A sanity check on AMC Entertainment

There is no shortage of one-sided views on $AMC and yet, puzzling there is little analysis I have come across on the name. It puzzles me because objective analysis is most helpful when there is such a polarity of subjective opinions on a company. On the one hand, this is a stock that is embraced by retail investors looking to become rich ASAP; on the other, it is scoffed by professional investors and has been for a while now even before it ascended on its climb to the moon. To fix this analytical black hole, I wanted to take a crack at analyzing the absurdity of AMC (sorry, I’ll be objective now).

How does AMC make money?

AMC Entertainment was founded in 1920 and today, it operates ~600 movie theaters in the US and ~400 movie theaters in Europe. They make money from selling tickets (60% of revenues) and selling expensive food and beverages (40% of revenues). Their biggest costs are content costs (what they pay studios for exclusive access to movies during the theatre window), rent, and depreciation of theater assets. After all these expenses, they have a thin ~5% EBIT margin. But, that excludes interest on a large debt load and after including that, net income has been negative for them in three out of the past five years.

Aside from marginal economics of the business, the industry has been facing headwinds like lower foot traffic to movie theaters as younger generations prefer to watch movies on smartphones or other devices at home than go out to movie theaters, decreasing theater window of exclusivity, and higher bargaining power of movie studios which are key suppliers for movie theaters. Let’s zoom in on a couple of these headwinds.

Declining attendance

Excluding the impact of covid-19, theater admissions were declining by 1.5%/yr since peaking in 2002. The reasons for this are that unlike in previous generations wherein youngest cohorts would be the most frequent movie-goers, the experience doesn’t hold the same appeal for the youngest cohorts of current generations. Part of the problem may be due to alternatives for attention like social media, video games, and a proliferation of streaming content. And then covid-19 hit and massively accelerated conversion towards streaming services and led to a big decline in movie theater attendance as they were closed. While there is considerable excitement about re-opening of movie theaters, it is also likely that part of the behavioural shift towards watching streaming content at home versus going to crowded movie theaters and paying for overpriced food and beverages will stick.

Shrinking theater window

This is the exclusive window of time that movie theaters have had access to new films before they are released on other channels like streaming services, TV, or DVDs. Traditionally, the theater window has 90d, but even before covid-19, there was pressure from movie studios like Disney that had growing clout over time due to consolidation of the industry. Then covid-19 let to a perfect storm where new streaming services were gaining scale and it was impossible for movie studios to release content to theaters as they were closed. This led to experimentation and in hindsight, success, of directly releasing films on streaming services. The new equilibrium between movie studios and theaters is a compromise heavily favouring studios as the new window is only 17d after which studios can release the movie on their streaming platform at a premium (for eg., there is a $30 mark-up to view newly released movies on Disney plus). What’s the impact of this? Well, gross margins are down ~300bps between 2016 and 2019 and as bargaining power continues to decline, gross margins are likely to continue to decline as well.

How does AMC counteract these headwinds?

Via pricing growth of ~3%/yr since 2002 justified by improvements to the theater experience like bigger and more comfortable seats and better-quality audio and video. Movie theaters are also rolling out monthly subscriptions for unlimited movies for a fixed price and this is still early days, but this may eventually make customers stickier to the movie-going experience. Last point is that this is still a fragmented industry and it is likely to that scale players like AMC and Cinemark will continue to gain market share from smaller chains and independent theaters.

And what would you pay for AMC?

Well, a year ago, only 500m but what a difference a year makes as AMC is now trading at 29bn in market cap even though it has lost 3bn in income over the last 12mons as a result of the pandemic.

You can make a case that AMC shouldn’t be valued based on backwards numbers as those were exceptional circumstances and at least in the near-term, their future is likely even brighter than pre-pandemic due to pent-up demand for a movie theater experience.

To keep it simple (my favourite principle), AMC was being valued at 2.1x enterprise value/trailing revenue pre-pandemic and assuming they have a blockbuster year this year that is 2x revenues versus pre-pandemic levels (ie., 10.6bn in revenues), even in that optimistic scenario they are trading at 3.7x enterprise value/forward revenue. Even if the average movie-goer goes 3x as often this next year as they’ve done pre-pandemic because of a euphoric amount of pent-up demand, then AMC still trades at 2.5x enterprise value/forward revenue. While I promised to remain objective, I will subjectively add that when I ask myself if I’m going to watch 3x more movies this year, the answer as I look to my new big-screen TV is a quick no.

Clearly, valuation weighs more than just what will happen over the next year and if you think that the future for AMC will be brighter going forward then there could be a way to still justify valuation. I view the probability being higher that as demographics continue to age and alternatives like streaming become more attractive, theater traffic will continue to decline and that margins will continue to get squeezed. Yes, there are offsets like gaining market share but, in my experience, owning a larger piece of a declining pie is generally an area to avoid and certainly an area to avoid when valuation is a premium.

So, what would I pay for AMC? A reasonable value may be found by looking at AMC’s competitor, Cinemark, which is trading at 1.9x enterprise value/2019’s revenue. This valuation acknowledges a worsening of trends for movie theaters post-pandemic than pre-pandemic. This is a quarter of the valuation that AMC is trading at – 7.4x enterprise value/2019’s revenue.

Does analysis matter at this point?

Probably not. If AMC can continue to dilute shareholders without consequence, then it would have limitless zero-cost capital to deploy and even a small return on this capital would make the company wealth creating as opposed to what it has been over time, wealth destroying.