Let’s cut to the chase: AMC Entertainment (NYSE:AMC) stock is wildly overvalued. In fact, speculators are paying twice as much for AMC stock now as they were even during the fall of 2017. But AMC’s business prospects have dramatically dimmed since then.
Actually, AMC stock traded for $15 or so back in late 2017. Now it’s at $9. If the stock price has gone down, how has AMC’s overall valuation gone up so much? The answer is a dirty word for investors: Dilution.
The Incredible Share-Printing Machine
AMC hasn’t been showing many movies at its theaters lately. However, it has gotten into another business: selling new shares of its stock. At one point last year, the company had around 100 million shares of stock outstanding. That leapt to more than 360 million when AMC last reported the figure.
Subsequently, even more AMC shares have been created through moves such as Silver Lake’s debt-for-equity swap which generated a fresh new 44 million shares of AMC stock. The company’s total outstanding share count will top 400 million when it reports its Q4 earnings on March 9. Economics 101 suggests that as you create more supply of something — in this case AMC stock — its price will decline.
AMC pretty much had to issue more stock. Otherwise, it would have gone bankrupt. That’s simply what happens to highly levered businesses that suddenly stop generating revenue.
Paying More for Less
The above discussion may seem abstract. So let me use an analogy. Let’s say AMC was a large pizza that had 16 slices. Back in 2017, if you ordered an AMC pizza, you paid $15 for each pie.
Now, due to the pandemic, the pizza pies are tiny and only have four slices. But the company has lowered the price to $9 for each pie. The pies are cheaper now. But, you might reasonably respond, I’m getting 75% less pizza, so I don’t care that the price for each pie is 40% lower.
That’s basically what has happened to AMC stock. Its price is technically lower, but because of dilution, each share now represents a much smaller percentage of the company than was the case three years ago.
Let’s put it another way. Suppose the company becomes prosperous again and starts paying out $100 million of dividends per year. In 2017, when there were 100 million shares, the dividend would amount to around $1 per share. Pretty nice. Now that same $100 million of dividends would be worth just 25 cents per share annually.
Back in the pre-pandemic era, AMC’s net income was around $100 million per year. Thus, based on the company’s market capitalization of almost $4 billion (which includes all of the upcoming shares), AMC stock is trading at a P/E ratio of roughly 25 times. And that assumes that the theater operator’s profits return to their pre-pandemic levels. That scenario, however, is unlikely to materialize.
Furthermore, even if AMC paid out 100% of its pre-pandemic profit to shareholders in dividends, the stock would only yield less than 4% annually.
The Verdict on AMC Stock
I beg you to consider AMC’s overall valuation and its epic levels of dilution before trading the stock. At minimum, don’t believe that the shares are cheap because the stock price has gone down. Adjusted for dilution, AMC stock is selling for twice as much as it did back in 2017, long before the pandemic. Also, back then, movie studios weren’t sending new films straight to streaming services. Even after the pandemic is long gone, it will be hard to put that genie back in the bottle.
I’m not criticizing AMC’s management. AMC was likely heading to bankruptcy before it started selling new shares. It was running out of cash and burning through more than $100 million per month. Meanwhile, no one was sure when its theaters would reopen. Things were looking gloomy for AMC.
Now, with all the cash that it has raised from its various money-raising maneuvers, the company has enough funds to have a fighting chance at survival.
Given the company’s dire circumstances, management did the right thing. Its debt-for-stock swaps were a particularly helpful means of reducing the company’s outsized liabilities. That said, the shares have become hopelessly diluted, and AMC stock will trade in the low single digits once the current short-squeeze craze wears off.
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.