On Monday, AMC (NYSE:AMC) stock jumped more than 25% after news emerged that its Chinese owners had ceded control. For months, analysts (like myself) worried that Dalian Wanda — a Chinese multinational conglomerate — could use its 64.5% voting share to self-deal. With the threat of that now gone, the future of AMC stock now rests entirely in Reddit investor hands.
That’s a good thing.
It’s good because AMC has a quirk in its books that even Dalian Wanda’s deep pockets couldn’t solve — a $16.1 billion load of long-term debt and operating leases. Although America’s largest theater chain will bounce back from pent-up movie-going demand in 2021, the firm’s abnormally high debt still leaves it on bankruptcy’s doorstep.
To save AMC and send the stock back to $20, it will take retail investor belief to defuse this ticking bomb. So, will Redditors come to AMC’s aid?
Here’s why they might.
A Great Business Overburdened by Debt
Contrary to popular belief, the in-person movie business was doing quite well before the coronavirus pandemic. As brilliant as AMC’s streaming competitors were, Netflix (NASDAQ:NFLX) and others couldn’t entirely replace the in-person movie watching experience. EBITDA margins at AMC hovered between 10-20% through 2019 — a level more commonly seen by blue-chip firms like Tesla (NASDAQ:TSLA) and Nike (NYSE:NKE).
The gilded experience, however, came at a massive cost. To upgrade its 10,543 screens worldwide, AMC turned to cheap debt financing — the addictive drug that tempts all corporate boards. From a financial standpoint, the effects were damaging but still manageable. By 2019, AMC’s 1.4x debt-to-equity ratio had ballooned to 8.5x. If everything went right, the $9.7 billion of debt would have gotten paid down over a decade or so.
But then the pandemic hit. As theater closures hit the entire U.S., AMC’s debt spiraled out of control. Today, the theater chain sits $16.1 billion in the hole. Interest payments alone will cost the firm around $500 million per year. And much like an underwater homebuyer, AMC will struggle to find ways to make its $200 to $450 million in operating earnings pay down debt.
Even if business comes roaring back in 2021, AMC will barely meet its interest payments. It would take a miracle to reduce the $16.1 billion of principal owed.
Can AMC Recapitalize on Reddit Investors?
There is, however, one way out: a method known as recapitalization.
When a firm’s share price is high, the company can issue new (overvalued) shares to pay off its debts. The higher the share price, the less the dilution to existing shareholders.
Tesla is a prime example of a well-run financing operation. For all of CEO Elon Musk’s successes in creating a winning electric vehicle, his $5 billion Gigafactories were only possible thanks to his financing team’s well-timed capital raises. Tesla’s $12 billion raise in 2020, for example, saw just a 22% share dilution that year.
AMC, meanwhile, has struggled to perform the same feat. Its Reddit-fueled rise to $20 in January was too short a window for the firm to issue more than $1 billion in fresh capital. To convert another $7 to $8 billion of debt to equity, AMC needs retail investors to keep the stock price high enough and demand to stay strong as management unloads new shares into the market.
What’s AMC Stock Worth?
In 2017, U.K.-based Cineworld (OTCMKTS:CNNWF) bought Regal Cinemas and its entire debt burden for $3.6 billion. The deal valued Regal at 1.2x EV-to-revenue. That was a reasonable price for an extraordinarily indebted cinema chain. (Regal had also taken out massive debts to fund its renovations).
AMC is likely worth a higher multiple. The chain has almost twice the locations as rival Regal, giving it more substantial negotiating power with Hollywood studios. The firm is also no longer battling the threat of firms like MoviePass, a now-bankrupt company that once sold all-you-can-watch theater subscriptions. Assuming a return to normalcy, a 2-stage DCF shows that AMC is worth $14 billion enterprise value today, a 2.6x EV-to-revenue multiple.
That suggests a $13 price per share.
Covid-19, however, has upended that calculus. With theaters going dark, movie studios have struggled to replicate the merchandising success of blockbuster releases. Disney’s (NYSE:DIS) 2015 Star Wars film, Star Wars: The Force Awakens, generated $5 to $7 billion in merchandising revenues alone. That’s twice what all of the media giant’s direct-to-consumer streaming businesses earned in 2020.
As Americans go back to watching in-person movies, Disney and other movie studios will likely relent on the onerous terms they once imposed on theaters. Movie studios don’t want to bankrupt theaters either, and that would push profits at AMC higher, at least for several years. And because of AMC’s high leverage, even a slight increase to a $17 billion enterprise value would mean a $24/share price. Furthermore, $20 billion EV (a 3.5x EV-to-revenue multiple) could even be on the books if EBITDA margins consistently hit 25%.
That would make AMC stock worth $35/share.
Should You Buy AMC Stock?
All this, however, hinges on whether Reddit investors will play ball. If retail investors refuse to join, AMC’s crushing debts will sink the ship before any movie studio can come to its aid. In that case, investors should expect a private equity firm to buy the debt and wipe out shareholders in bankruptcy court. Shares will be worth $0.
But with Dalian Wanda now out of the picture, minority investors will now dictate where AMC prices will go. So, if you’re looking to gamble on a faster-than-expected reopening, AMC is an excellent stock to try. Reddit investors are known for sticking to their guns, even when times get tough.
Just make sure you limit your risk, and also consider other sure-bet reopening stocks as well.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.