To most investors, the term “funding secured” should be music to their ears.
In 2018, Tesla (NASDAQ:TSLA) shares jumped 11% when CEO Elon Musk tweeted that he would take his firm private for a… high… $420 per share. And many businesses today owe their existence to their fundraising skills. According to Thomson Reuters, 31% of companies in the broad-based Russell 3000 index have generated more money from stock or debt issuance in the past 12 months than from their operations.
Yet, these same rules haven’t applied to AMC Entertainment (NYSE:AMC) stock. Shares of the Kansas-based cinema chain tumbled 20% this week after shareholders approved their version of a “funding secured” moment. More declines are likely on the way.
Two weeks ago, I warned that AMC’s common stock was worth around $1.80-$2.35 per share if the APE/AMC conversion went through. And because AMC still trades at a $4 valuation, there’s still plenty more downside for this increasingly dilutive stock. Risk-seeking investors remain better off buying preferred APE shares.
AMC Stock: The Background
Here’s a short version of what has happened so far.
In 2022, AMC Entertainment found itself running out of cash. The company had spent billions upgrading its theaters since 2016, and the Covid-19 pandemic came at the worst possible moment. By June 2021, AMC had exhausted its ability to issue more shares for cash, meme rally or not.
In August 2022, CEO Adam Aron and his team had a bright idea. If shareholders wouldn’t raise the cap on authorized AMC shares, why not create a separate APE preferred version without such restrictions? It’s perfectly legal under Delaware law, after all.
But the lack of Hollywood hits had turned AMC into a cash hog. In the fourth quarter, the company lost a net $105.6 million from operations and improvements. So 929,849,612 APE shares later (give or take), the theater chain is also beginning to exhaust the cash it can raise from preferred shares.
There, you’re caught up.
When ‘Funding Secured’ Is Bad News
Now, AMC’s preferred APE shares have long traded at a discount to AMC’s common issue because of their uncertain legality. Delaware law allows corporations to issue voting preferred stock, but regulators generally frown on corporate actions that unilaterally dilute shareholders.
That’s created a significant arbitrage gap between the two classes of shares, which I detail here in my guide to AMC’s convergence trade. (TLDR: It’s an expensive but potentially profitable trade).
On March 14, AMC shareholders created the first of several catalysts needed to collapse this spread. By a wide 87-13 margin, shareholders approved the conversion of the underpriced APE preferred shares into the overpriced AMC common ones. They also voted to allow an additional 4.05 billion AMC shares for management to issue as needed.
From an enterprise standpoint, this is phenomenal news. Even if new AMC shares were issued at a pre-reverse-split $2, such a capital raise could generate over $8 billion for the company. That would easily wipe out AMC’s $5.2 billion debt and still leave another $2.8 billion left over for wasting on popcorn deals… gold mines… or whatever management can dream up next. It would also allow AMC to stop spending $90 million on interest payments every quarter. If AMC could achieve 2018-level margins, such a windfall would guarantee corporate profitability.
However, AMC’s sudden share dilution is terrible news from a common shareholder’s perspective. To these AMC shareholders, their 517 million shares outstanding suddenly become 1.447 billion. The pie of any future AMC profits is now set to become divided between far more hungry mouths.
The prospect of future share issuances is even bleaker. In this scenario, AMC could potentially increase outstanding shares to 5.5 billion, leaving AMC’s original shareholders a fraction of their former stake.
It’s no wonder why the company also added a 1-for-10 reverse stock split in their votes this week.
Where Will AMC Go From Here?
Final AMC/APE conversion approvals now rest with Delaware state courts. In one scenario, the courts could lift its injunction, immediately allowing the conversion. Alternatively, the same judge could turn the process into a multi-year legal battle.
I won’t pretend I know which way it goes.
But either case will end up with continued losses for AMC shareholders.
If courts immediately approve the conversion, investors will see share counts jump to 1.447 billion and for the AMC/APE prices to converge, probably in that $1.85-$2.35 range I mentioned before. Hedge funds and arbitragers walk away even wealthier, and Reddit investors wonder what just hit them in the face. (In this case, selling all your AMC shares and buying APE ones is advisable if you insist on remaining invested).
Meanwhile, a lengthy court battle will only delay the inevitable demise of AMC. Management will be forced to raise money by issuing the lower-priced APE shares, which increases future dilution. Absent that ability to raise money, the theater chain will likely follow its competitors into bankruptcy within 2-4 years. In this case, common shareholders walk away with nothing, while preferred shareholders (surprise!) get first dibs on whatever bondholders don’t take.
Perhaps common shareholders really don’t care. In the March 14 proxy vote, only 35% of AMC stockholders voted, compared to virtually 100% of APE shareholders. Retail investors are notorious non-voters, even when it’s in their best interests.
But for investors hoping for AMC’s “good old days” at $40… $50… even $60… those days are over. AMC today has plenty more stakeholders than it used to. And even though it may someday become the last theater chain standing, it’s no guarantee that common shareholders will walk away with a profit.
On the date of publication, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.