Summary
AMC has entered into a potential settlement with class action plaintiffs to allow APE units to convert into AMC shares, adding a material sweetener for AMC stockholders.
The judge has not yet approved the agreement, which offers slightly improved terms to AMC shareholders over APE unitholders.
If the settlement holds, then AMC shares should trade at approximately an 8% premium to APE units prior to conversion (depending on the exact number of APE units issued).
AMC remains hard and expensive to borrow, but there may be remaining arbitrage opportunity into conversion, though AMC stock has historically not traded 'rationally'.
J. Michael Jones
AMC preferred (APE) units may now convert into AMC $AMC Entertainment(AMC)$ shares as a settlement has been agreed to the pending class action. However, the judge must approve the settlement and the settlement is slightly dilutive to APE holders. Whereas previously the conversion was effectively 1-to-1, with the settlement which gives additional shares to legacy AMC shareholders (1 extra share for every 7.5 AMC shares held) the conversion factor is approximately 1.08 AMC shares to 1 APE unit, depending on exactly how many APE units have been issued at the time of conversion and assuming the legal settlement holds.
Historical Recap
Movie theaters were basically shut down during COVID-19 and then, as if to make things worse for AMC, the rise of streaming services as an alternative to movie theaters' first-run rights hit demand further. Other theater companies have gone bankrupt.
This hostile environment leads to AMC issuing significant equity and debt to remain solvent. As this dilution continued, AMC was ultimately prevented by shareholders from issuing the additional shares which it arguably needed to maintain liquidity and potentially pay down debt. AMC then creatively issued preferred APE units in late summer 2022 as a way to sell what were intended to be as close to AMC shares as possible, but without shareholder approval, and then planned to convert those APE units into AMC shares after a vote, which was easier to win because the new created APE units could vote too, and would disproportionately benefit from conversion.
AMC's vote on March 14, 2023 allowed for conversion but was pre-emptively blocked by a class action. Now, AMC has a "binding settlement term sheet" with the plaintiffs which should allow conversion, though it needs to be approved by the judge.
A Literal Arbitrage
This is a very close to an arbitrage in the literal sense, because APE units should become AMC shares (albeit at a slight discount) if things proceed as AMC planned. APEs will cease to exist and unitholders will become AMC shareholders, if all goes to plan.
However, there remains a large spread between AMC shares and APE units, even based on after-hours pricing on 4/3/2023. As I wrote previously, the trade is not costless as implied options premia, AMC borrow costs, and short squeeze risks all make the trade less attractive and more expensive than it initially appears.
Still, the trade is worth monitoring, because we have two assets that now appear likely to converge, and yet trade at quite different prices. To be clear, AMC shares should now trade at a slight premium of around 8% to APE units if the conversion occurs in short order on the settlement terms because of the settlement sweetener that gives AMC holders extra shares, but absolutely not at more double the current price in my view.
Fundamental Value - Not Much
Still, regardless of what has been very interesting and creative financial engineering, we should remember that the equity value of AMC may be zero. Let's take a very rosy $300M of pre-COVID best-case EBIT for AMC and assume AMC can get back to that. Well, even if they do meet that EBIT goal, $4.5B of debt with a 7% interest rate means that the company is still losing cash ($315M of interest expense vs. $300M of EBIT).
Next, bear in mind that my EBIT number is an imagined and arguably best-case scenario, whereas the interest expense is a cold, hard fact and could rise further in the environment of dramatically rising interest rates over recent months.
Therefore, when considering the arbitrage, we must bear in mind that AMC shares may ultimately be worth zero. That's not to say the company is worthless in enterprise value terms, it isn't, it just means that all the value is potentially held by the debtholders given the high leverage today. There's arguably no value left beyond that for shareholders.
Of course, I'm not saying AMC will go bankrupt in short order. Indeed, issuing even more shares at above their intrinsic worth may help get AMC out of its current troubles to some degree, but we should not necessarily expect APE units and AMC shares to 'meet in the middle' of their current prices over the medium-term since leverage is so high. Remember, if the class action settlement holds, that involves even more incremental dilution with no real improvement to the business or capital structure. You have to really believe that AMC will execute exceptionally well to see equity value here. I remain skeptical.
Investment Considerations
It is fascinating to see AMC shares trading at $4/share after-hours given the potential settlement when APE units trade at $1.80/unit. In theory, if the settlement proceeds as planned, these prices should trade much closer, with AMC at around an 8% premium to APE. The vote has taken place, so the main risk now is whether the judge approves the so-called settlement term sheet, assuming both parties stick to its terms.
Therefore, if you can short 1 share of AMC and long ~0.93 units of APE without paying an implied $2.20 of total costs (in terms of option premia or borrow cost) before closing and hold the trade at a size where margin calls won't force you to close the trade prematurely, you may well make money.
The question of course is if the market will offer that after today's news. For now, the spread between APE units and AMC appears excessively high, but over recent months borrow costs and options premia have been extremely elevated too. That creates the illusion of a juicy spread, but not necessarily a profitable trade once all costs and risks are considered.
Risks
AMC shares have historically not traded in a way that I would consider rational. This could happen again. Even if we think we know the 'end state' value of APE units and AMC shares, the interim values could end up at any value, and similar to other meme stocks, have historically seen wild volatility arguably divorced from business fundamentals and more driven by technical trading factors.
AMC borrow costs are very high, as are option premia/implied volatility. This means that even if APE units and AMC shares were to converge, you may not necessarily make money on a convergence trade after all costs. Also, options are unavailable on APE units.
AMC may have zero equity value given its debt load, this is a factor in constructing a trade to capitalize on the AMC/APE spread over the medium term.
If the settlement holds, a well-specified arbitrage now requires slightly fewer APE shares for every AMC share held. The trading impact of that is uncertain.
Conclusion
The AMC/APE convergence trade appears to have risks associated with the vote removed after March 14, now risks associated from the class action appear to have reduced. That said, the settlement appears to offer a greater share of the economic value to AMC shareholders at the expense of APE unitholders meaning the trade is no longer 1-to-1. Nonetheless, with such a wide spread and apparently low risk, there may be money to be made on convergence even taking account of elevated borrow cost and high implied volatility. It is important to factor in those elevated costs before placing any trade, as is having sufficient liquidity to manage any interim short-squeeze. Still, we may finally be close to the end of the months-long AMC/APE saga.
Soource: Seeking Alpha
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