There was no rest for the public relations department at AMC Theatres this holiday season. With most motion picture executives around the globe having already left the office for at least the two weeks surrounding Christmas and New Years, the senior management of the largest exhibitor in the world was hard at work buttressing their finances, reducing their debt, naming new board members, officially ending negotiations to acquire specific theatre assets from the recently bankrupt Cineworld, announcing a reverse stock split and taking over a shuttered Arclight Cinemas location in Boston.
All the while AMC’s chief executive officer, Adam Aron, took to Twitter like a far more rational and reasonable Elon Musk to say, in-part, that he would not be receiving a rase in 2023, nor would he be selling his shares of AMC stock. Indeed, all of this frenetic activity was surely designed to improve the stock price of the the company’s common shares and AMC Preferred Equity (APE) shares, as much as it was to signal to Wall Street that betting against AMC is very short sighted (a pun that will be made more clear by the end of this piece).
Going APE Over Financials
Aron and AMC entered 2022 on a meme stock high with USD $1.6 billion of cash-on-hand and a stock price of USD $26.52 giving it a market cap of USD $13.96 billion. One year later, after three straight quarters of reported losses, the company’s cash had dwindled to USD $684.6 million (as of 30 September 2022) and 2022 ended with it’s stock price at UDS $4.07, a remarkable 84.65% decline that left their market cap at USD $2.10 billion. Since August of last year, AMC’s share price has declined nearly 72%.
That figure, like many statistics, is a little misleading. That’s because on 22 August of last year AMC issued their APE special dividend to shareholders which had the effect of doubling the number of shares in circulation. The price of AMC common shares fell 42% that day to USD $10.50, though combined with the USD $6 share price of APE, the fall was only 8% to USD $16.50. Since then however, the APE share price has declined to USD $1.36.
The exhibitor turned to its APE offering after shareholders rejected management’s request to issue more common stock to raise operating capital. AMC had chosen this route several times during the Covid pandemic to stay afloat until their theatres could reopen and start showing movies again. In 2019, the company had roughly 104 million outstanding shares. In 2020, that number rose to 117 million. Last year, the figure rose to 514 million outstanding shares. Shareholders were through with having their equity in the company diluted.
With APE however, AMC does not need to seek shareholder approval to issue new shares and raise more money. On 19 December of last year the company announced they had sold 125 million shares of APE, raising USD $162 million in cash since its August introduction. Three days later, AMC relied on APE once again in two transactions with Antara Capital, one of its debt holders. The exhibitor not only raised an additional USD $110 million through a sale of APE shares, but swapped an additional 91 million APE shares for $100 million in debt, saving the company USD $10 million a year in debt service.
Of course, what this means is that there are now more outstanding shares of APE than there are of AMC common stock. Have no fear, because in the same breadth in which the company announced their Antara deal, AMC said they would seek a special shareholder vote to convert all APE shares into AMC common shares. This will more than double the number of outstanding common shares to well over 1 billion. AMC would then orchestrate a reverse-stock-split of common shares at a 1-to-10 ratio, meaning for every 10 common shares of AMC stock a shareholder would get one share. This would reduce the number of outstanding shares to the 100 million level near where it stood in 2020.
Theoretically, the value of shareholder’s investment in AMC will remain unchanged. For example, if a share holder owns 10 shares of AMC at its USD $3.85 closing price on 6 January 2022 they have a USD $38.50 investment in the theatre chains. After the reverse split, they will have one common share of AMC worth USD $38.50.
Yet theory and reality often find a way of diverging, especially when one understands that should shareholders vote for the APE conversion and reverse stock split, they are potentially agreeing to give AMC “the same ability to issue additional common equity as it currently has to issue additional APE units.” Translation, AMC could issue additional common shares of its stock, just as it did with APE shares, diluting existing equity shareholders. The devil is always in the details, isn’t it?
Now you may be very confused by all these numbers, percentages and financial mumbo jumbo. And if that is confusing just wait until you hear why the timing of all these announcements was likely orchestrated to come at a pivotal moment and for very specific investors, even if that meant they were made Christmas week when few others were paying attention.
Selling AMC Short
The concept of short selling can be difficult to grasp and harder to comprehend, so we’re going to try and make a very convoluted investment strategy somewhat intelligible here by keeping it on very basic terms. Short selling a stock is when an investor borrows shares of a given stock (such as AMC) from a broker promising to pay it back on a given date or under specific circumstances, but then immediately sells the borrowed stock to someone else at the current market price. The investor is predicting that the price of the stock will fall below what they borrowed and sold it for so that when they are required to purchase the stock in the future to return it to the broker, they can do so at a lower cost, keeping the difference as profit.
It’s like borrowing your friends Ferrari today, immediately selling it for USD $100,000 to someone else with the idea that when you have to return the car in three weeks, you can probably buy a Ferrari for USD $50,000 and pocket the difference. An oversimplification, to be sure, but when it comes to investing, if a company’s shares are being heavily “shorted” then there is a wide-ranging belief that the its stock price is more likely to fall than rise. There are other reasons for short selling a stock, such as hedging, but for our purposes, it’s a bet against a company.
Thus, the short interest in a stock is an indicator of sentiment about a given company’s future fortunes. Short interest is measured by the the number of shorted shares divided by the number of outstanding shares to come up with a percentage. Anything under 10% is considered very positive as investors believe the price of a stock will rise and aren’t interested in selling it short. Anything over 10% is considered to have a high negative sentiment and 20% is extremely high.
