AMC Short-Squeeze Presents Many Potential Ways To Make Money
May 28, 2021 9:50 AM
Summary
AMC was losing money before COVID-19.
They've gotten through the pandemic by taking on high interest debt and selling too many shares.
Even though there's a short squeeze underway, high debt and tough business will catch up to them.
In high volatility, opportunities abound to short the stock, buy bonds or trade options.
AMC Entertainment Holdings, Inc. (AMC) is a bad business with a growing debt load and a growing share count, but it's share price is climbing in a short squeeze as I write this. In this article, I want to explain what's going on "under the hood" at this company and how it effects shareholders, bondholders and options traders and outline a few strategies for profiting from recent events.
Background on AMC and the declining movie business
AMC Entertainment is the world's largest movie theater company. It became a public company in 2013 its current CEO joined in 2016. Despite a number of attempts to improve and grow such as the acquisition of Carmike Cinemas and other initiatives, AMC was not a very profitable business in the years before Corona hit:
Source: Form 10-K
In the four years preceding 2020 as you can see above, the company produced a total of over $400 million in net losses. If I had to offer an opinion on why that is, I would think factors that make it harder to make money running a movie theater include:
Streaming Video on Demand from companies such as Netflix (NFLX), Amazon (AMZN), and Disney (DIS),
New and more common home theater systems (see for example this article), and
Gaming and online gaming from companies such as Twitch (owned by AMZN) and similar offerings from Microsoft (MSFT) and Sony (SONY) and others.
Many people still went to the movies and I'm not trying to argue that movie theaters were a dead business as of 2019. I'm just pointing out that not only did AMC perform poorly in the years leading up to COVID-19, but also that it's easy to understand why they were having a tough time. All that was an issue even before the crisis hit.
COVID-19 and the Crisis of a Lifetime
Movies and other similar recreational activities should be a way for people to get away from stress and relax, but in 2020 this dynamic was turned on its head as places of public recreation such as movie theaters themselves became a cause for concern. So as AMC explains in its filings, the company suspended theater operations on March 17, 2020. You can see the effects of the lockdown on the company from this quarterly breakout:
Source: Form-10K
Why You Need To Sell AMC Now
The large loss of almost $2 billion in the first quarter includes a large loss from the impairment of the company's assets. But the losses in the other quarters are real, cash losses. Building a theater represents a high fixed cost, but then operating one has relatively low variable costs (ie, once you've opened the theater it costs the same amount to show a movie to one person as it does to 100 people). So the losses from not operating at all or operating at very low capacity are terrible. These losses continued into Q1 when the company lost another $569 million according to its quarterly report.
These losses are COVID-19-specific and not likely to be repeated, but I just want to set the stage for understanding the transactions described in the next section.
Crippling re-financing transactions
To deal with the fallout and dire financial situation the company found itself in after COVID-19, AMC entered into a number of aggressive financing transactions. As described on pages 20-21 of the company's most recent quarterly report, the company took high interest PIK/Toggle notes at 15% interest (PIK stands for "payable in kind" meaning that instead of making interest payments, the company can "just put the debt on a credit card" and agree to owe more in the future). The company also redeemed convertible notes, exchanging other high interest debt for shares.
The company reports the following debts totaling $5.1 billion as of March 31:
Source: Form 10-Q
The company continued issuing shares in exchange for debt and issuing shares at the market in exchange for cash, including a transaction closing on April 29 that issued shares at $9.94 per share for proceeds of $428 million. Incredibly, the companies share count has grown from 100 million shares just over a year ago to 450 million as of the last quarterly report. (The first page of the quarterly report reports the share count date as of May 2, so I infer that this includes the shares issued at the end of April).
So I would infer from the transactions above that the company's enterprise value looks something like this:
Market cap = 450 million x $26.50 (Thursday's closing price) = $11.925 billion
Debt = $5.1 billion
Cash = $813 million (as of 3/31) + $428 million = $1.2 billion
Enterprise value = $11.925B + $5.1B - $1.2B = $15.8 billion
For a troubled company, issuing shares to pay down debt can be a great move. I agree this was the right way for AMC's management to proceed. But to get the perspective of one large shareholder, the company's former largest shareholder sold off 100% of its holdings in the month following the April 29 offering. That's a pretty dramatic expression of "voting with your feet," and in light of the diminished business prospects described in part 1 of this article and gloomy financial picture painted in these filings, it seems reasonable to infer that shareholder is not optimistic about the company's future.
