With the megaplex concept's blockbuster success, multiplex properties began closing at an unprecedented rate: 400 closed by the end of 1997, 600 in 1998, 1,100 in 1999, and more than 800 during the first half of 2000, according to Brain. The market is in transition, he reiterates, as the industry reconfigures from a 15 percent penetration of megaplex theaters to about 50 percent within the next five to eight years. With 36,000 total screens in the market today—with 15 percent of those, or about 5,400, in megaplex theaters—a tripling of the market means that more than 16,000 additional screens will be unveiled in the megaplex format over the next five years. At an average cost of about $800,000 per screen to build (according to the National Association of Theatre Owners), multiplied by 16,000 screens, EPR today is well positioned to capitalize on the estimated $13 billion in financing needs of the first-run movie exhibition industry.

EPT is moving forward with a 100 percent stadium seating requirement in all its properties.

"Our business plan is to own the top 15 to 20 percent of the megaplex market by 2005, representing at least $2 billion in assets," asserts Brain. "We will continue to take advantage of the high demand for capital being generated by the operators involved in the reconfiguration process. This high demand will translate into high yields on capital for our shareholders."

Brain also notes the expansion and improvement of the concessions being purchased by movie patrons today, which represent an additional one-third of ticket sales (about $3 billion), generating a higher rental revenue from the same capital investment in a single megaplex property.

Stadium Seating

Stadium seating is not a new concept in entertainment, but it is new to the theater experience because, until recently, most multiplex theaters were built in strip centers and had to conform architecturally, with low ceilings and low floors that do not accommodate this seating concept. However, as the industry shifts from a multiscreen to a megaplex format, the new megaplex properties and designs allow the stadium seating venue, which many moviegoers prefer.

In a survey conducted by A.C. Nielsen/EDI (as reported in Credit Suisse First Boston's Film Exhibition Industry Overview), 52 percent of heavy moviegoers (representing 66 percent of total ticket sales) that were familiar with stadium seating stated they would be more likely to choose a theater with stadium seating.

"Every one of our properties offers stadium seating, a feature that customers really want," says Brain. "We view this venue as critical in any property we buy. We are not interested in acquiring any properties that aren't 100 percent stadium seating."

Brain says his company looks at the performance of a property by not only its top line ability to gross, but also its return on asset: "Stadium seating is very successful on an absolute basis but also on a relative basis when compared to its higher costs. Our estimate is that stadium seating—although probably about 20 to 25 percent more expensive to develop on a per seat basis—generates approximately double the return on asset."

The larger seating capacities offered by stadium seating directly affect the amount of parking required for a property. While the code requirements for a megaplex are the same as for a multiplex (one parking spot for every four seats, though EPR on average provides one spot for every three seats), the larger seating capacity requires at least a thousand parking spots, which makes a project more challenging to site than a multiplex. However, this larger parking capacity could offer a good synergy with other uses that co-locate with the theater, such as an office building, since the two uses would demand the parking spaces at opposite times (day vs. evening).

New Technologies

The newest technologies enhancing the megaplex experience include digital sound, which is entering the industry in several different formats. These differences are in the process of being sorted by standard and/or by a clear winner in terms of the cost/benefit equation.

Some major exhibitors are also testing the digital delivery of video on the big screen. This technology will mean a huge change in the industry, which almost uniformly still presents images through a strip of plastic. "Most major operators have one to four auditoriums (not theaters) equipped to experiment with the quality and cost associated with digital presentation," notes Brain.

The real significance to EPR of these new digital technologies may be the new financing opportunities they create. Explains Brain, "Since we are a specially financed company for our industry, there is the potential that we could get involved in digital equipment as part of the financing package we provide. This is not the case today and we do not have any specific plans in motion; but with the expansion of the REIT Modernization Act, there is the opportunity for REITs to have taxable subsidiaries engaged in non-real estate businesses related to the business on the real estate property. In our segment, this could someday mean digital technology, but not today," he reports.

Our estimate is that stadium seating—although probably about 20 to 25 percent more expensive to develop on a per seat basis—generates approximately double the return on asset.

Beyond Cinema

Going forward, EPR is considering expanding beyond cinemas to include other entertainment formats, such as live theater and sports stadiums, reports Brain. "We chose the name 'Entertainment Properties' because we think there are also good opportunities in other entertainment venues," he says.

Brain reports a lot of need and discussion in the sports stadium segment regarding both large arenas for professional football and mid-sized ones for basketball and hockey. "There's a bit of a vacuum in the supply in this category, with a split between public and private sources, and between who will be the developer and who the lessor. It's a very fragmented industry with a very inefficient capital formation process, and that's exactly what the cinema and megaplex industry was when we entered it. We've seen that fragmentation and inefficiency create a good yield opportunity for investors."

Brain says one of the reasons EPR stands out in its segment is because the megaplex format has been its sole focus and understanding, as opposed to other public REITs in which the megaplex is a minor element of an overall business plan. He says some smaller, private REITs that specialize in the megaplex arena have limited capital, far fewer properties, and/or a focus on minor metropolitan areas with smaller formats, such as the 16-plex.

All of EPT's properties are developed as megaplexes.

Brain says the megaplex segment has a number of strong qualities including: superb current growth; a great long-term potential; growth with low revenue per capita; stability, without discounting. Additionally, the segment is not highly threatened by the Internet and has specialized properties that do not allow easy competition from other property types. "It's difficult to convert another large box into stadium seating. Even so, the typical big- box property offers only about a third of the parking required for a megaplex. We're in a protected position," he asserts.

He adds that the megaplex movie concept offers a renewal of the entertainment experience—i.e., the constant introduction of new movie titles. As opposed to themed restaurants, for example, which are well patronized when they open but become less exciting as the experience gets old, theaters have renewed content all the time. "Properties that offer a continual renewal of the entertainment experience have an enduring value," Brain asserts. "Even as the Internet, home theater and other 'cocooning influences' succeed to some degree, they do not negate the out-of-home experience, which is still highly valued."

Brain says investors are also attracted to EPR because in a depressed equity market and tight debt environment, where money is expensive, EPR does not have many development projects with capital expenditure requirements that force the company to go out and raise money. Other companies with multiple development projects have to feed those projects with capital and continue to build out even when money gets expensive, he says. Since EPR buys on completion, when the cost of funds gets too high, it simply quits buying properties.

EPR has judiciously positioned itself in a market poised for a resurgence once capital and development are unleashed.

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