I have no position in AMC, perhaps the most meme of all meme stocks.
I covered in November last year (a pretty good cover in retrospect) and an allocator wanted to know why. So I wrote out some notes.
For people unfamiliar with the meme stock phenomenon I have written this out long-form, filling out some details. The highly familiar will be bored with this. That said I will post it here for all regardless.
Background
AMC (a highly levered chain of movie theatres) and Gamestop (a slowly dying chain of shops that sell computer games on CD-ROMs) were the definitive meme stocks of the January 2021 short squeeze. (In that period many short squeezes happened hurting many funds including mine, though in my case only to a limited extent.)
In both AMC and Gamestop the companies raised money and retail investors motivated in part by a “get shorty” attitude bid the stock up.
Gamestop however raised so much money that bankruptcy is unlikely. Gamestop has a lot of net cash (though it does still run sharply cash-flow negative). AMC by contrast remains highly indebted, is burning through the cash and – absent very substantial capital raises – will likely file bankruptcy in the next twelve months.
AMC is the most extreme “meme stock” in the market today. Holders of the share refer to themselves as “Apes” harking back to the line from the Planet of the Apes movie – “Apes stronger together”. There are more than four million shareholders and twitter and reddit are awash with shareholders goading each other to buy more and hold often for the benefit of the “community”.
Capital raises are a problem for AMC despite what was at times a very strong bid in the stock. AMC articles only authorise 524 million shares and almost all of these shares have been issued. Unissued shares are necessary to back options for the senior management. (Senior management are unsurprisingly loyal to senior management.)
Apes repeatedly made clear to management that they would not vote to increase share authorisation. Management made clear that unless this happened bankruptcy was likely. That said the Apes are the owners – and so management found it difficult to increase the number of authorised shares.
Management however found a “solution” to this problem. There was an unused authorisation dating back almost a decade in AMC’s articles for a $50 million preference share issue. So they invented a preference share which was identical to a common share in every way except one – it has a 1c preference in liquidation. It has the same vote as an AMC common stock, it has the same dividend entitlement etc. To play to the crowd this preference share was called “AMC Preferred Equity” and given the ticker APE. (There is a minor simplification here: preference shares have a par of a dollar, and an APE is a one hundredth of a preference share.)
AMC could not issue common stock – but it could issue preferred stock in any quantity it likes (up to 5 billion shares being 50 million dollars divided into one cent shares). They then distributed those shares one-for-one to AMC common stock holders.
The AMC and APE shares are identical to each other. Actually the preference shares are very slightly better as they have a preference in bankruptcy – but they are otherwise identical in rights. They have the same vote, the same entitlement to distributions etc.
However AMC stock – which was limited in supply – traded at four times the price of less-limited supply APE stock.
The company started raising money by issuing APE stock.
However it could not do this for very long because the value of APE stock fell and fell – eventually trading below $1.
At the same time the borrow cost for the AMC stock was increasing caused by arbitrageurs who were on the seemingly obvious trade of buying APE stock and shorting AMC stock and waiting for the price difference between seemingly identical instruments to close.
This is not my business. We saw shortages of AMC borrow and rising borrow rates and perceived the risk of being squeezed as very high. We covered our entire shorts in AMC and APE in November 2022 for a substantial profit.
We do get squeezed from time to time – but we are sensitive to the risks and we cover these with a fair dose of paranoia.
The drama however continued without me or my fund.
AMC needed to have equity with an actual bid to raise capital. The bid in APE stock was nearly exhausted. So they issued $110 million dollars of APE to a hedge fund (Antarra Capital) at about 67c per share. The hedge fund promised to vote those shares for conversion to AMC. At the time AMC was trading about $5 per share – so this was – it seems – a very large gift to Antarra Capital.
The gift also meant that the conversion vote would likely pass – and it did pass. Antarra is by-far the biggest voting block in this company.
Now the long APE trade short AMC trade made absolute sense. There were several “free” dollars sitting on the table. All you needed to do was go long the APE stock and short a similar amount of AMC and you could pocket the difference in the spread. The net effect was that there was massive demand to short AMC stock.
The borrow cost of AMC went rapidly above 200 percent. If the conversion was rapid (say a few weeks) this looked like easy money.
Of course “free” money on Wall Street is seldom “free”. The first thing that happened was a class action lawyer sued on behalf of AMC holders arguing they were being ripped off in this trade. It is hard to see how – because APE stock is structurally superior by the one cent preference to AMC – but that was what they argued.
And in their haste to get the deal done the company agreed a settlement with the class action lawyers that made the conversion slightly more favourable to AMC holders. This deal had to be ratified by a judge.
And so there was a date – a date at which the judgement would be ratified – and which the conversion would happen – voted on by shareholders and agreed by company and the class action lawyers. And so – because the “free” money was now “derisked” the attractiveness of the long APE short AMC trade increased even further.
The day before the judge was meant to rule the borrow cost on AMC stock rocketed up to 900 percent. Every last possible AMC share had been borrowed. The cost to get into the “free money” game was high.
And then the “free money” problem reared its ugly head. The judge did not ratify the class action settlement.
This was the set-up for a generational short squeeze. You have millions of ardent retail investor longs who want nothing more than to squeeze shorts and who coordinated via social media. You have a huge number of possibly over-levered shorts betting on the “free” money arbitrage play. And you do not have a resolution.
I genuinely expected a massive short squeeze.
Fortunately for the arbs still short this AMC’s CEO came out and repeated his statements that if the deal does not go ahead AMC will go bankrupt. I suspect he owed this to his saviours at Antarra Capital - though some AMC holders were (justifiably) angry at the AMC CEO for killing their payday.
On the day of what could have been a generational squeeze AMC stock was “only” up 35 percent on the day having traded nearly 100 percent up in the pre-market.
And now - fairly likely - the judge will approve the conversion albeit with a delay.
I am not an arbitrageur and have no expertise in Delaware Chancery Law - so I am not on the trade - but likely the free money will finally be earned.
What next?
This will anger the Apes who - in unison - swear they are never going to sell their shares. #NeverLeaving in the twitter hash-tag parlance.
But soon most the shorts will cover automatically, being long APE and short AMC and with conversion covering the short.
After that the Apes will find that management - desperate to avoid bankruptcy - will issue shares at will.
The squeeze will never happen. And the Apes will get what they deserve - a nearly worthless or worthless share which is not in short supply.
I am a shortseller - and I will not get what I want - a profit from this. I was scared off by the borrow cost. I have not gone back.
Such is life.
John
Several people have rightfully pointed out that the only about half a dozen words need to be changed in the settlement before the judge will agree. But hey it still had a 900 percent borrow - and small things can - but in this case did not - cause large squeezes.