by Lorna Pappas

Editor's Note: This is another in our series of articles profiling companies in the REIT and publicly traded real estate industry. Portfolio runs profiles like this one on companies that have shown leadership, innovation or resourcefulness that we believe our readers will find of interest.

Here's the script: An investment banker dealing with capital markets for its client, AMC Entertainment, seizes the opportunity to provide financing by forming a specialty REIT focused on megaplex theater development, and turns a $2,000 balance sheet in mid-1997 into mid-2000 revenues of $55 million. This story, entitled "Entertainment Properties Trust (EPR)," has gotten some strong reviews, with a leading role performed by David Brain, president, CEO and co-founder of this Kansas City, MO-based company. It was Brain, the ex-investment banker, who recognized the potential of a situation characterized by the success in 1995 of AMC's megaplex movie theater concept, the exhaustion of AMC's own capital resources to support this property type, and the potential for a specialty REIT to serve as a mechanism for financing AMC's real estate development needs. Launched with two people, a fax machine and phone, and a few thousand dollars in personal savings, EPR completed an initial public offering in November 1997, created through the sale and leaseback of all but one of AMC's megaplex theaters.

Today the company's core strategy is to manage, acquire and develop a diversified portfolio of high-quality properties—specifically targeting megaplex movie theaters (those with 14 or more screens), as opposed to smaller multiplexes (with four to eight screens). These theaters are then leased to entertainment-related business operators generally under full credit, long-term triple-net leases. The REIT now owns 26 megaplex movie theaters in 13 states: Eighteen of the theaters are managed and operated by AMC, and are among the most productive in AMC's portfolio of 214 properties. The remainder are managed and operated by Muvico (3), Edwards (2), Consolidated (2) and Loews (1). All of EPR's megaplex properties are state-of-the-art theaters built within the past three or four years. The majority of its megaplexes consistently are among the top 100 highest grossing theaters in the U.S.

A typical EPR building sits on 20 acres, has 1,200 parking spaces, 4,000 stadium seats and 20 screens, drawing a whopping 80,000 moviegoers per year per screen, on average. At $7 per person in most markets today (few moviegoers shop price), EPR is generating revenues of more than half a million dollars per screen, compared to today's industry average of $240,000 per screen, says Brain.

We believe an AMC bankruptcy filing and a consolidation among theater operators could benefit EPR. —Jim Sullivan, Prudential Securities

Operator Pressures

As of August 2000, EPR had a "Strong Buy" rating with Prudential Securities, and a "Market Outperformer" rating with Goldman Sachs. This is despite the weak box office sales, higher wage expenses and hefty debt burdens felt by the movie industry in 2000. Many movie exhibitors have suffered poor performance and even bankruptcies this year, with AMC among those feeling the pressure. Together with the rest of the theater operators, AMC is in the midst of an expensive replacement cycle whereby the megaplex theater is replacing the multiplex in most major markets.

Jim Sullivan, managing director and senior real estate analyst of Prudential Securities, notes that EPR stock has come under pressure this year as investor concerns have centered on AMC's financial challenges. About 50 percent of AMC's cash flow is generated by the 18 AMC-operated theaters in EPR's portfolio (nearly 10 percent of AMC's total theaters). Regardless of this strong link to AMC, Sullivan asserts, "We believe that EPR's risk of financial loss due to AMC's problems is minimal. In fact, we believe an AMC bankruptcy filing and a consolidation among theater operators could benefit EPR and improve rental coverages in megaplexes."

At EPR, Brain points to a substantial spread between the perceived and actual risk of his company, which is creating value in EPR stock: "The perceived risk is high because of the financial challenges now being faced by movie operators, which are our tenants, but EPR's actual risk is quite low, since all our properties have always performed well and continue to do so. The anticipation of operators' pending bankruptcies is worse than the event itself. In the meantime, we don't have much chance to surge ahead as an equity value, but we are well positioned for a bounce-back in price once the actual risk is realized by investors."

Affirms Jim Kammert, senior analyst with Goldman Sachs, "We continue to encourage purchase of EPR shares."

The megaplex concept seeks to make the facilities able to draw audiences from up to 15 miles away.

Brain explains that the credit crisis operators are in today actually was created by the success of the megaplex. He says the new concept was so well received that operators accelerated their megaplex development programs, but couldn't get their old stores closed quickly enough. The duplicate store systems degraded operators' financial performance ratios, and thus their credit ratings, ultimately leading to some of the bankruptcies now being pursued by operators. He says the industry is in a period of digestion: New screens already opened are being absorbed into the market, older screens are closing at an accelerated rate, while new development is at a standstill. "This digestion period is good in the long run, because it will lead to more prudent development that is more in sync with the expiration of older store lease terms. Capital will flow back into the industry as more rational and deliberate store development programs are pursued in conjunction with store closings," states Brain.

Megaplex Concept Solves a Riddle

The traditional multiplex theater was a success when AMC introduced it decades ago. In May 1997, the entertainment giant took the bold step of investing $20 million in the new megaplex concept, and opened the AMC Grand 24 in Dallas, Texas. The new format became a huge success as it solved an ongoing riddle—what's showing, where and when?

"The megaplex store format had immediate and outstanding success, outperforming all expectations, because it offered great selection and convenience," notes Brain. "Twenty-four screens reflected about all the films in the market at any one time, playing continuously, so the location itself became the destination, and the driver became the real estate, rather than the film."

Brain says that when AMC subsequently introduced its "Movie Watcher Card," offering a free movie with every tenth visit to the Grand 24, the company was able to determine how far consumers were traveling to visit the new theater. "Customer draw more than doubled, from about a six-mile radius to 15 miles," discloses Brain. "The megaplex had become a destination; people were traveling past smaller theaters showing the same films because they knew the Grand offered a greater selection of showing times and films, which translates into convenience," says Brain.

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