Description

Company: AMC ENTERTAINMENT HOLDINGS, INC. (AMC)

Security: $200MM 10.5% Senior Secured Notes ‘26 (1st lien)

Price: 66.5 Cents / +21% YTM

Recommendation: Long

Executive Summary/Summary Thesis

It has been well telegraphed that cinema attendance is down 80-90% both in the US and internationally over the last six months due to the pandemic and as such exhibitors like AMC Entertainment (AMC) are burning cash every month while waiting for attendance to pick up on the back of good news on the vaccine front. That happened this week with promising results from Pfizer. Admittedly many questions remain about the vaccine which are beyond the scope of this post but the enhanced clarity on timing provides greater confidence that attendance will return to a semblance of normalcy in the next few years. As such, at ~66.5c (+21% YTM), the 10.5% Senior Secured Notes ‘26 (“the 1st Lien Bonds”) present an attractive risk/reward in AMC’s capital structure for the following reasons:

Thesis:

1. Sustainable business model - profitable business economics particularly for blockbuster/franchise movies notwithstanding continued pressure to shorten theatrical window and the rise of streaming platforms.

2. Restructuring: a strategic imperative - a bankruptcy filing with an agreed upon RSA seems like the most probable outcome and quite frankly the right thing to do. At the current burn rate AMC is expected to hit a liquidity event in Q1/Q2-2021 and will need to restructure. It is reported that AMC is now working with Alvarez & Marsal on a cost reduction and liability management program including presumably rightsizing the capital structure, reducing cash interest and evaluating/rejecting unprofitable lease locations. Given the recent news regarding Pfizer’s vaccine trial data, however, there is a low probability upside case that AMC is able to raise subordinate capital to prolong the liquidity runway. 

3. Pent up movie slate - build up of blockbuster content waiting to get released to the box office which is key to driving attendance and optimizing theatrical revenue for the studios (tough to replace in direct to home format).

4. Attractive valuation - while the 1st Lien Bonds are up ~10pts this week on the back of the Pfizer news, they are potentially more attractive today the reduced downside risk. The creation multiple is 4.8x ‘22E Adj. EBITDA or 7.1x ‘22E UFCF. 

5. Possible preference claim upside - against Silver Lake if the company files Ch.11 before the one year lookback post the July 2020 distressed exchange; there are two obvious bookends, equitable subordination vs status quo - a settlement is more likely.

Risks:

1. Pre-Covid: shorter theatrical window and more movies shifting straight to PVOD

2. Post-Covid: commercially viable vaccine takes longer to produce/distribute than market expects 

Catalysts:

1. Audience pickup - confidence in returning safely to cinemas (vaccine/treatment related)

2. Studio release slate - Box office success of a few blockbuster movies will give studios confidence to release more big ticket movies that have been delayed (also vaccine related)

3. Restructuring event - rightsize capital structure and reduce cash costs (rent and interest)

Note: Worthwhile reading prior write-ups on AMC and other theater operators on VIC for background information.

Brief Company Background 

AMC is well covered by the sell-side and has been written up several times on VIC so I won’t dwell on the business or the industry in too much detail. Briefly, AMC is the world’s largest theater company with 958 theaters globally housing ~8k screens in the US and ~3k screens in international markets (mainly in Europe, via its Odeon and Nordic acquisitions in 2016/17, and Saudi Arabia). In the US, ~52% of households live within 10 miles of at least one AMC theater location. The company operates in 44 states and is a market leader in the top two US markets, NY and LA. In 2019, the company generated ~$5.5bn in revenue (of which $2.4bn was domestic box office, equating to #1 market share with ~21%), $864MM in Adj. EBITDA (pre-ASC 842) and $518MM in capex (of which ~50% was growth-related). The revenue model is largely driven by (i) the box office - a ~50% gross margin business and dependent on the quality/appeal of the movies that are released by the studios (such as Disney, Universal and Warner Bros.), and (ii) increasingly important food and beverage spend - an ~85% gross margin business and driven by attendance (which in turn is also dependent on a quality movie product). While attendance has averaged an annual decline of ~1% over the last several years, domestic box office revenue has remained stable driven by 1-2% annual price increases. The top three theater groups (AMC, Regal and Cinemark) command ~50% domestic market share. AMC has higher rent expense than its two peers, given its large market presence, which contributes to lower EBITDA margins. AMC has some noteworthy investors in its capital structure including Dalian Wanda Group of China, which owns 49.9% of AMC’s equity, and Silver Lake Partners, which recently restructured its exposure from an unsecured bondholder position to 1st lien secured debt. 

