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Popcorn Paradoxes at AMC | financial times


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welcome back. Yesterday I argued that the decline in some tech stocks was evidence that we are “selling crazy”. This was proven not to be true everywhere by Wednesday’s market action in MIM stocks, which sounded a lot nuts. Today I am searching for reason in the midst of madness.

Comments on Unhedged? message me: robert.armstrong@ft.com

Popcorn Paradoxes at AMC

Here is a good point from the economist Peter Garber:

Before we reduce a speculative event to the essentially inexplicable or bubble-driven category of audience psychology, however, we must exhaust plausible economic explanations. . . Descriptions of the “bubble” should be a last resort because they do not explain events, and are merely a name that we associate with a financial phenomenon that we have not invested sufficiently in understanding.”

We were recently reminded of the importance of this will – dubbed the “Garber judgment” – by Hertz’s bankruptcy. Oh, how smart are we laugh at Poor Stupid Retail Investors Who Bought Hertz Stock After They Filed for Chapter 11. But Then Investors Filed Nice recovery In bankruptcy, they mocked us instead.

To put the same point differently, for someone who makes a living trying to understand financial markets, saying “it’s just a bubble” means “I quit”. And Mrs. Armstrong did not provoke quitters.

So bear with me as I try to understand what investors are doing here:

  • On Friday afternoon, at about $26 per share, AMC Entertainment shares looked like an expensive standard meme stock, having soared from $2 late last year. It’s a movie series, so 2020 has been a bad year, but it’s been running water before that, in part because of high debt. lost money in 2017 and 2019;

  • Then, on Tuesday morning after the long weekend, AMC announced that it had sold 8.5 million new shares to a hedge fund, Mudrick, for $230 million, or about $27 apiece.

  • After news of the sale – which reduced the ownership of the company’s existing shareholders – shares rose to close on Tuesday at about $32;

  • Then, later on Tuesday, news came that Mudrick had sold all the shares he had already bought, and made a profit. box Considered Stocks are overvalued.

  • On Wednesday, the stock rose strongly, closing at $65.

  • Also on Wednesday, AMC announced that it will offer retail investors free popcorn.

This latest move by the AMC is clearly a sarcasm for those of us who still believe in economic rationality. But let’s rise above it, like the pros, and try to understand what AMC investors are doing here.

(Obviously, what Mudrick and AMC are doing is rational of course; they get it while they’re getting something good.)

Corporate Finance 101 says that any corporate investment project in which the expected returns are greater than the cost of capital increases the value of the company. AMC has just raised some very cheap capital, which means it should be able to invest it with an excellent return. This is our best cornerstone for a basic case of owning a stock: AMC is a company with a magical money tree (owning a company at a high price because other investors are willing to own it at a high price seems circular, and it probably is, but stay with me for a minute).

How cheap was the new capital? A very rudimentary way to measure the cost of equity capital is with dividend yield, which is just the price/earnings ratio turned upside down. It tells you how much of a company’s dividend each new share is entitled to, as a percentage of the price paid. This is a bit tricky in the case of AMC, because they had losses even before the pandemic. But the company made a profit of $110 million in 2018, and generated nearly as little free cash flow (cash dividend, if you will) in 2019. Using these historical earnings as a numerator, I came up with a dividend/cost of capital return well under 1 percent. This money costs almost nothing.

(I realize that there are more sophisticated ways of determining the cost of equity, such as the capital asset pricing model, that would result in a much higher cost of capital, say 7 percent. I’m not impressed with this. AMC just raised that capital at a higher rate on the basis of minimum Earnings forecast. The money was all but free, people, whether your finance professor liked it or not.)

Now, access to cheap capital is not very useful if you do not have good investment opportunities (just ask a large US bank). AMC says it will use the money to buy new movie theaters from equal competitors, but it has a much higher return option than that: its own debt.

By calculating the annual interest that the company paid in the first quarter, it appears that the company is paying a mixed rate of about 11 percent. Raising the equity at current prices and pushing it lower, it achieves an epic spread of more than 10 percent.

How much new stock does AMC have to collect to cancel its debt? Excluding $90 million in operating leases, the company has $5.5 billion in debt and has $800 million in cash on hand. Let’s say she uses all the cash to pay off the debt, and then sells the stock at $60 (a discount on yesterday’s close) to pay off the remaining $4.7 billion. This will require 78 million new shares, on top of the 409 million existing shares.

(Is this all largely speculative? Sure. Missing an important detail? You bet. Could this volatile company really get nearly $4 billion in new stock from the market? It’s going to be tough. But the bottom line here is Pay the controversy will go.)

Here are the numbers as I see them. If AMC returns to its 2019 revenue levels next year, and maintains its current debt levels, its income statement would look something like this, as far as I can see:

Now imagine they’re raising all of that new equity at $60 a share and paying off all debt except for the leases. Then the profits and losses look like this:

AMC has suddenly become profitable! The retail investor, by providing the company with cheap capital, brought the company back into the black. Except, of course, one small problem: These inventors now own a stock that, at $60, is trading at more than 200 times earnings, and that looks like a bubble. Even with the most resilient investors, recapitalizing your way to a sound valuation is difficult.

To lower this percentage, you could sell more shares and invest them again, in something new. But at some point, we must assume, the market got tired of giving AMC completely free money. I think I will quit now. Sorry, mom.

good reading

Yesterday I wrote about Howard Marx’s argument that we are now in “low yield world”. As it turns out, Marks isn’t the only investor who sees it this way. My colleague Robin Wigglesworth wrote a story about some of the others Here.

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