Right now the short interest in AMC is at 21% with over 108 million shares having been borrowed and shorted. Let’s put this another way, 21% of AMC is owned by investors who hope the share price of the company will fall. These investors made roughly USD $1.75 billion shorting AMC in 2022. As well, they are increasingly willing to pay a premium to bet against AMC because of the borrowing rates charted by brokers. A standard borrowing rate to borrow and short a stock is between 0.3% to 3.0% per year of the stock value, applied daily. In October of last year the borrow rate for AMC’s shares hit 18% and then skyrocketed past 100% in November before returning to the 38% range. By January 2nd of this year the price skyrocketed to 138.5% and is hovering around 98% at the time of publication.
This high borrow rate indicates that there is so much short interest in AMC that it has become hard to find shares of the stock to borrow for such purposes. It also has may have a lot to do with what is known as naked short selling; when an investor, broker, etc. short sells a stock without first borrowing the shares. It’s when you sell your friend’s borrowed Ferrari for $100,000 but you never actually borrowed the car in the first place. While you don’t have to worry about returning the car to your friend, what happens when it is time to deliver the car to the buyer?
A naked short seller must borrow and deliver the shares they’ve sold to the buyer within three business days and if they don’t it results in what is known as a failure to deliver (FTD). The seller then has 35 days from the trade to obtain the shares and close out the position. A naked short seller is hoping that in the three day window the price of the stock they are shorting will decline rapidly below their sale price so they can buy shares on the open market and deliver on-time.
If this sounds like it can lead to market manipulation of a stock price, you’d be correct. That’s why the United States and Europe made naked short selling illegal for everyone but market makers after the 2008 financial crises. Yet there are a number of loopholes and enforcement has been lackluster causing the practice to continue. Because of this, the number of FTDs reported by the Securities and Exchange Commission has been tied to the level of predatory naked shorting of any given stock, even though there are any number of legitimate reasons they can occur.
The number of FTDs for AMC stock has continued to be unnaturally high since at least June of 2021. After hitting between 1.2 and 2.1 million FTD shares at the end of September, AMC’s stock hit a new high of 4.3 million on the 14th of November. On that same day, much larger companies than AMC, with higher trading volumes, had negligible failures to deliver; Amazon had 253, Apple and Google had 0, Microsoft had 11,443 and Tesla had 2,519.
In those cases the FTDs are probably due to a systems glitch or a time lag between exchanges. Those trades usually close out within five days of the failure. However with AMC it is more likely that the FTDs stem from naked short sales executed by sophisticated investors brokers and dealers who are legally the only entities allowed to so.
Per SEC regulations, the seller of a naked short, even one that has failed to deliver, must eventually deliver the shares to the buyer so the trade can be be closed out. Ideally within 35 days. Stocks that have a high volume of FTDs on a given day will often have a high volume of shares traded about 30 days later, which can sometimes drive up the price a bit . So it is not entirely surprising that AMC began its run of financial press announcements on December 19th, a little more than 30 days after the 4.3 million FTDs on November 14th, in an effort to bump the stock price. That the borrow fee for AMC shares also raised to 40% on 29 November, and climbed to 50% by 22 December is potentially another sign of naked shorting.
But there are many methods that allow traders to never close out a naked short, all of them ethically and legally questionable. And that’s a major issue with naked short selling; it creates “phantom” or “synthetic” shares in a company destroying the value of a stock for legitimate shareholders. It can even propel a company into bankruptcy. The ability to sell an infinite number of shares, even for a short period of time, is designed to manipulate the stock price, usually down.
Investment banks and financial institutions are well aware of this predatory naked shorting and often turn a blind eye since they make a fortune through the trading fees generated by the activity. The SEC routinely fines these firms for amounts that are trivial compared to the revenue earned through sales that end up as uncovered FTDs.
Putting The Squeeze On
In a tweet from last August Aron suggested that he didn’t think synthetic shares were effecting AMC’s share price. He hasn’t commented publicly on the high level of FTDs in the company’s stock but one way to flush away phantom shares is through the proposed reverse stock split. Even if the common share price of AMC were to decline before APE shares and their value converted, as is probable, the combined value of each share of stock after the reverse split will be so high that short sellers will be left exposed. More to the point, they will be forced to go into the market to purchase shares before the split all at once which could have the effect of causing a short squeeze like the one the company experience in June of 2021.
Because a reverse stock split is often utilized to increase the price of a company’s stock above a delisting threshold, it is commonly viewed as a negative financial maneuver. Yet AMC could be employing it more to squelch short selling and reduce the number of outstanding shares in the market. The latter is necessary due to the likelihood AMC will need to issue additional shares in the company to raise capital sometime in 2023. This will serve not only to provide funds for ongoing operations, but more importantly potentially help restructure AMC’s crippling debt load.
AMC has USD $5 billion in long-term debt and USD $11.79 in total liabilities. This is against USD $9.21 billion in assets, putting the company upside down to the tune of USD $2.58 billion. This is why you constantly see Aron and senior management at AMC attempting to lower the debt through various transactions. Naturally, increasing revenue to the point of profitability would be the most ideal method of both servicing and reducing the company’s debt. In fact, without a quarter or two of profit AMC could run out of money by the end of 2023 as it stands today.
Aron obviously knows that issuing new shares of common stock could provide enough of a runway for AMC to fully recover from the pandemic. Yet he also understands the dilution this will cause will be painful for shareholders. This is why over the holidays he took to Twitter to point out that he is one of the company’s shareholders, owning 1,097,200 shares and why dilution may be necessary. Aron also confirmed that he would not be selling any of his stock in 2023, nor would he, or nearly 20 of the AMC’s top executives be receiving an increase in their salaries.
Say what you will about Aron, he certainly uses Twitter more effectively than most. Now if we could just get him to teach Elon his secrets.