Lease accounting - It is worth noting that in January 2019, AMC adopted ASC-842 accounting treatment for leases which essentially reclassifies Finance Lease Obligations from a capital lease to an operating lease. Given the initial base terms of theater premises leases typically range from 12 to 15 years (with the average remaining lease terms of +11 years) this change could obscure the earnings power of the business, particularly at the EBITDA level. Without ASC-842, rent expense for 2019 would have been $851MM compared to the reported expense of $968MM (above the EBITDA line) while D&A would have been $546MM compared to the reported expense of $450MM. 

Situation Update - Liquidity and Cash Burn

After a global shutdown in Q2-2020, AMC resumed operations in Q3/early Q4 at ~90% of domestic and international theaters with limited seating capacity of between 20% and 40% (mandated restrictions). With attendance still down 80-90%, AMC has negotiated some rent concessions but mostly rent payment deferrals with its landlords (for 12-24 months or through the lease term) and reduced labor/utility costs to manage cash burn. The company is now burning +$100MM per month (compared to ~$300MM per month prior to COVID) mostly on opex (labor), debt service, some rent expense and minimal maintenance capex, and has sufficient liquidity to survive ~6 months outside bankruptcy absent a capital raise. The likelihood of a spike in attendance before Q1/q2-2021 that would result in cash flow break-even is low in my opinion, and as such, a restructuring/liquidity event is almost certain.    

Capital Structure

Thesis:

1. Sustainable business model

The cinema business has historically been viewed as a necessary component of the theatrical release supply chain by the studios particularly for large franchise/blockbuster titles which require significant upfront marketing dollars in order to generate attendance viewership. Attendance is ultimately driven by the quality of movie content, and as such, industry sales can vary from year to year. Notwithstanding the ‘lumpiness’, AMC has generated revenue of $5-5.5bn per annum over the 2017-19 period, gross margins in the ~65% context, Adj. EBITDA margins of ~15% and unlevered FCF conversion on a maintenance capex basis of ~70%. On a per-theater basis, AMC is EBITDA break-even at ~25% occupancy.  Given the fixed cost contribution to opex, incremental EBITDA margins are typically in the ~30% range.      

In recent years, and particularly over the last six months, the relationship between the studios and theater companies has evolved due to the growth of streaming platforms and the prospect of shortening the ‘sacred’ ~75 day theatrical window (time between theatrical release and move to at-home/other platforms), which was catalyzed by the AMC-Universal deal. To recap, the deal reduces the window to 17 days (3 weekends) after which Universal will be entitled to offer its titles on PVOD platforms at ~$20/rental. In return AMC will receive an undisclosed cut of the PVOD revenue stream for those titles which, while positive, is almost certainly below the ~50% that AMC currently receives at the box office (given that PVOD platforms only take ~20% of the split). While the deal crystallizes the “worst fear for the industry” and AMC has been criticized dearly for it (and it could be argued that were it not for AMC’s precarious financial position - no revenue and overlevered capital stack - they wouldn’t have done the deal), I believe it was only a matter of time and am less bearish for a following reasons:

• We now know the downside and it isn’t a disaster - the prospect of shortening the window and moving titles to PVOD has been an overhang for the industry for a while. Given that ~80% of industry-wide box office take generally occurs in the 1st 3 weekends, AMC has now quantified its downside and negotiated some upside optionality. As a result, assuming AMC receives ~10-15% of the PVOD residual, the company should be able to retain ~85% of its pre-deal box office take.

• The bigger question - can the studios forego theater economics entirely? I don’t believe so for the following reasons: (i) Math - the amount of revenue that studios generate from the domestic box office and associated downstream revenues would be challenging to replace by forgoing theatrical releases completely (not necessarily on a per-movie basis). gross revenues from theatrical releases are typically 1.5x-1.7x the studios receive just from the theaters due to the other associated downstream revenues. Take Disney/Fox for example: their combined pro forma 2019 box office was ~$4.2bn, but the total gross revenue was estimated to be closer to ~$7bn given the implied contribution from downstream ($7bn is 1.66x $4.2bn). To replace this ~$7bn revenue stream, Disney would need to sign up an additional ~100MM streaming households at ~$70 annual subscription fee out of a total of ~140MM households in the US or ~100MM net that don’t currently have Disney+, i.e. Disney would have to sign up every incremental domestic household that doesn’t currently subscribe to Disney+ - not a near-term event I think; (ii) Advertising - typically movie trailers are aired on the circuit four weeks before the movies are released - this is effective advertising for the studios as they hit the target market and it is unlikely in the near-term that the studios would be willing to forego this avenue of advertising; (iii) Perception - studios take a risk with a direct to home release as consumers are generally conditioned that movies that go straight to PVOD are “not good enough to be shown in the theaters'' - clearly perceptions can change over time but also not a likely near-term event. 

