AMC Entertainment: The Possible Outcomes And Probabilities

Summary

• AMC was poised for a strong recovery prior to the recent health crisis.
• COVID-19 has hit the company like a meteor.
• AMC, currently, has zero revenues and a large fixed cost base.
• Although it managed to raise some liquidity, it may not survive beyond 2020.
• Is it a takeover candidate? This article will discuss the possible outcomes and probabilities.

AMC Entertainment (AMC) was poised for a strong recovery in 2020. Following several years of debt-fuelled expansion manifesting in acquisitions of screens, expensive CAPEX program, and, quite frankly, gross misallocation of capital by management - 2020 was billed as the year for free cash flow generation and deleveraging. It was meant to create that virtuous cycle of increased free cash flow, lower debt, lower interest costs, upgraded credit rating, and, ultimately, meaningfully, enhance the value of the equity stub.

But then, the COVID-19 crisis hit the company like a meteor. Prior to discussing this, it is useful to revisit the pre-crisis debate on the impact of streaming on the industry.

The rumour of (movie-going) demise is greatly exaggerated.

This topic has been hotly debated in previous articles and comments section.

My view is that this is not necessarily a binary outcome. The increasing popularity of streaming services certainly dampens demand by reducing the frequency of visits to cinemas and, therefore, hurts overall industry growth. However, the industry has and will continue to adjust to it (reclining seats, F&B, memberships programmes, etc.). So, in short, whilst I agree there is an adverse impact, it is very far from the death knell to the industry, some describe it to be.

I also do not believe the theatrical release window arrangements with the film studios will change any time soon. The economics are compelling in monetising the value of new titles through the theatrical release window compared with PVOD. Aside from the big screen and social experience, theatrical releases also benefit from F&B cash flow as well as distinct revenue for each and every viewing customer (PVOD can be watched by large number of family and friends for a single fee).

The Liquidity Crunch

The COVID-19 crisis, essentially, left the company with no revenues but substantial fixed costs. The latter predominantly comprise of the quarterly run rate of ~250 million theatre rental expenses as well as $90 million interest costs.

Liquidity is king in a crisis, and it is clear that AMC was ill-prepared.

As of 31 December 2019, it had total liquidity of $597 million, comprised of $265 million of cash and $332 million of availability under revolving lines of credit.

As the lockdowns began in earnest, the company went into liquidity preservation mode - furloughing most employees (including CEO and management) and stopping all other payments where possible (e.g. looking to defer theatre rental payments).

By 31st March, its available cash reserves reduced to ~300 million, predominantly from existing revolving lines of credits. AMC appeared to be on the brink of bankruptcy. Then, on the 17th of April, it received a lifeline with a $500 million private placement offerings carrying a yield of 10.5%.

The additional funds would allow it to survive until the end of November without any revenue coming in the doors. The hope from management is that cinemas will be able to reopen in the summertime and AMC will survive in its current form.

The key question, of course, is the proverbial "what now?". What are the possible outcomes and associated probabilities going forward.

Option 1: AMC will survive and thrive (20% probability)

This is the optimistic scenario.

The health crisis will subside and theatres will reopen in mid-July with much fanfare leading with Christopher Nolan's sci-fi thriller "Tenet". Whilst initially social-distancing measures (such as limiting capacity) will apply, these will subside in the weeks and months to come as the health crisis continues to subside and AMC will benefit from the pent-up demand for cheap live entertainment.

The deleveraging narrative will be resurrected, short-sellers will be squeezed, and the scars from COVID-19 will begin to heal (and substantial damage has been already done). However, AMC can start looking forward to restructure its capital base and begin to unshackle from large and expensive debt assumed in the expansionary years.

Option 2: AMC will survive but struggle (15% probability)

In this scenario, AMC will survive but the "new normal" will mean lower revenues as cinema attendance does not revert to prior highs (either through social distancing measures and/or accelerating trend towards streaming). In a largely fixed cost base business, this can quickly translate to a downward spiral and AMC will struggle to keep its head above waters, generate free cash flow, and/or address its debt-laden balance sheet. AMC will try to buy some time by driving down costs further and monetising some assets. The share price will likely stagnate with a persistent downward bias.

But, ultimately, in the medium term, this scenario will probably lead to one of the other options listed below.

Option 3: Bankruptcy (25% probability)

The bond market tells you that this is a very credible possibility. AMC bonds are trading one notch above default and as low as 30 cents in the dollar.

AMC's CEO Adam Arun has done his utmost best to avoid this option and buy some time. I believe it has been extremely close to "game over" prior to the Fed's actions supporting the debt markets. Fortunately, for current AMC shareholders, it managed to buy some time until November 2020 with the $500 million private placement.

In this scenario, the health crisis is not resolved and/or second wave is coming during the fall. AMC is forced to close its theatres again and liquidity dries up.

Shareholders effectively get wiped out.

Option 4: China's Wanda as a white knight (10% probability)

China's Dalian Wanda Group is AMC's largest shareholder and holds 49.8% of its common shares. Clearly, it has a strong interest to protect the value of its investments but does it have the political backing (and cash flow) to do so?

This article summarises the known considerations, including China's desire to focus domestically and reduce overseas investments (Wanda offshore ambitions were curbed substantially two years ago) as well as Wanda's own woes in dealing with the COVID-19 impact on its commercial property and own domestic Cinemas businesses. All in all, in the near term, this makes this scenario appear to be less likely.

Option 5: Acquisition (30% probability)

AMC share price soared following speculation of a buyout by Amazon (AMZN). There are a number of reasons why Amazon would be an interested party. Firstly, it can be quite complementary to its Amazon Studios business helping to monetise content further before moving it to the streaming platform. Secondly, it can neatly bundle it as part of its Amazon Prime perks - the playbook with Whole Foods acquisition could be on the cards again. In fact, in 2018, both Amazon and Netflix (NFLX) were reported to be in the running for Landmark Theatres but lost out to another bidder.

The film studios may also be in play now given that the old anti-trust rules, barring them from owning theatres are likely to be abolished.

Final Thoughts

From an existing shareholders' perspective options, 1, 4, and 5 are clearly preferable (which, in my view, represent a total of 60% probability).

I assign the highest probability of 30% for option 5 (an acquisition) simply because the economics make sense for a number of candidates. From a potential buyer's perspective, the bankruptcy route may have been the most preferred route to acquisition - primarily due to the high levels of debt on the balance sheet. AMC changed the calculus on this (at least, temporarily) with the $500 million private placement eliminating any bankruptcy talks and now there may also be a fear of missing out for certain buyers. If COVID-19 trajectory continues to improve, a deal may be struck sooner than later.

Having said that, the outcomes are quite binary and a high probability of severe downside exists as well (assessed as 40%, in my view).

Whilst I am moderately bullish on AMC, I see it as a short-term speculative trading position for now.

I am also very keen to read others' views on AMC in the comments section.

Disclosure: I am/we are long AMC, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.