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It’s been three days since AMC Entertainment Holding (AMC) preferred equity units started trading on New York. The company issued the AMC Entertainment Holdings Preferred Equity (APE) units as a dividend to existing investors on a one-for-one basis. In essence, it was a two-for-one stock split.
AMC issued the units so that it could raise more capital in the future without having to get approval from its common shareholders. Like many moves made by AMC CEO Adam Aron since Covid began in early 2020, the short-term benefits to the company are apparent.
Long-term, however, this could be a move that leads the company down the same Chapter 11 bankruptcy path that Cineworld (CNWGY) is currently considering for its Regal Cinemas business in the U.S.
Here’s why.
AMC’s Debt Is a Major Burden
The world’s largest cinema chain finished the second quarter with $10.46 billion in total debt -- $5.08 billion in operating lease liabilities and $5.38 billion in long-term debt -- versus $965.2 million in cash and short-term investments, for $9.49 billion in net debt.
That resulted in $355 million in interest payments over the past 12 months through June 30, the company’s highest annualized interest expense over the past decade.
When investors consider the likelihood of a company going bankrupt, one metric to lean on is the Altman Z-Score. It indicates how likely a company will be to file for bankruptcy protection over the next 24 months. At the moment, AMC’s score is -0.56. Anything below 1.8 is considered to be in the distress zone, which implies that it’s very likely AMC could file for bankruptcy protection over the next two years.
This brings me to the preferred units it just issued. The company did this to give it some wiggle room for raising capital in the future.
Before issuing the preferred units on Aug. 19, it had no preferred equity outstanding. On the other hand, there were 516.82 million common shares outstanding, 7.4-million shy of the maximum allowed.
So, based on current prices, it had $740 million available. To get more, it would have to get the approval of a majority of investors. It asked shareholders in May 2021 to increase the shares authorized by 500 million. Two months later, after much protest, it dropped the idea.
Flash forward to 2022.
With debt levels high, it needed to come up with a way to unlock more than $740 million in potential cash. Preferred equity units were the answer. On Aug. 4, AMC announced the special dividend.
The Workaround Is Brilliant
The board, which required no shareholder approval to increase the authorized amount of preferred equity from 50 million to 1.0 billion, did just that. Then it issued 516.8 million APE units, with shareholders getting one APE unit for every AMC share held.
“The dividend of AMC Preferred Equity units exclusively to our shareholders in our opinion is perhaps the single biggest action we will take in all of 2022 to fundamentally strengthen AMC for the long term,,” Aron stated in its Aug. 4 press release announcing the dividend.
“This new AMC Preferred Equity gives AMC a currency that can be used in the future to strengthen our balance sheet, including by paying down debt or raising fresh equity. As a result, this dramatically lessens any near-term survival risk for AMC, as we continue to work our way through this pandemic.
So, after giving effect to the issuance of preferred units, AMC now has 483.2 million preferred equity units available to issue at any price it wants in the future. For simplicity's sake, let’s assume it does so at the current unit price of $7.11. That’s $3.44 billion, about 5x what it could raise by selling 7.4 million shares.
The problem is that, theoretically, the common shares and preferred units should be equal in value. It says so in AMC’s regulatory filing about the APEs.
“Because the AMC Preferred Equity unit is designed to have the same economic value and voting rights as a share of common stock, in theory, the common stock and AMC Preferred Equity unit should have similar market values and the impact of the AMC Preferred Equity unit dividend should be similar to a 2/1 stock split,” the filing states.
The workaround is brilliant until it actually issues preferred units for actual cash.
Who’s Going to Buy the APEs?
Barron’s reported on Aug. 24 that legendary investor, Jim Chanos, was taking advantage of this situation to make a little arbitrage trade with the two stocks.
To profit in this trade, Chanos shorts AMC and goes long on APE. Over time, Chanos is betting that the current gap of $2.45 as I write this will shrink to nearly $0.
For those who don’t have the stomach for this kind of trade, you have to wonder why anyone would buy newly issued APE units in the future. After all, it tried to get approval once before to raise the ceiling on the number of authorized common shares and failed.
It will surely fail again.
AMC had 104 million shares outstanding in June 2020. If you forget about the 524 millon maximum in place at the moment and assume the sky’s the limit, AMC’s share count after converting the preferred units to common would be 1.03 billion, or 10x the amount just 26 months ago.
The reality is that AMC today has a market cap approximately 10x what it was back in June 2020, but its business is easily in much worse shape than it was in its best years pre-pandemic.
CEO Adam Aron is trying to con investors into buying what he’s selling. Chanos knows better. AMC could be on the path to bankruptcy despite what the company says about strengthening its balance sheet.
The company’s act is smoke and mirrors. Nothing more.
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