My expectation is that studios will continue to view broad domestic and international theatrical releases as an important revenue contributor for franchise/blockbuster movies while experimenting with different distribution models for lower budget movies. As such, given the structural headwinds I believe industry box office will be lower going forward and am modeling a 15-20% decline in 2022 (compared to 2019) which I simplistically assume will be ‘steady-state’ for the near- to medium-term.

Operating Model:

2. Restructuring - a strategic imperative:

Between balance sheet leverage and high rent expense, AMC came into the crisis with no margin for error. With ~$511MM in pro forma cash at the end of Q3-2021 and another ~$85MM of identified cash proceeds from stock/asset sales, AMC has close to ~$600MM in liquidity. At a +$100MM burn rate in a no/minimal revenue environment, the company will run out of cash in Q1/Q2-2021. Given recent reports that the company has recently hired Alvarez & Marsal, I expect the company is very focused on a comprehensive restructuring plan designed to raise capital, reduce cash interest and reject unprofitable leases. 

Assumptions: 

(i) Restructuring process: company negotiates restructuring support agreement with the 1st liens and files prepack/pre-arranged in Q1/Q2-2021; process last 6 months and costs the company ~$50MM in fees

(ii) New money: company raises $800MM at 8% in super senior financing (bridge/DIP/exit)

(iii) Conservative post-reorg capital structure: 1st lien debt is converted to 100% of the equity; 2nd lien debt receive warrants that come into the money when the 1st liens are made whole (on a pre-petition basis); the new money financing is the only debt on the post petition capital structure.

(iv) Rent expense: rent is a significant cost for exhibitors and especially for AMC given its large metro market exposure. The rule of thumb within the industry is that during a normalized attendance environment, nearly all theaters on an individual basis generate positive cash flow before occupancy costs (rent and real estate taxes). Post occupancy costs, the larger circuits have reported that ~90% of theaters generate ‘positive contribution margin’ each year, implying that ~10% lose money, and the principal reason for losing money is generally due to competitive dynamics within a market. As such I have made a simplifying assumption that the theaters that lose money are the same theaters every year and the company uses Chapter 11 ro reject those ~10% of leases. In terms of treatment, unexpired leases of nonresidential property are categorized as executory contracts in bankruptcy and can be assumed, rejected or in some cases assigned within 210 days (including extensions). This is a critical consideration for AMC because if they assume the lease it will survive the bankruptcy process as an administrative priority claim (pari with salaries and other ongoing opex) but if the company rejects the lease, it would be treated as an unsecured claim for which I have assigned zero value given the prevailing impairment (market price materially below par) to the priority secured debt. 

There is also a strategic rationale to reject leases now - given the expectation of lower steady-state box office revenue given the aforementioned structural headwinds from shortening the window and the rise of streaming platforms, it would be wise to use the tools available in bankruptcy to streamline the cost structure more in line 10-20% lower topline. Clearly rent expense at ~$11.4bn in box office (in 2019) isn’t economically rational for industry revenue of 15-20% less (my base case for 2022/steady-state).  

(v) Revenue trajectory: given the Pfizer news, I assume attendance will begin to pick up in Q2-2021 and studios will start releasing movies that have been thus far delayed. For 2022, I assume industry revenue drops to ~17.5% (compared to 2019) and AMC maintains its market share in the 20-21% range (within historical context). It wouldn’t surprise me if AMC and the other larger circuit operators gained market share post-pandemic as a result of smaller operator shutdowns during COVID due to a lack of resources and/or limited access to financing. 

(vi) Opex and Margins: I have assumed lower margins in 2022 (12% pre-lease rejection, ~14% post) compared to 2019 (~16%) due to the fixed cost structure and decremental contribution margin profile of the business. 

(vii) Maintenance capex: I have assumed ~$21k per screen in 2022 (steady-state) which is almost double the ~$11-12k capex per screen derived from the company’s guidance for 2020/21. 

Pro Forma Capital Structure:

Pro Forma Liquidity Profile:

3. Pent up movie slate

After the disappointing attendance numbers for ‘Tenet’, studios have largely opted to delay the release of big budget movies as opposed to releasing them straight to PVOD. There is now an impressive lineup of movies scheduled to be released in 2021 (I assume the 2nd half) such as the new Bond movie, Black Widow, Wonder Woman and Batman. The delay has also had an impact on the release dates for movies that were initially scheduled to be released in 2021 and are now getting pushed back to 2022 such as the Avatar sequel and the next Star Wars movie. Clearly, under normal conditions, there is a symbiotic relationship between content and attendance, and collectively these big ticket franchise films present an attractive slate of content for movie-goers when they feel safe/comfortable returning to the cinema.    

