June 3, 2020
A ‘going concern’ note is given to companies that don’t have the financial resources to make it through the coming twelve months of operation. This morning AMC Theatres announced that there is substantial doubt that it can remain in business by issuing a going concern notice. Their stock is up 6% on the day, and up over 300% from their low set on March 17th.
To be fair, they have $700 million in cash, and only ‘lost’ $275 million in the first quarter (negative free cash flow) based on operating results, but the second quarter will likely be worse. I have been following the company for some time, and there doesn’t seem much financial flexibility for the company as their debt load and operating metrics were not favourable BEFORE the COVID crash.
Taking a deeper look at the company shows that they have $2 billion of property on their balance sheet (against about $12 billion in debt and lease obligations), but it is likely most of that property is in the form of leaseholder improvements, and if so they have limited value.
There are many discrepancies that have become visible in the current financial markets, but it is truly bizarre that a company announces that it may not be in business in a few months, and the stock goes up. This can be partly explained away by the Federal Reserve actions that are purchasing billions of dollars in treasury securities and now high yield ETFs. It is putting a floor under the prices of bonds for many companies and leaving funds available for risk taking.
Unfortunately it won’t put people in movie theatres and it certainly won’t help equity investors in companies that are intrinsically bankrupt.
This leads back to the difficulties with valuation. The market is seriously over valued by any measure that reflects normal business activity, and when the return of capital becomes a key story, rather than the return on capital, investors may seriously question how much risk they will take. Companies like AMC may bring that line of questioning to the fore.
Over the past 20 years other significant failures spurred this soul searching. Nortel, Enron, WorldCom, Tyco, Bear Stearns and others. Many are caused by outright fraud of course, but equity holders bear the brunt based on a failure of capitalism to effectively assess the risks. (There is no evidence of outright fraud in AMC or most other troubled companies today, they are simply over levered). AMC has clearly stated there is a high probability that their company has no value but buyers (risk takers), are purchasing shares just the same.
Central banks have turned capitalism and economics on their head and they represent a very, very poor form of socialism for large enterprise. The laws of economics are not apparent in the post COVID markets. Be careful with your capital.
Practical Advice 