We see that bondholders are skeptical too:
Source: FINRA
On the one hand, these bonds are junior to Second Lien Debt with a PIK/Toggle feature at 10 and 12% interest rates so it makes sense that these junior bonds would trade at more than 12%. On the other hand, the spread for CCC-rated companies is under 6.5% now so this represents a very high default premium. In my opinion this is an even more dramatically high spread because you can short the equity of AMC stock and reduce the credit risk from a bankruptcy or default.
Different Ways to Play Market Action
A. Short the Stock
First, for the reasons described in parts 1 and 2, I am bearish on AMC's share price. I've shorted shares myself and I believe they'll come back down under $10 after a full quarter of being re-opened. At that point, it should be clear that the business at its core is not really profitable.
There will be a lot of back and forth about the nature of the current ongoing short squeeze and comparisons to GameStop (GME), but I think those comparisons are unwarranted. Most importantly, GameStop is pivoting from the money-losing model of running brick-and-mortar stores to the potentially far more profitable model of online sales of equipment and streaming games and experiences (note, this is one of the trends that means fewer people watch movies at AMC!). Likewise, GameStop is in a strong and improving financial position rather than the highly indebted one at AMC. Finally, GameStop has new and inspired management in CEO Ryan Cohen and his management team. Time will tell whether or not they are successful, but this is a very different situation from the one in which AMC finds itself.
B. Long the bonds
As AMC continues to obtain financing by selling shares, it will pay down debt. Over time, they'll negotiate less onerous debt and obtain new financing that allows to re-finance existing debt at lower rates. I don't like this trade myself because I think 12% per year compounded is not a good enough return to take on the risk of loss from these bonds if the company does default rather than re-finance, but if you're bullish on the company's prospects, buying the bonds instead of the stock presents an attractive, lower-risk way to invest.
C. Capital structure arbitrage
This would involve buying bonds such as the ones described above and shorting an amount of the company's stock. The biggest risk to owning the bonds is that the company files for bankruptcy, in which case the stock would fall towards zero. By shorting the stock while buying the bonds, the capital structure arbitrage play protects you from some of the risk of non-payment and bankruptcy because you make money on the short stock position from the same event that would cause a loss for the bonds.
Personally I would expect that over the coming months, the stock will decline from here and the bonds will stay near this price until a larger stock sale or re-financing transaction because of the presence of senior debt paying more than 10% interest.
D. Options Plays
The high volumes in AMC stock and unusually high amount options trading produce a lot of opportunities for planful options traders. Naturally if you want to take a position on the direction of the stock up or down you can buy calls or puts. I find that in excited conditions such as the ones we see today, these options are likely to be overpriced and it can be hard to make money without the most exquisite of timing. To that end, I think this is a good time to try to make money on elevated volatility strategies including selling condor pairs of spreads or creating spreads near the recent share price.
I'm interested in taking advantage of this volatility by selling out of the money puts (which is actually a long position). So for example, almost 2000 July 2022 puts with a strike price of $10 traded yesterday as high as $3.00 per contract. If you sold one at that price, you wouldn't lose money until the stock was below $7.00 per share and you could earn a return of $3.00 on your $7.00 of risk for a 42% upside. Normally selling put options means taking on too much risk for too little return, but at times such as this it can be worth it. As volatility declines the puts should be expected to fall in value - even in a scenario in which the stock goes down.
Personally, I'm interested in shorting out of the money puts as a way to earn returns on my short position in the stock. I'm already short shares so the "risky" part of selling puts isn't a risk for me, it's a positive outcome. I'll consider selling a mix of out of the money puts including $10 strike July 2021 puts for more than 60 cents and January 2022 puts with a $20 strike for $8.50. Selling puts such as these would amount to "giving up" some of the returns on my short if the stock declined a lot, but I would be interested in covering at $11.50 anyhow, so selling a $20.00 put for $8.50 seems like a good idea.
Conclusion
For the reasons stated above, I think AMC shares are headed lower in the near future. I've outlined strategies in part 3 that I think can help planful investors and traders find ways to profit from the unusual circumstances here.
As always, the stock market, bonds and options present risks. The largest short-term risk here would be from the short-squeeze continuing longer than expected. Over the longer term, it is possible that the company's prospects could improve but I think that's unlikely.
