To The Moon

Summary

• A court has approved a settlement offer between AMC Entertainment Holdings, Inc. and investors, allowing the conversion of preferred equity units into common stock.

• The settlement will result in a reverse stock split and a decrease in the number of common shares, potentially leading to a convergence in prices between common stock and preferred equity units.

• The future of AMC Entertainment remains uncertain, with structural issues and a lack of true growth in the movie theater industry. Investors should approach the stock and preferred equity units with caution.

lisegagne

From time to time, markets can behave very irrationally. This also extends to individual companies. Oftentimes, but not always, this irrational behavior can be traced back to some specific event or circumstance. And when that event or circumstance runs its course, you ultimately see the security or securities in question revert back to some level of normalcy. This is what I believe will transpire fairly soon when it comes to movie theater operator AMC Entertainment Holdings, Inc. $AMC Entertainment(AMC)$.

Over this past weekend, news broke that a court agreed to the newest settlement offer between AMC Entertainment and a group of investors who were holding up a conversion of the preferred equity units $AMC Entertainment Preferred(APE)$ that the company had issued into common stock and a subsequent reverse stock split. It is my view that this will have profound ramifications for the speculators and investors in the firm. Ultimately, this should pave the way though for the market to finally start focusing on fundamentals and to move past the ‘meme stock’ mentality that has dominated the narrative for the business.

A look at recent developments

According to a press release issued by AMC Entertainment on August 14th, the judge overseeing the case between AMC Entertainment and a group of shareholders who were preventing the business from forcing a conversion of the preferred equity units into common, has finally agreed to let the deal move forward. Last month, I wrote a detailed article discussing everything leading up to this point and all of the intricacies involved.

Instead of rehashing those details here, I would encourage you to check out that article here. The short version is that, for every 7.5 shares of AMC Entertainment that investors in the firm’s common stock currently own, AMC Entertainment will issue a settlement of one additional share.

Author - SEC EDGAR Data

This transaction will only occur after AMC Entertainment first engages in a reverse stock split, taking the number of common shares of the business from around 519.2 million to 51.92 million. The preferred equity units will be decreased from 995.4 million to 99.54 million before being converted into common stock on a one-for-one basis. The settlement will be adjusted for the stock split, resulting in 6.92 million shares of common being distributed to existing shareholders of the common. At the end of the day, this will take the number of common shares of the business to 158.38 million. However, the implied price will be approximately 10 times what it currently is.

In response to this development, shares of the common stock plunged 35.6%. By comparison, the preferred equity units jumped by 16.3%. The reason for this divergent movement stems from the fact that, ever since the preferred equity units were issued, there was a significant price disparity between the two enterprises. Even now, that gap persists. At present, shares of the common stock are at $3.39 each. That compares to the $2.07 that the preferred equity units can be picked up for. Economically speaking, they are the same and, as of August 25th of this year, the preferred equity units will no longer exist because they will have been converted. So you would expect the prices of these two to converge.

The big question is how this will take place. We already saw that one moved up while the other moved down. There's no doubt that AMC Entertainment is struggling financially at this time. Given the fact that the preferred equity units have been used to raise capital while the company has been restricted from offering more common stock, I believe that the preferred equity units more appropriately value the company as it stands today. If I am correct, this would mean that the common should continue to fall more than the preferred equity units rise. This doesn't mean that there is not some sort of upside for the preferred equity units. Based on closing prices as of August 14th, the common stock has baked into it that extra fraction of a share associated with the settlement. That should work out to about $0.45 per unit. If we factor this into the equation, then the spread between the preferred equity units and the common would still be approximately 41.9% if we assume that all of the extra closing of the price will be on the upside for the former.

Once this all comes to pass later this month, there should be no further catalyst to encourage rampant speculation. This doesn't mean that the volatility will die down immediately. But at some point, we should return to some degree of normalcy that prioritizes, and justifiably so, fundamentals over all else. When I last wrote about the company and rated it a "sell" in July of this year, I made the argument that the absolute best-case scenario for shareholders would be an enterprise that is fairly valued. But given the risk associated with that, I believed that investors might be better off looking elsewhere for opportunity.

Author - SEC EDGAR Data

My overall assessment of the situation remains unchanged. But it is true that shares of the common stock have plunged 42.1% since that day while the S&P 500 has dropped only 1.4%. At some point, a decline can make a company attractive again. And since the publication of that article, management has come out with additional data while the market has also changed. As you can see in the chart above, financial performance in the second quarter of 2023 improved considerably compared to what the company reported one year earlier. Revenue, profits, and cash flows, all improved markedly. As the chart below illustrates, the company still has pain on a year-to-date basis. And even the second quarter results were not exactly fantastic.

Author - SEC EDGAR Data

As I pointed out in my prior article, the recovery the company has been showing can be chalked up to a broader recovery for the box office. And so far, box office results are continuing to show strength. The greatest example that has developed over the past several weeks has been the Barbie movie. As of this writing, the movie has captured $1.19 billion in global box office receipts, making it the 25th highest grossing film of all time. In the domestic market, it has generated $526.4 million, making it the 18th highest grossing film here at home. And surely, these numbers will only improve from this point.

The-Numbers.com

It's also important to point out, however, that it is unclear that the company truly can stage a full recovery. As I pointed out in my prior article, the best-case scenario would be a return to what the company generated in 2019, which was the final year before the pandemic. But there have been structural issues at play. For instance, back then, the company had ownership interests in 1,004 different theaters and 11,041 screens. As of the end of the second quarter, this has dropped to 906 theaters with 10,120 screens.

The-Numbers.com

Prior to the pandemic, the number of tickets sold for shows in theaters continued to decline domestically. But overall box office results continued to improve because of higher pricing and higher spending inside of the theaters. But on an inflation adjusted basis, box office results remained in a fairly narrow range for much of the past 26 years (excluding the pandemic years and since then). So this is not a market that is experiencing true growth on a real basis. That should also weigh into the decisions that investors make.

The-Numbers.com

As for pricing, if the business were to achieve the kind of performance that it generated in 2019, and if I am correct that the preferred equity units most accurately reflect the true value of the enterprise, then the company would be trading at a future price to adjusted operating cash flow multiple of 7.3 and at an EV to EBITDA multiple of 10. In a space with even modest growth and without all the trouble that AMC Entertainment has, such as continued uncertainty regarding its $4.41 billion in debt, I would be drawn to these multiples. But add in all of these issues and broader economic concerns, and I believe that the company might still see some downside from here. I am more neutral on the preferred equity units, however. Like I said, these could very well continue to increase some as prices converge.

Takeaway

Based on the data provided, I must say that I am happy that this drama is drawing to a close. AMC Entertainment Holdings, Inc. stock has been dominated by irrationality far longer than what is typical. In the event that the company stages a full recovery, it is possible that some upside potential could exist. But when it comes to the common stock, I would not like to be involved in that bet. I am more neutral on the preferred equity units at this time since I also have a difficult time imagining the common stock of the company falling enough to completely make up the gap between the two. But no matter what, this is a volatile situation and investors should tread cautiously.

Source: Seeking Alpha