4. Attractive valuation and good covenant protection:

The 1st Lien Bonds are attractive both on an intrinsic value basis and relative to the comps and prior acquisitions.   

AMC has historically generated 11-12% return on capital and traded at 7-8x EV/EBITDA. Currently, the creation multiple for the 1st Lien Bonds is 4.5x my estimate of ‘22E Adj EBITDA (and ~3x ‘19 Adj. EBITDA). Pro forma for a restructuring, which includes both a priming facility (negative) and cost savings from lease rejection (positive) and I believe the more relevant metric, the creation multiple is ~4.8x ‘22E Adj. EBITDA and ~7.1x ‘22E UFCF. 

Relative to acquisition multiples, AMC recently sold some European assets for +9x ‘20e EBITDA based on a pre-COVID budget. The abandoned Cineworld-Cineplex deal was initially agreed to late 2019 at 12.5x EBITDA without synergies but closer to ~9x with synergies.  

Cinemark, the closest public comp, trades in the 5.5-6x range based street estimates for ‘22E Adj. EBITDA. Admittedly Cinemark is in better shape financially and generates higher returns on capital (largely due to lower rent expense/higher percentage of owned properties) but AMC should begin to close the gap on a post-restructured basis.   

In terms of covenant protection, the 1st lien Bonds have senior secured priority status and rank pari passu with the 10.5% ‘25s and the bank debt. As such they can’t be primed outside bankruptcy. There has been much discussion on ‘creditor on creditor violence’ particularly in loan-only capital structures such as Serta Simmons, but given the existence of pari passu secured bonds in AMC’s capital stack, I don’t believe the 1st Lien Bonds in AMC will be subject to lien subordination given the higher threshold in the bond indenture (66.7%) compared to the credit agreement (50.1%). 

5. Legal claim 

Fraudulent conveyance/preference payment claim against Silver Lake would be available to the 1st liens if the company files within 1 year of the distressed exchange. It can be argued (and presumably will be) that Silver Lake is an insider in the Boardroom and used their influence to extract disproportionate economics in the distressed exchange offer. As an insider the look back period would be 1 year from the date the exchange offer was consummated (July 31st, 2020), compared to 90 days for outsiders. As a condition to the exchange offer, Silver Lake negotiated an uptier elevation of its entire $600MM senior unsecured convertible note to senior secured status (pari with the 1st liens) in exchange for its consent right to consummate the exchange while the subordinated unsecured class (junior to Silver Lake) received an elevation to a 2nd lien position. The subordinated notes were also given the opportunity to invest $200MM in a new 1st lien bond. At the last minute (not part of the initial offer) Silver Lake agreed to also iinject $100MM in the new 1st lien note presumably as an attempt to level the ‘reasonably equivalent value’ playing field of the consent right. I believe Silver Lake’s use of the consent right was aggressive and will be litigated assuming AMC files before July 31, 2021 which is a probable event per my base case unless the company miraculously pulls off a significant junior capital raise. The two bookend scenarios would be equitable subordination of the Silver Lake $600MM convert now 1st lien (which would reduce the 1st lien attachment point by ~0.6x) or status quo.The more likely outcome is a settlement vs protracted litigation.  

Risks:

1. Shorter theatrical window and more movies shifting straight to PVOD - there is little question that the window will narrow from the current status of 75 days. Industry consensus is closer to 30-40 days but there is clearly risk it could be shorter than that, particularly given the AMX-Universal deal. To be conservative, I am modeling 15-20% lower domestic box office revenue on a normalized basis (relative to 2019) for the industry going forward.

2. Ongoing covid battle - Clearly there is ‘covid-beta’ risk with this name and given the 2nd wave we are currently experiencing in the US, a significant delay in the development/distribution of a commercially viable vaccine will prolong cash burn, necessitate more (super senior) financing and ultimately delay revenue/cash flow generation trajectory. 

Catalyst

1. Audience pickup - confidence in returning safely to cinemas (vaccine/treatment related)

2. Studio release slate - Box office success of a few blockbuster movies will give studios confidence to release more big ticket movies that have been delayed (also vaccine related)

3. Restructuring event - rightsize the capital structure and reduce cash costs (rent and interest)