it makes possible have done great business at the box office (28 were released in the UK last year grossing £237.4m, representing a quarter of box office takings according to the UK Film Council) and tickets sell for a 30% premium. There will be 30 films released in 3D this year, including this month's fourth instalment of Pirates of the Caribbean, starring Johnny Depp (right).
Rather than going through a middleman to share the costs of installing new kit, as other exhibitors have done, Odeon wanted to have direct relationships with its key suppliers and spent four years negotiating individual deals with all six major Hollywood studios. This allowed others to get ahead. Apollo Cinemas, a second tier UK operator, signed a deal with Sony as far back as March 2009, and was fully digital by Christmas 2010. Apollo managing director Rob Arthur says: "It's raised the profile of Apollo. Instead of just being a small regional player we can punch above our weight". Odeon is now catching up, with half of its screens already converted, and completion due early next year, when it is likely to be the first of the big three chains to go fully digital.
What's helped Terra Firma with Odeon is that cinemas have shown themselves recession-proof in attracting audiences. Admissions rose from 165m a year in 2005 to 173m in 2009, the highest level since 2002, before dipping to 169m in 2010, according to EDI Rentrak. Britons also pay more per film than continental Europeans to go to the cinema, spending £15 a year on an average of 2.7 films.
Nevertheless, the group has, for now, lost its position as the biggest UK earner; its UK revenues have only grown modestly from £295m in 2006 to £314m in 2009 (the latest figure available). When Terra Firma merged Odeon and UCI in 2004, the chains together controlled 35% of UK box office. According to Dodona Research, that number fell to 25.8% for 2010. Cineworld has squeaked ahead, with a 26.1% market share. "I like to think of us as the blue collar workers," says Wiener. "We work harder, our average ticket price is lower than our other two main competitors in the UK, but our box office is higher."
The Odeon Leicester Square, which remains Hollywood's favourite venue for premieres outside the US, suffered during the recession. The venue could traditionally be relied on to make over £5m annually from ticket sales, over £6m in a good year. But in 2009, estimates seen by the Guardian suggest the takings fell to £3.8m, with the Empire and Vue venues in Leicester Square benefiting. Performance bounced back in 2010 to over £5m, but of the four cinemas competing for business in the square, Odeon's two now take a smaller share of the total than at any time for a decade. Nonetheless, Odeon has grown, largely thanks to a doubling of its international revenues. Just over half its income is from overseas. It is the largest exhibitor in Italy and Spain, and there are more cinemas in Germany, Austria, Ireland and Portugal. In 2005, ebitda (earnings before interest, tax, depreciation and amortisation, a key measure for private equity owned companies) was £68m, and it has now risen to over £90m in 2010, with £125m forecast this year. Revenues were £478m in 2005, and rose to £641m in 2009, the last year Odeon has filed accounts for.
The opportunities for further consolidation in the UK are limited. Combining any two of the top three – Odeon, Cineworld and Vue Entertainment – would lead to one group controlling at least 40% of cinema screens, which would most likely trigger a competition inquiry and forced cinema sell-offs. Although Vue has estimated the savings from a merger with Cineworld and went as far as hiring advisers to look at a bid for Odeon in recent months, it is for now out of the running.
Hands spent £650m on buying and merging the Odeon and UCI chains. About a third of the investment, £200m, was Terra Firma Capital and the balance was debt. Some of the debt has been paid off and now stands at £370m, according to the company, while Terra Firma recouped over £100m in a refinancing in 2007.
Private equity investors typically look for at least "two bags" – a doubling of capital invested – over a four- or five-year period. Which means Terra Firma will be hoping to sell for at least £800m, enough to pay back the banks and make a £200m profit on the £200m investment. But if Hands sells at the multiple he bought Odeon for – roughly 10 times ebitda, generating a sale price of £1.2bn – he will have made a £600m profit and four not two bags' worth of return.
Hands and Gavin have not seen a film together since the 2008 premiere of the Abba-inspired musical Mamma Mia!. With the Terra Firma founder now a tax exile on Guernsey, a trip to the Odeon Leicester Square may be a while in coming. But both are fond of a singalong – Hands is known for his karaoke evenings. If Terra Firma makes its three bags, Gavin will no doubt be joining Hands in Guernsey for a comeback rendition of Money, Money, Money.
Source http://www.guardian.co.uk/
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