Andrew Shapiro has talked to Seeking Alpha’s Jason Aycock about his single highest-conviction position, Reading International (RDI) (See the RDI post archive):
If you could only hold one stock position in your portfolio (long or short), what would it be?
Our best risk/reward idea is Reading International (RDI), an internationally diversified movie exhibitor, with a related business segment that owns, develops and operates substantial real estate assets, many of which are entertainment-themed retail centers (“ETRCs”) anchored by Reading’s cinema multiplexes. Reading’s cinemas generate growing, recession-resilient and recurring box office and concession cash flows. The cinema business builds value by paying down acquisition debt, as well as funding the front-end cash demands of developing Reading’s valuable real estate assets. The development process includes purchasing raw land, up-zoning, development and construction, eventually generating cash through leasing or outright sale.
In addition to its upside from present prices triggered by impending catalysts and growing cash flow, Reading has an enormous “margin of safety” both from the value of its huge landholdings in Australia, New Zealand and the United States, as well as a reasonable valuation of its cinema segment.
Tell us a little more about the company behind the stock.
Over the past few years, Reading has strategically expanded its many cinema circuits in Australia, New Zealand and the U.S. through organic growth and acquisitions, building the fourth-largest exhibitor in Australia, third-largest in New Zealand and the 12th-largest here in the United States. Its approximately 462 screens in 56 cinemas and four live (“Off-Broadway”) theaters are primarily situated on owned or long-term leased land.
Reading’s cinema segment cash flows have continued to show resiliency in recessionary times, producing approximately $35 million of adjusted EBITDA for the 12 months ended June 30. In addition to selective new theater openings and culling of underperforming theaters, Reading has begun equipping a majority of its theaters with digital 3-D capabilities that will provide incremental cash flow into this cinema segment.
As for the real estate segment: Unlike other cinema exhibitors, Reading owns over 16.5 million square feet of real estate, of which only 1.2 million square feet is already developed and generating approximately $13.5 million of adjusted EBITDA for the 12 months ended June 30. In many instances, Reading benefits by having its own multiplex as an anchor tenant and by having itself as landlord. Developed real estate includes the Courtenay Central shopping center in downtown Wellington, New Zealand; the Red Yard Centre in the Auburn suburb of Sydney; and the Reading Newmarket Centre near Brisbane, Australia.
A substantial portion of the more than 15.3 million square feet of additional land owned by Reading holds great cash flow growth potential as it is developable in desirable urbanized locations throughout Australia, New Zealand and the United States, but not yet generating a dime of cash flow. These undeveloped parcels are in various stages as stand-alone developments or “phase two” expansions of existing ETRCs. In addition, Reading owns the land underneath its New York City and Chicago live theaters, including the Union Square Theater, and also midtown Manhattan real estate underneath its Cinema 123 on Third Avenue, across from Bloomingdales – all prime land.
Reading’s 51-acre Burwood Square project in Melbourne, Australia, is by far Reading’s most valuable undeveloped parcel, on its balance sheet for around $45 million. Purchased in 1996 when it was a former brickworks and rock quarry, this giant parcel has now been upzoned to be a “major activity center,” zoned for residential, commercial, entertainment and retail use, and is one of the last prime developable sites fairly close to Melbourne’s central business district.
It should be noted that Reading owns its Burwood parcel (as well as its recently completed and leased Indooroopilly Brisbane office building) debt-free, unencumbered by any mortgages.
Most of Reading’s real estate that has been held or developed over a long period of time (some, like Burwood, since the mid-90s) is on the company’s balance sheet at values which we believe greatly understate current market value. These parcels have enjoyed – to varied degrees – substantial unrealized appreciation from up-zoning, surrounding population growth, property improvements, construction and lease-out, and, in some instances, more than a decade of market inflation.
As more of Reading’s real estate assets are converted to either current cash flow generation or outright sale, Reading ought to be viewed more and more as an undervalued growing operating company attracting a multiple, rather than simply an asset play.
How does your choice reflect your firm’s investment approach?
