Critics say a $725 million syndicated loan to Regal Cinemas Inc. may be the feel-good hit of the summer but could become a thriller in years to come.
The loan by Bank of Nova Scotia is part of a planned $3 billion buyout by Kohlberg Kravis Roberts & Co. and Hicks Muse Tate & Furst Inc. The deal not only contains a risky loan, analysts say, but worsens Regal's credit overall.
Reports issued in the last week by Moody's Investors Service and Standard & Poor's say Regal, based in Knoxville, Tenn., has been destabilized by the buyout's $470 million in junk bond debt. They say that should the movie business sustain a downturn, the loan portion could default.
"They've piled on a ton of debt through the LBO," said Heather Goodchild, an analyst with Standard & Poor's, in an interview Tuesday. "It's very hard to predict how Hollywood is going to do."
Standard & Poor's responded to the deal by downgrading Regal's corporate credit overall from BB to BB-minus-the same rating it assigned to the Scotiabank-led loan.
But a source close to the deal dismissed the analysis by saying investors "believe in the strength of the industry." The loan closed Wednesday with 73 investors, including money managers and banks.
"This was a very easy loan to syndicate," the source said. "There's been a fairly strong endorsement in the marketplace. There's a lot of confidence in KKR and Hicks Muse."
But the loan package suggests the deal does carry some risk. Two parts are priced at "highly leveraged" levels, according to Securities Data Co. The four-part loan comprises:
A $120 million term loan due in 2005, priced at 225 basis points above Libor.
A highly leveraged $120 million term due in 2006, priced at 250 basis points above Libor.
A $135 million highly leveraged term loan due in 2007, priced at 275 basis points above Libor.
A $350 million revolving credit facility due in 2005, with 0.425% commitment fee on any unused portion.
Scotiabank is the lead arranger and administrative agent. BankAmerica Corp. is syndication agent, and Chase Manhattan Corp. is the documentation agent. Morgan Stanley Dean Witter & Co. underwrote the high-yield bonds, which were priced to yield 9.5%.
Weakened credit may have been anticipated but it certainly was not the goal for Kohlberg Kravis and Hicks Muse when they made a deal for the cinema chain. The leveraged-buyout firms were looking to cut costs and, if possible, negotiate better terms with Hollywood's major studios.
By combining 2,333 screens with the 3,014 screens they already owned through acquisitions last year, the deal shops would create a 5,347 screen behemoth. It would be the biggest U.S. cinema chain, with 17% of all screens-well-positioned to win a higher share of ticket revenues.
Regal shareholders approved the deal, which is expected to be completed by Friday, only last week.
Analysts said that even if Regal's anticipated savings do materialize, they might not matter as much as whether people want to go to the movies.
"Regal, like its competitors, remains dependent on the quality and quantity of films in release, which can lead to year-to-year swings in attendance and earnings," Ms. Goodchild said.
In addition, Regal Cinemas is undergoing a huge expansion effort that is expected to gobble up any free cash through the end of 1999, Ms. Goodchild said.
Moody's agreed, adding that ticket sales have been a "slow growth" trend in recent years, the environment is extremely competitive, and the industry risks "overbuilding" of theaters.
But the source close to the loan said that expansion coincides with a shift among the movie-going public. These consumers are attending movies more for the luxury theaters Regal is building than for the movies being shown.
"They want stereo sound and stadium seating and gourmet coffee bars," the source said. "That's what these guys are doing."