UK cinema industry poised for blockbuster year of deals

Showing films has never been more profitable. Consolidation might make it even more so

It is likely to be another blockbuster year for the UK cinema industry thanks to a string of eagerly anticipated new releases such as The Matrix Reloaded, The Hulk and the third Lord of the Rings movie. UK cinema admissions rose 13 per cent to 176 million last year, according to the Cinema Advertising Association and are predicted to rise another 4 per cent this year.

But never mind the excitement on the screen, the real action might be taking place off it.

The reason is that 2003 could be the year of the deal in the UK cinema sector. The Odeon chain was sold for £431m at the weekend to a consortium of investors led by two banks, WestLB and Lehman Brothers. Experts say there could be another two of three deals in the pipeline as the market starts to consolidate after a period of breakneck expansion. So get your bucket of popcorn and your gallon of Coke and settle down for the ride.

As Richard Segal, the chief executive of Odeon cinemas, says: "The expansion phase has come to an end and a period of consolidation is upon us. We'll see a smaller number of major players emerge in the next 18 months."

Rumours abound as to which chains might be on the block, with most of the major players linked to deals. Much of the speculation has centred on Universal, the film and music division of the troubled French conglomerate Vivendi. Vivendi has a big stake in UGC, the second-largest UK chain which it owns in conjunction with a private French group. It also has a 48.5 per cent stake in UCI, the joint third-largest UK cinema group in which the Viacom-owned Paramount also has a 48.5 per cent stake.

Some expect AOL-Time Warner to review its holding in Warner Village which is a 50-50 joint venture between Warner Bros and Village Roadshow, an Australian company.

One chain which is definitely on the market is Ster Century, a South African company which controls five cinemas in this country and one in Dublin. The cinemas are being sold by ING Barings.

The shake-out might seem surprising given the rude health of the industry. UK cinema admissions have been rising steadily for more than a decade, fuelled by the growth of plusher multiplex cinemas and the Hollywood hype machine. Admissions are expected to rise again to 182 million this year, double the level of 1990. An extra boost has come from movies which are seen as "home grown" such as Lord of the Rings and the Harry Potter movies which continue to break box office records.

So why the consolidation? John Wilkinson, the chief executive of the Cinema Advertising Association, says: "In 1998-99 the UK market had a lot of new entrants such as Cinemark [a US company] and Hoyts [of Australia]. Many of them came in saying 'we know how to make the UK work'. But most of the best sites had gone and they just forced up rental payments. Most of those people have effectively withdrawn now."

Another factor is the implosion of the internet boom. A spokesman for Leicester-based cinema specialist Dodona Research, says: "Some of the joint venture partners have suffered problems after the blow up of the TMT boom so this has resulted in potential instability of some of these chains."

Odeon, which operates 608 screens in 97 sites across the country, might even choose to go shopping for more. As Mr Segal says: "I think Odeon would be very interested in exploring opportunities that are provided by the marketplace." Last year Odeon reported earnings before interests and depreciations of £46.6m on a turnover of £212m.

CinVen the venture capital group which has just sold Odeon, had already put the UK's largest chain together with ABC cinemas which it bought in 2000. Though CinVen took out £260m in December via a securitisation deal with Morgan Stanley and Royal Bank of Scotland, there could be scope for further financial engineering.

Odeon owns £300m of freehold property which WestLB is likely to use as backing to repay debt or raise funds for investment. "These opportunities will be vigorously pursued in the short term," Mr Segal confirms.

But there could be new entrants from overseas. One possibility is Philip Anschutz, the US billionaire investor whose Regal Entertainment Group operates 6,000 screens across the US, a market share of 20 per cent. Another is Onex Corporation, one of Canada's largest businesses which last year bought the Loews Cineplex business in the US.

One analyst says: "I think they will be here sooner rather than later." Mr Segal at Odeon agrees, saying: "I think both of them will be here in the short to medium term."

Also waiting in the wings is the easyJet entrepreneur Stelios Haji-Ioannou. He wants to bring easyCinema to the masses, charging as little as 20p for a seat, starting with his first multiplex in April. To do this he must do battle with the Hollywood distribution firms which he says keep prices artificially high.

It is high distribution charges which lead some sceptics to wonder whether cinema operators make all their money on the Coke and the popcorn and none at all on the price of the ticket.

The charges paid by cinemas to their film distributors are on a sliding scale and struck on a cinema by cinema, screen by screen basis. In essence it means that if a showing is full the distributors take the lions share of the takings. If it is virtually empty the cinema gets a bigger cut to help it cover its costs.

"People who say we don't make any money on the tickets know diddly about this industry," Mr Segal says. He states that two-thirds of gross profits come from box office receipts, about 26 per cent from food and drink and about 8 per cent from booking fees and screen advertising.

But cinemas have to pay full VAT on the tickets and 1 per cent of gross receipts to the Performing Rights Association for use of music in the cinema and in the films.

One unique asset Odeon has is the presence of the Green Brothers' Entertainment Film Group in its consortium. The Greens run one of the most successful independent film distributors in the world and its business was responsible for the Lord of the Rings films and the latest Austin Powers movie.

"WestLB could package the Odeon with the Entertainment Film Group and have a vertically integrated movie business which could be floated at a later stage," one analyst comments.

Odeon also has interesting ideas to grow its core cinema operation. As well as showing films it wants to host business conferences, which has been a growing source of revenue. It also wants to show "alternative film content" such as rock concerts, Broadway musicals, opera and ballet. During last year's football World Cup it showed games beamed live from Japan and South Korea. "We will sweat the assets going forward," Mr Segal says.