2022 saw the sharp reversal of many trends impacting markets during the two years prior. One notable shift was the rapid downfall of many "Meme stocks," such as AMC Entertainment (NYSE:AMC). AMC has erased all of its 2020-2021 gains and is now trading near its 2019 price range of ~$5-$6 per share. The stock is still heavily short-sold, accounting for around 22% of its outstanding shares. AMC began the year well, rising by a staggering 50% during the first week of 2023 as some speculative interest returns to the market, potentially aided by hope in "Avatar." Of course, many still speculate that the company will file for bankruptcy this year, following the footsteps of Cineworld (owner of Regal Cinemas) (OTCPK:CNNWQ).
In my view, investors must consider two critical questions regarding AMC. First, does the theater industry have an economic future despite advancements in in-home entertainment? Second, is AMC's valuation appropriate, given its financial position? If the theater industry is dying, then AMC will certainly not survive. However, too often, investors appear bullish on AMC simply due to their bullish outlook for the theater industry. It is certainly possible that AMC will face bankruptcy (financial restructuring), even if more people go to theaters in 2023 - due to the abysmal state of the company's financial position. Given the immense dilutions the stock has faced since 2020, the company's fair value is likely well below its current price. Thus, even if AMC avoids bankruptcy, I doubt it will maintain its current price.
Box office ticket sales have declined across North America for the past two decades. In 2003, over 1.5B tickets were sold in the US and Canada. By 2019, that figure had fallen to 1.2B, despite a roughly 14% population increase. 2020's lockdowns led to immense one-off losses, with just 223M tickets sold that year - rising back to 813M in 2022. Overall, it is clear that the theater industry is recovering, though ticket sales were still around one-third below normal levels last year. Fortunately, the 2022-2023 holiday season movie list has been strong, with far better ticket sales than seen in the previous year.
The impact of the pandemic and the lockdown response on the theater industry is waning quickly. This includes not only the direct avoidance of theaters but, more importantly, the significant decline in movie production during 2020-2021, which led to a continuing decline in movie-going. In 2023, it seems these impacts are primarily behind the film industry, with far more high-budget movies planning to be released this year.
However, that does not change the fact that the long-term growth in in-home entertainment has challenged the theater industry. Surveys suggest fewer people are interested in theaters due to their higher relative cost than in-home entertainment. The lockdown period accelerated this change by rapidly improving the content available for streaming, particularly movies that are normally "theater exclusive."
Theaters like AMC compete by improving in-theater technology, adding more dining services, etc. While this strategy differentiates theaters from in-home streaming, it also increases the cost of going to films. Typically, movie-going is not very cyclical, and demand does not fall during recessions. However, now that the total cost of seeing a movie is much higher, I believe demand is likely more cyclical. Thus, if there is a continued decline in household financial stability in 2023, I expect US box office sales to take a hit.
Overall, I believe the theater industry will survive, but it appears likely to be weighed by continued pressures from streaming competition. This factor has negatively impacted the theater industry since the early 2000s. In fact, AMC was a benefactor of this change since its core strategy was rapidly acquiring failing theaters, renovating them, and increasing prices to improve profits. Over the past decade, these trends led to the massive consolidation of the theater industry from many chains (and "Mom and pop" theaters) into essentially three: AMC, Cineworld, and Cinemark (CNK). Unfortunately, rapid consolidation has not changed the overlying negative secular trend.
AMC's rapid acquisitions also left it with an immense debt burden. See below:
Today, AMC has extremely high debt compared to its chronically negative operating cash flow. The company also has relatively high-interest expenses of nearly $400M annually. Even before the pandemic, the firm had about as much operational cash flow as interest costs, meaning around half of its EBITDA was going to interest. Interest rates are higher today, so the firm will pay more in the future if it manages to refinance debt and its revolving debt.
While the pandemic period destroyed AMC's cash flow and revenue, it may also have saved the firm. AMC has been in an inferior financial position since the late 2010s and has seen its cash balance dwindle. As speculative investors raced into the stock in 2020, leading to a massive valuation rise, the company sold shares and increased its cash position dramatically. Of course, it is now losing its working capital quite quickly. See below:
Due to its excessive debt leverage and the poor secular environment for theaters, AMC had chronically negative working capital before the pandemic. In other words, it owed more money than it had on hand. The colossal cash raise in 2020 dramatically improved its working capital to positive levels. However, because AMC has failed to achieve profitability, it has quickly lost almost all its cash from sold shares.
That said, due to immense dilution, AMC's revenue per share is now over 85% below pre-pandemic levels. Even if AMC's sales recover to pre-pandemic levels (40% above TTM sales), its revenue-per-share would still be around 80% below its 2019 peak. Even if its sales, margins, and profits return to "normal" levels, it will still deliver over 80% less than it did then due to its massive dilution. Based on this fact, AMC should be trading at an 80%+ discount to its 2019 price.
Still, it seems highly unlikely AMC will recover to its previous status. Even before 2020, AMC struggled to keep operating costs below its gross profit (necessary for a positive operating income). Today, its operational costs are consistently higher than its gross profits, so it cannot turn a sufficiently positive operating income necessary to pay its debtors. See below:
A company with a positive operating income and negative net income (due to interest expenses) can usually perform debt restructuring deals that keep it in business, although wiping out equity value. However, a firm that cannot turn an operating profit cannot pay debtors at all, meaning it is at risk of liquidation. While AMC's operating income may recover this year, the rise in part-time service worker wages makes it difficult for AMC to accomplish this.
Overall, I am very bearish on AMC and believe it will likely lose its value in 2023. This thesis has very little to do with the broader film industry. In fact, I wager that AMC will go bankrupt this year even if box office sales return to pre-pandemic levels. Core reasons include the abysmal state of the company's balance sheet, namely its rapidly declining and negative net working capital. Combined with the rise in operating costs, interest expenses, and the slow return of its gross profits, I believe its cash hemorrhaging will continue until the firm declares Chapter 11.
In my view, the one way AMC survives is if it can continue to sell equity. At $2.9B, AMC is very expensive today compared to its sales. Today's price-to-sales ratio is over 400% above its late 2019 pre-pandemic level. Its financial position is also, in my opinion, far worse today than it was then, making the stock considerably overvalued. As long as it remains overvalued, the company can sell shares to raise a great deal of cash to prolong its lifespan. In Q4, the firm sold many shares through its (APE) preferred equity counterpart. This strategy is effectively a back-door method of selling equity without directly diluting common shares. Of course, if APEs are converted to common stock, that dilution would be direct.
AMC may survive 2023 if enough investors are willing to overvalue the stock sufficiently to dilute equity and raise much-needed cash. At this point, AMC's cash flow seems unlikely to become positive and rise enough to offset its negative working capital. Thus, I do not believe AMC can avoid Chapter 11 but merely delay the inevitable. This fact makes AMC a risky short bet today, particularly considering its higher short interest raises the short-squeeze potential.
Will AMC's history repeat and buy the firm more time? Maybe, but I doubt investors will be as gullible today as they were in 2020-2021. Two years ago, immense speculative investing activity across the stock market led to excessive valuations for many stocks. That bubble has popped, leading to vast losses for many retail investors (particularly in the "meme-stock" genre). Thus, I do not believe AMC can rely on that segment of investors to bail out the stock a second time. Still, a short-squeeze rally that spurs more dilution is possible, particularly if the "theater recovery" trend continues. Thus, while I am extremely bearish on AMC, I am unwilling to short-sell the stock unless it has a more significant short-squeeze rally.
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