My firm, Lawndale Capital Management, and the funds it manages have for over 17 years targeted capital appreciation in securities where our research-intensive and active style can add value by identifying and capitalizing on market mispricing. We invest as very active owners, preferring to have strong friendly relationships with the portfolio company managements and boards, but never afraid to take any and all measures that are in the best interests of protecting and creating value, including proxy fights or other legal steps. We regularly take 13D filing-size positions and communicate our views.
We seek large returns through concentration in a few core companies that are analytically out-of-favor (contrarian), analytically complex (special situation), or analytically uneconomic (illiquid). We find small and micro-cap company stocks, and small issues of more senior securities such as preferred stock, and corporate debt of even larger companies, are often priced inefficiently due to illiquidity and investor neglect or incomplete fundamental analysis.
We balance our quest for substantial returns with a fundamental tangible asset-based and deep value-style approach, seeking a “margin of safety” that cushions the biggest risk to our returns: the extensive time and effort to unlock value in our portfolio companies.
Our Reading investment fits right in with our strategy. It started even more analytically illiquid and complex when initially invested in Reading’s three micro-cap predecessor companies, Craig Corp., Reading Entertainment and Citadel Holdings. These companies had much smaller public stock floats and an interrelated ownership structure confusing to most investors. We encouraged and supported a year-end 2001 merger of the three companies to become the single, simpler and larger small-cap Reading International. Even today, tracking progress milestones and estimating the value of Reading’s multiple undeveloped foreign parcels turns off most investors and every sell-side analyst. The fact that Reading’s current stock price basically provides its sizable undeveloped landholdings for free more than adequately provides us our required margin of safety.
How much is your selection based on the Reading’s industry, as opposed to a pure bottom-up pick?
The concentrated private-equity-like portfolio approach Lawndale takes creates inherently larger event risk, so we seek to invest as generalists in several different industries. That being said, as deep value balance sheet-focused investors, we have a predilection for companies with hard assets where investors aren’t pricing those hard assets. For example, with Reading, we own a sizable cinema player that owns a lot more land than investors give it credit for.
In general, our selections are bottom-up where we identify assets undervalued by the market due to perceptions or misperceptions of perpetual deterioration or perpetual stagnation at best. We look for operations that can be turned around, credit quality that can be improved, or dysfunctional boardroom and management situations that are fixable with a catalyst such as ourselves.
How is Reading positioned with regard to competitors?
Initially, the entrenched real estate moguls in Australia severely stalled Reading’s development plans in the late ’90s and early part of this decade, but that logjam has been overcome and almost all of Reading’s parcels have now received their up-zoning.
While Reading’s small theater footprint in the U.S., relative to Regal (RGC) and Cinemark (CNK), had hurt availability and terms on first-run films several years ago, an antitrust lawsuit against the largest movie studios and exhibitors (long since favorably settled) and growth of Reading’s market share in certain markets (70% Hawaii, 12% San Diego) has alleviated this issue.
How does Reading’s valuation compare to its competitors?
Extracting the value of all of Reading’s real estate from its enterprise value imputes a compelling, very low or even negative multiple on Reading’s geographically diverse cinema business. Alternatively, Reading’s cinema business, using multiples below those of comparables, plus its understated book value on its developed real estate, exceeds Reading’s present enterprise value. Thus, the value of all of Reading’s substantial to-be-developed real estate is “free,” serving as a substantial “margin of safety.”
Without individual cash flow figures available on Reading’s land, our valuation model becomes a three-pronged matrix. On the cinema segment, we use an EBITDA multiple as well as a multiple on-screen count. For developed parcels, we are compelled to use a multiple on net book value, based on building age and occupancy and/or appraisals the company previously disclosed. On the to-be-developed parcels we use very conservative assumptions in an NPV approach. Finally, while cinema segment G&A is accounted for in its EBITDA, including a deduction for the value of real estate segment and normalized corporate G&A expenses results in a total value range for RDI of at least $8-12/share. [Reading closed Wednesday at $4.32.]
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