AMC Entertainment (AMC) released second-quarter earnings last week, with revenues down about 20% from pre-pandemic levels in 2019 and continued losses -- but the real show-stopper was the theater chain's plan to issue a dividend of preferred stock, called AMC Preferred Equity, or APE (APE).
In fact, AMC initially slipped on the earnings report that was largely in line with expectations, but then turned sharply higher on excitement over its APE offering. For context, the same day of the earnings release, competitor Cinemark (CNK) revealed similarly weak earnings report, sending shares down 13%.
Let's see how this new plot twist in the stock could play out for investors interested in the famed "meme" name -- as in will this suspense turn into a happy ending or a horror show -- or could the bonds save the day?
The preferred stock dividend will be issued on a one-for-one basis for each share of common stock, with each preferred share convertible into a share of common stock. Oddly, the dividend was worded as a "reward" for shareholders, when it is essentially a stock split. A stock split is not a reward, nor should it be couched as one. The preferred is merely a clever remedy for issuing new shares to raise capital. AMC management has been handcuffed by shareholders who had refused to approve the issuance of additional common shares when last voted upon.
If shareholders would consider it rewarding to issue new shares, they should have approved management's last attempt. Nonetheless, AMC's CEO, Adam Aron, appears to believe that raising capital to pay down debt, restructure leases, and potential mergers and acquisitions, will strengthen the balance sheet and "ensure AMC's near-term survival." Clearly, raising capital is a positive to take near-term bankruptcy off the table, but investors must prepare for significant stock dilution to achieve this goal.
What's troubling is the rhetoric of AMC's highly promotional CEO when describing the positive benefits of raising capital, such as being "bad, bad, bad news for those who wish us harm."
I believe this is an unfortunate plea of victimhood from the CEO. No nefarious plot exists against AMC when the short case is already made, I believe, compelling enough by the CEO's own words -- that capital raises are needed "to ensure our survival in the near-term." Adam Aron makes the short case clear enough in suggesting that AMC's survival is still at risk from the pandemic for a company with a $12 billion market cap and $10 billion in net debt and lease obligations.
If AMC can raise equity capital through the new preferred APE shares, at elevated stock levels, to buy back debt at depressed levels, there's a clear benefit to the capital structure. Unlike the equity, there may be an investment case for the bonds. Investors who believe Adam Aron can raise billions to pay down debt would find it more logical to buy AMC bonds maturing in 2027, currently trading at 58 cents on the dollar for a yield to maturity of 20%. An investment of $10,000 would return about $14,500 in gains over the next five years for almost a 150% return. These bonds, of course, are currently deep in junk territory at CC+.
But the investment case for owning the equity is nonexistent outside of short-lived meme stock opportunistic short squeezes. The movie theater sector will live on, but will never thrive and is likely in secular decline. The capital structure of AMC will improve, but we've yet to see the market's appetite for potentially billions of dollars of additional equity raises. AMC is pre-authorized to issue up to 4.5 billion additional preferred shares of APE to raise cash. Selling just a fraction of the authorized shares will cause massive dilution to equity holders.
At its core, AMC is a movie theater chain, albeit the largest in the world, and subject to changing technology and consumer preferences for movie viewing, causing the industry to stagnate, at best. Please don't underestimate how much fresh capital AMC can raise to ensure its survival, pressuring the shares after the preferred dividend is issued. On the other hand, the more equity raised, the better the bonds can trade. Therefore, the only investment thesis that merits consideration is to sell AMC stock to buy the bonds.