The online group WallStreetBets has emerged as one of the major forces driving stock market trading lately. GameStop (NYSE:GME) stock is the one that’s drawn the most attention from Reddit traders. In a close second, however, you have cinema chain AMC (NYSE:AMC). AMC stock has blasted off from $2 to a high of $20 so far in 2021 thanks to the surge in trading interest.
Subsequently to that rally, AMC stock has given back a fair chunk of its gains. On Tuesday, shares lost half their value, and are currently around $9. Still, the stock is up several-fold from where it was just a month ago.
Is this a good time to buy the dip and hold with the WallStreetBets crowd? Or has AMC’s moment passed it by? Here are some things to keep under consideration.
AMC Was on the Verge of Bankruptcy
As of December 2020, AMC warned that it would need about $750 million cash to survive 2021. It was issuing fresh stock to the public. AMC also sold debt at a punitive 15% interest rate to raise more capital.
Why was the situation so dire? The company’s cash burn was around $125 million per month last fall. And it seemed things would remain challenging through 2021. Film companies such as Warner Brothers – part of AT&T (NYSE:T) – announced far more extensive direct-to-streaming release options for films, damaging AMC’s competitive position.
All in all, it appeared that AMC was in a death spiral. By the end of 2020, AMC stock had fallen below where it was during the height of the novel coronavirus pandemic. Even with all the Covid-19 reopening trades working, AMC stock kept dropping. But the movie hadn’t stopped just yet.
Can WallStreetBets Save AMC Stock?
Famous investor George Soros developed the theory of reflexivity. To summarize it, reflexivity suggests that momentum itself can change the future. Once you have a positive feedback loop going, it can become self-sustaining, gathering more energy as people recalibrate their expectations to the new price and sentiment. Over time, the future can branch off from what an economist would have predicted as more and more people act based on current prices rather than underlying fundamentals.
That could well play out with AMC. Just a month ago, most professional financial analysts would have suggested that AMC was going to go bankrupt. Its balance sheet was in a dire situation, and its ongoing business will face a long slow recovery from the pandemic. This looks like a classic open-and-shut bankruptcy reorganization case.
Now that the price has gone up so dramatically for the stock, however, it creates energy around AMC. New shareholders may go check out a movie to support their cinemas. Traders will tell their friends to buy stock. And management can show off the higher stock price when it is negotiating with landlords and creditors.
AMC May Survive, But Dilution Is Inevitable
It’s important to remember that there’s a distinction between a company’s operating business and its common stock. The American bankruptcy system is set up to allow companies to reorganize themselves without having to liquidate their operations. It’s common for firms to go bankrupt, cancel their stock, but continue operations with new ownership. That’s likely what would have happened to AMC if WallStreetBets hadn’t charged in.
Now, it seems, AMC will continue carrying on under its existing ownership rather than transferring to new operators in bankruptcy. Still, however, creditors must be paid. Bondholders always have first claims to a company’s assets, and AMC has plenty of creditors.
We saw this play out in practice last week. Institutional investor Silver Lake elected to convert its $600 million of AMC debt into common stock at $13.51 per share. It then sold the whole position into the market, cashing out nicely while the stock was riding high. Who bought all those newly converted AMC stock shares from Silver Lake? By and large, it was probably retail traders.
This is the issue with AMC and other popular Reddit stocks right now: The supply of stock isn’t fixed. Companies like AMC can and will offer more stock to the public to shore up their balance sheets. In some cases, such as with the convertible debt here, other holders have the ability to dilute the stock as well.
A big appeal of Bitcoin (CCC:BTC) is that it has a fixed supply of tokens. No central bank or corporate board can decide to issue more Bitcoin. However, the supply of a GameStop or AMC stock is not fixed. In fact it can and will go up dramatically if traders drive the price far away from fundamentals.
While it’s fun to think of recent events as an uprising against Wall Street fat cats, when you actually look behind the scenes, big players like Silver Lake are still making money. Meanwhile, as we saw Tuesday, the price of AMC and other hot stocks can plummet overnight.
The Bottom Line on AMC
AMC stock still has a chance. In particular, the fact that the stock has gone up so much gives management more options.
For example, AMC could announce a huge stock offering to raise additional capital for the business. This would hurt existing shareholders but potentially give the company enough money to survive its losses from the Covid-19 pandemic. This option simply didn’t exist in any meaningful fashion when the stock was way down at $2 a month ago.
So in a weird sort of way, the online traders may save AMC from bankruptcy. That said, there’s virtually no way to justify a stock price this high up. A short squeeze is one thing, but it’s another thing to keep a price elevated even in the face of sour fundamentals. Unless AMC’s theaters enjoy a far faster than expected recovery from Covid-19, the stock price will slump once again.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
