Want to Buy a Bridge? No? Then Do Not Buy AMC Stock

An Explanation of the Concepts of Absolute Priority & the Fulcrum Security

I read a funny article in the Wall Street Journal last week. Authored by Alexander Gladstone, the article, titled, AMC Says It Might Go Bankrupt if You Don’t Buy Its Stock, describes AMC Entertainment Holdings’ launch of yet another attempt to raise much-needed cash by way of a stock offering. 

Wow, that’s about all I can say. Wow.[i] Actually, I think I can squeeze out a few more thoughts. Here are some:

• Bold
• Audacious
• Fraudulent

Well, not fraudulent but certainly some indication that P.T. Barnum was right when he said, “there’s a sucker born every minute.” (We actually have no direct evidence of him saying this, as far as I know)

Monkey See, Monkey Do

It’s not wild speculation to assume the executives at AMC looked to Hertz when they decided to go down this path. As the article recounts, Hertz acted with even more audacious chutzpah when it began to sell equity during its own chapter 11, before the SEC stopped it.

An Exceptionally Bad Investment Hypothesis

Buying the common stock of AMC, especially on the heels of Warner Brothers’ announcement that every movie it releases in 2021 will premiere on HBO Max at the same time they appear in theaters, seems particularly stupid.

Layer on top of that: (a)what Disney was already doing; (b) recent ticket sales show that most moviegoers are not ready to back to theaters; (c) theaters that are open today could be forced to shut again at any time; and (d) even when COVID is behind us, the fact that the movie-making apparatus has been largely shut down so long that there will be a dearth of new movies for some time to come thereafter.

For these reasons, the legendary counsel of the philosopher Ben Stern comes to mind: “I told you not to be stupid, you moron.”[ii]

No Soup for You

As the article reports, AMC itself said a couple of months ago that it could run out of cash by year’s end. There is an industry push to get government aid in the form of the proposed Save Our Stages Act, S. 4258 and H.R. 7806. However, as currently proposed, AMC is ineligible to be a recipient of any aid under it.

Even the premiere of a Seinfeld movie and a loan to AMC from Jerry Seinfeld himself would be unlikely to make investing in AMC common stock anything other than a bad idea.

I represent movie theater operators and I am confident their owners are not angry at me for not asking for payment in stock.

But BlackRock Isn’t Stupid, Is It?

Earlier today (I write this article on the evening of December 9th), AMC rose 9%, though by the close of trading those gains were all but given back (the stock closed up .26% for the day). The reason for the earlier jump was generally attributed to BlackRock’s disclosure yesterday, after the Closing Bell, that it now owns 4.6% of AMC (which represents a five percent increase in its holdings from the time of its last SEC disclosure about AMC, filed on February 5th).

No, Virginia,[iii] BlackRock is not stupid. But there are many reasons why a large equity holder of a company might elect to increase its equity holdings by five percent, despite (and perhaps even because) that company is facing the barrel of bankruptcy.

Where There’s Smoke There’s Often Fire; Here the House is Already Burning

AMC has been in an extended period of restructuring for a long time (dating back to the Before Times). Debt exchanges have occurred. Tranches of debt are trading well below par. AMC is represented by law firm Weil and investment banker Moelis- two of the leading go-to firms for large, distressed companies, particularly those that file chapter 11.

But wait, there’s more.[iv]  I don’t know if the prospectus  AMC filed with the SEC last week in connection with its 200,000,000 share offering is without precedent, but it certainly is unusual. The first risk factor (or more than 30 separate risk factors) states straight-up:

“[O]ur ability to obtain additional liquidity, which if not realized or insufficient to generate the material amounts of additional liquidity that will be required until we are able to achieve more normalized levels of operating revenues, likely would result with us seeking an in-court or out-of-court restructuring of our liabilities, and in the event of such future liquidation or bankruptcy proceeding, holders of our common stock and other securities would likely suffer a total loss of their investment.”

A smart (or at least not stupid) investor doesn’t need to get past this first risk factor to know to walk away. If you want to gamble and cannot get to Vegas because of COVID, that may be a different story. But don’t confuse investing and gambling.

I’m not going to bother getting into the fact that with around a thousand locations, the lease negotiations alone will be a powerful force pushing the company toward chapter 11.

Bankruptcy Jargon Decoded: Absolute Priority & the Fulcrum Security

AMC has more than $6 billion of debt. In contrast, its balance sheet says it has more than $11 billion of assets. Balances sheets are funny (not in the “ha-ha” sense), though. They tend to be totally accurate on the debt side. But on the asset side, not so much. 

What’s a company with virtually no revenue worth? And what’s it worth when it’s bleeding more than $100 million each month?

The absolute priority rule of bankruptcy is straightforward: when there is not enough cash to pay every creditor of a company, the secured creditors get paid first; the unsecured creditors get paid next; and the shareholders get nothing unless all the creditors are paid everything they are owed. You can read a fuller explanation by Dentons partner Patrick Maxcy here. 

What commonly happens in a reorganization (whether it is out-of-court or through a chapter 11 plan of reorganization in bankruptcy) is that the company is valued. Then, unsecured creditors who rate highest in priority get the equity of the company, and equity gets zero. A simple example- Assume: 

• Senior secured creditor with a lien on all assets is owed $10 million.
• Junior secured creditor with a lien on all assets is owed $20 million.
• Wholly unsecured creditors are owed $40 million.
• The company is valued at $20 million.
• Possible result: Senior secure lender keeps its lien and remains the senior secured lender; junior secured lender keeps its lien, but it is undersecured. That means it is the fulcrum security and that, in turn, means that it gets 100% of the equity of the reorganized debtor. If you prefer a definition rather than an example: the fulcrum security is the class which receives payment and below which no class receives any consideration is commonly referred to as the fulcrum security.

If you care about the concept; if you need to understand it, then read Valuation: The Pillar of Corporate Restructuring. If it is useful to you, then also read Corporate Restructuring 2017: Why Some Attorneys See Rising Rates, but Most Don’t. I know the title sounds irrelevant and dated but trust me on this.

And if you have questions afterward, feel free to reach out to me. I don’t write this column because it is my hobby or of some altruistic desire to make you smarter about this stuff. I write it because even pre-COVID I didn’t like to wine and dine clients and referral sources, rather, I preferred to win clients by doing excellent work and letting them see that I know my stuff. So, yeah, if you get in touch with me, I’ll respond.

See You at the Movies

Video may have killed the radio star.[v] But the combined forces of COVID and studios who would like to bypass the big screen will not kill the dream palaces. We like our stories. We like them on big screens,. And we like to be around other people.

Most movie theater operators will- for the medium term- pay percentage rent or otherwise just a whole lot less rent, and they will evolve. Think virtual reality, more in-house dining, more IMAX, and similar experiences, and hell, maybe even Smell-O-Vision will stage a comeback.

And many operators, and I think certainly AMC, will have a change in ownership. If I am right, then any stock you buy in AMC today will soon be worthless.

[i] Lilly’s Purple Plastic Purse was one of my children’s favorite books.

[ii] In honor of the announcement of the new five-year contract.

[iii] In honor of the Holiday Season.

[iv] In honor of Ronco, the maker of the pocket fisherman, a company I represented when it was owned by private equity.

[v] In honor of the very first music video played on MTV, the ironically titled, Video Killed The Radio Star by the Buggles.