AMC Entertainment: Judge's Denial of APE Conversion Causes More Uncertainty and Risk

What does a slogan from a very popular movie have in common with investing in the stock market? In a word, uncertainty. I am referring to "Forrest Gump" and the titular character's famous line: “Life is like a box of chocolates; you never know what you‘re gonna get.”

AMC Entertainment Holdings Inc. (AMC, Financial), a company that operates movie theaters in the U.S. and Europe, offered excitement and drama of its own on Friday, making headlines and adding a lot of volatility to its shares, as a Delaware judge blocked the conversion of its preferred shares to common stock. The news sent shares nearly 63% higher after the market closed on July 21. The stock closed at $4.40 and, after hours, rose to $7.17. Its preferred stock, however, sank as much as 63% to 67 cents.

Here is what you should know about this decision and its effect on the stock's performance.

A closer look at the judge’s decision

The controversial preferred stock, also known as AMC Preferred Equity Units or APEs, were issued last year, which included a 30% bloc to Antara Capital LP. Each unit represents 1/100th of a preferred share, which are theoretically worth 100 class A shares. While they are equivalent to common stock, they trade at a steep discount.

Since the issuance, the company has been trying to convert them. However, many retail investors have come out in opposition of the move that would dilute their shares. Nearly 3,000 of them wrote to the court to speak out against the settlement. Further, a lawsuit accuses AMC of an illegal corporate engineering scheme aimed at sidelining its investor base.

Writing for Delaware’s Chancery Court, Vice Chancellor Morgan T. Zurn emphasized that her ruling did not concern the many market manipulation theories—"about synthetic shares, Wall Street corruption, dark pool trading, insider trading, and RICO violations"—that were addressed in the letters sent to her.

Rather, the verdict was focused on the settlement's scope, which she said was overbroad. Further, Zurn mentioned there was “antagonism” between common and preferred shares. “Awarding more shares to common stockholders necessarily comes at the expense of preferred units,” she said.

In the end, Zurn rejected the nine-figure settlement that would have allowed the conversion to proceed while handing out extra stock to mitigate the dilution of ordinary shareholders.

Implications of the decision

This decision has a lot of validity, but let’s not forget the main priority of any company’s board is to maximize shareholder value. The conversion would add dilution for ordinary shareholders, pushing their intrinsic value lower, which is not a positive thing. However, AMC Entertainment really wanted to convert the APEs and issue additional shares to address the problem of rising interest rates that have made loan financing activities and capital structure more complicated.

Future volatility and risks for AMC

Regardless, I believe more volatility is to be expected for AMC Entertainment.

First, there is a 1-for-10 reverse stock split, which has been approved by the majority of voting shareholders but has yet to occur.

The company also raised more than $155 million of cash through the sale of APE units in the first quarter of 2023 and has reduced its debt by more than $200 million. However, the estimate is that it will take years for the entertainment industry to return to pre-pandemic levels and, during this period, the company needs to raise additional capital. The least expensive way to raise cash is to issue stock and increase the equity of its stockholders.

AMC Entertainment has been reducing debt, which is very prudent, but I believe over the next several years, it will have to issue more stock to survive. Ironically, the judge’s decision seems to be an obstacle for AMC's attempt to get its balance sheet into much better shape, especially for improving the equity section.

Remembering the meme stock phenomenon

AMC Entertainment stock was once a leading meme stock. Back in 2021, these stocks gained widespread attention and popularity among retail investors, primarily through social media and online communities, rather than conventional financial analysis or fundamental factors. As such, they experienced significant price volatility, driven by the collective actions and sentiments of individual investors, who coordinated and shared investment ideas on platforms like Reddit and Twitter.

These stocks were completely disconnected from their fundamentals, leading to speculative trading patterns. Meme stocks also often triggered massive short squeezes, wherein short sellers, who bet against the stock, were forced to cover their positions quickly, leading to a rapid price increase.

Fundamentals and other key metrics

On May 5, AMC reported first-quarter financial results that beat estimates for both earnings per share and revenue.

The adjusted earnings topped Wall Street's consensus by 3 cents, while revenue of $954.4 million was $16.20 million higher than analysts had anticipated and improved 21.5% year over year.

In a statement, Chairman and CEO Adam Aron said, “Our results for the first quarter of 2023 represent AMC’s strongest first quarter in four full years. We kicked off 2023 by continuing on our positive glide path to recovery, with more than a 21% growth in total revenues and a $69 million improvement in adjusted Ebitda compared to the previous year. The first quarter of 2023 and fourth quarter of 2022 mark the first two consecutive quarters of positive adjusted Ebitda since March of 2020. This progress is a testament to the ongoing recovery in the industrywide box office, as well as AMC’s enduring commitment to excellence and innovation as our guests enjoy a superb movie-going experience at our theatres.”

I am not impressed with these comments as AMC Entertainment has very low financial strength, a very poor growth rank and its profitability is non-existent as of 2019. The company is losing money and has burned cash for the past three consecutive years with a cash-to-debt ratio of 0.05. This is too low and indicates there is a severe liquidity problem currently. As such, it is not surprising that the current ratio and quick ratio have low values, both standing now at 0.43.

It also has a weak debt-to-equity ratio of -3.73 and debt-to-Ebitda ratio of -108.41. Further, AMC Entertainment has negative shareholder equity. Negative stockholders' equity is a strong indicator of a potential bankruptcy as the company's liabilities exceed its assets.

The Piotroski F-Score of 3 out of 9 is very low, implying poor business operations, while the Altman Z-Score of -0.88 places the company in the distress zone.

Final thoughts

AMC Entertainment is struggling to achieve long-term success, but the patn to recovery is not only very bumpy, but highly uncertain as well. The judge’s decision may result in a brief rally, but this hides deeper and more severe fundamental flaws.