Lawyers have to abide by a code of ethics that is upheld by the bar association in each state to make sure that their specialized knowledge and training is used for the betterment of their clients and the public at large. It’s a great ideal and is intended to keep those with esoteric knowledge of the law from taking advantage of those who aren’t as educated or aware of their rights.

No such pledge exists for the financial industry or their professionals. If there did, we may not be seeing the current events playing out with meme stocks such as AMC.

The Narrative is All Wrong

In January of this year, AMC was caught up in the GameStop and other meme stocks frenzy. Shares of these firms rallied by eye watering amounts. Retail investors piled in realizing that they had the collective power via Reddit forums and chat rooms to actually move the market. This is something that institutional investors have realized for years and is the source of a number of market rigging scandals by traders and others who are entrusted with large amounts of capital that can move the market. When it’s thousands of people instead of a few people though, the regulators have decided to keep their hands off, lest they get the backlash they received from many retail traders during the congressional hearings in February on what exactly happened with stocks like GME.

The general narrative was that these retail traders were finally standing up to those evil hedge funds and their billionaire owners who were shorting the shares of a struggling company. Indeed, many hedge funds did get burned, some of which were eventually bailed out by other hedge funds to the tune of billions of dollars. I have gone into detail about that episode in other posts so won’t discuss it in more detail here. Yet just as fast as it shot up, GameStop collapsed as the fickle retail investors lost interest and moved onto the next hot item like Dodgecoin or Ethereum. The price of GME fell from a high of $347 a share to $54 a share within a week. This was a predictable anomaly as it wasn’t based on any fundamentals, just the greater fool theory that someone was willing to pay more for the shares.

In this first iteration of meme stock madness, the public as well as institutional investors were caught off guard. Those who saw the run up as irrational were able to position themselves in deep out of the money puts and profit from the eventual drop. Other tactics such as a put spread may have offered even cheaper ways to use options to bet on the downfall of the stock. So it’s likely that some of the same people the retail mob was supposed to be fighting them profited from their fickle behavior and made just as much as the little guy did on the way up except it was done on the way down.

It was bond holders and management that didn’t get to take advantage of the run up in share prices but AMC seems determined to not let such an opportunity pass them by.

How AMC Positioned Themselves

Companies, just like people, adapt and learn and in the case of AMC and their management, led by Adam Aron decided that if the retail mob got behind them, they were going to utilize the opportunity to the fullest extent.

To understand what is meant by this, it helps to understand the basics of how public companies raise money. Basically there are 2 options, they can sell new shares and get cash from investors or they can issue debt which they eventually have to pay back from fixed income investors. The equity capital never has to be paid back but now those new owners get a say in how the company is run while the debt has to be paid back but the lenders have less say over how things are run.

AMC gorged itself on debt prior to the pandemic and as of March 2021 had $813 million in cash and $5.46 billion in corporate debt. With cash flow from operations totaling $579 million in 2019 (the last full “regular” year) compared to a debt service expense of $651 million in 2021, not only does AMC need a huge bounce back in movie goers (doubtful) but it also needs to find cash from somewhere else, and that’s where the suckers, I mean, retail investors come in.

Now that the stock has been bid up to as high as $60 a share from $10 a share in the past few weeks, management sees its opportunity on where to find that cash they so desperately need and they have definitely taken advantage of it raising $800 million through share sales in the past few weeks. See the problem I highlighted above with the cash flow is that AMC was having problems even before the pandemic but the pandemic just put them on a footing to drive them to bankruptcy sooner. The company had about 38 million shares outstanding at the start of 2020. After multiple conversions of bonds to shares (convertible bonds) and outright share issuances, the company now has over 500 million shares outstanding, that’s a dilution of approximately 92% and their prospects for profit haven’t increased dramatically.

Meanwhile, while the shares have been diluted another 11% in the past few weeks, the market cap has swelled from under $5 billion to $25 billion. Essentially $25 billion dollars in investor money is chasing about $500 million in normalized operating income, before debt is even taken into account. If we look at that operating income on a per share basis, in 2019 it was about $13.5 per share, where as now it’s less than $1 per share. This is before debt service is taken to account which would essentially wipe out all the income per share.

Granted that the $800 million will go some way towards relieving the debt burden on the company but it won’t save it yet. This is why the CEO was beaten back when discussing a 500 million share issuance in April and has had to content himself with a 25 million share issuance and not to come until 2022. Even in the rosiest scenarios, just based off of the profit and cash flow on a per share basis, the shares should be valued around a $1 and that’s being generous given management’s inclination to further dilute shareholders.

Who This Benefits

There are only 3 main beneficiaries of this scenario and the crash that will happen:

• The retail traders who were able to get in early and sell high. This will be a minority, since it consists of insiders and potentially of people who banded together to pump up the stock.
• The management of AMC, that gets to avoid bankruptcy, can award themselves shares based on the outrageous price and keep their jobs.
• The sophisticated traders and investors who can make money off the volatility. Think those that write and buy call and put options. An easy play on the way down is deep out of the money puts.
• Finally the same hedge funds that the retail mob wants to fight, will be getting a nice payday from this. Take for example Mudrick Capital Management, a distressed asset fund that was able to lend AMC money in a private side deal and then quickly convert those to expensive shares which were sold to investors. The shares were sold for a weighted average of around $53 a share the other day, which means they would have brought in about $450.5 million, all for a $230.5 million investment which was made a few days ago. This essentially doubled their money and they pocketed $200 million in a few days. So much for fighting the power.

Who Will Lose

In the end it ends up being the little guy that loses….again. The retail traders that jumped on the hype thinking they can make a quick buck. Once the price comes back down to a range more in line with the fundamentals of the stock and the hype wears off, many retail investors, or 80% of the investor base for AMC, will likely bear the bulk of the losses. A sequence of events we have seen play out before that will likely leave those that were hosed, bitter and disavowing the system for years to come.

The hardest part of this is watching it all unfold, knowing the outcome and still seeing people have to shoot themselves in the foot to learn a simple lesson: there are are no secrets and there are no free lunches on Wall St. Most of those that benefit from stocks and the market are long term investors who figured out the keys to discipline and patience years ago and are realizing them constantly. The get rich quick traders almost always end up getting the short end of the stick. Unfortunately most of these people didn’t have much to begin with. It’s another case of the taking from the poor and giving to the rich.

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