AMC Foolishness has an estimated cost
“On the one hand, in a world of free money, there is almost no pain in being insensitive. And no reward for prudence. Do you run your business at a loss? No problem. Just borrow everything you need. “Bill Bonner
In Undermining Capitalism with Unrealistic Values and Gross Distortion we talk about how the measure of recent extreme monetary policy undermines capitalism. The article highlights how yield-hungry speculators are accumulating in debt classified as rubbish, even though they all warrant a loss of purchasing power.
Our complaint goes far beyond the bad price of the financial markets. It is more insidious. Deformed market values reduce the productive output of the economy and therefore harm equal wealth and income. Badly allocated capital is inflating the value of meme stocks, such as the nearly bankrupt AMC film chain, and extracting resources from the productive sectors of the economy.
The bad news is not good news
The Wall Street Journal recently published, “Bad news for the economy is good news for the stock market.”
We can summarize it in one sentence: bad economic news is good news for stock prices as they guarantee the Fed will provide incentives for longer.
In a robust economy, with the promotion of productivity as the central axis, investors should greatly favor the good economic news. Conversely, in a market fueled by excessive speculation, the bad news and liquidity that accompanies it comes from economic reality.
The juxtaposition of their preferences defines the type of market the Fed encourages.
March of the zombies
In properly functioning markets, investors aim to buy assets with promising growth potential. In addition, they should generally shy away from investments with limited or no growth potential. Such a capitalist process allows new companies with productive ideas to raise capital. At the same time, it limits capital flows to firms with unproductive assets and little potential.
This dynamic guarantees a growth of productivity. We can think of the process of self-service as capitalist Darwinism, or call it the virtuous cycle..
When a central bank recklessly manipulates interest rates, the process fails. Under these circumstances, capital tends to gravitate towards speculative investments. The most able, or those who offer the economy the most productive benefits, do not receive the share of the lions’ capital. Very often, companies called zombies take their capital.
Zombies are companies that are rescued and / or unable to meet their debt payments without issuing more debt. These companies not only stay alive, but often thrive when rates are too low and speculation spreads.
Most zombie companies do not offer promising growth or innovation. Instead, they take advantage of investors with the attractiveness of higher stock prices.
The following graph shows the strong correlation between the number of zombie companies and the level of actual returns.
The following chart shows that the shares of zombie companies have returned nearly three times the S&P 500 since January 2020. Not bad, as the severe recession has severely hampered many of their gains.
In the same vein, Goldman Sachs ’unprofitable technology index, which is not 100% zombie companies, but includes many, has killed it for lack of a better word.
AMC- The Walking Dead
To better understand zombie companies, let’s dissect a living, thriving zombie.
AMC Entertainment Holdings, AMC, is the largest film chain in America. They have been around for 101 years.
We compare the quantitative definition of a zombie and see how AMC hides.
- Income is not enough to meet debt payments. As shown below, AMC’s revenue only exceeded interest expense once in the last ten years.
- An Altman score below 1.8 suggests that a company could go bankrupt. This score uses five common trading ratios to help predict bankruptcy probabilities. As shown, AMC’s Altman Z score has not been close to 1.8 in the last five years.
AMC easily qualifies as a zombie.
As shown above, AMC was a walking zombie before the pandemic. Not in vain, AMC fought the pandemic. Its revenues have fallen to less than 10% of its pre-pandemic levels.
More worryingly, despite the vaccines, moviegoers are not returning to cinema as they were. While there is still apprehension to go to the movies, AMC is also a victim of streaming. During the pandemic, services like Netflix, HBO, Hulu and others became a more viable option for watching movies. To add insult to injury, most films are introduced simultaneously into the theater and through home broadcast services.
According to The Numbers, the situation is serious for cinemas. For example, the current success of Black Widow has brought in revenue of about $ 167 million. In 2019, by comparison, Avengers: Endgame grossed $ 357 million at its best weekend.
The chart below shows how movie ticket sales just bounce back slowly.
AMC is not dead
Even though we paint a gloomy picture of AMC, it’s not dead. Filmmakers need cinemas and will keep them alive. This is evident in their support for AMC and other theaters. For example, AMC now receives some of the profits from streaming movie studios.
For CNBC- “What we learned during the pandemic is that it is not easy to replace all those who lost income from the theater window.“Said Eric Handler, media and entertainment analyst at MKM Partners.”This fuels many declining income opportunities. There will be changes to the model, but I still think the theatrical will stay“.
From a macroeconomic perspective, we are irrelevant whether AMC survives or goes bankrupt. What worries us is the amount of capital that is being misallocated to AMC.
The chart below shows that AMC’s market capitalization or valuation has recently fallen from $ 25 billion to $ 18 billion. Currently, at $ 18 billion, its market capitalization is approximately six times its pre-pandemic level.
Given the pandemic-related losses and new habits of moviegoers, should the market cap be higher than in previous years? NO! It doesn’t matter what we think. AMC has become a popular meme stock and investors seem willing to use its prized capital to chase it far above previous valuations.
Speculators do not take into account AMC’s balance sheet, profit and loss account or prospects. Instead, focus solely on whether or not it will increase.
What if the $ 18 billion in capital went to something productive? Imagine if AMC investors focused on cancer research, space exploration, nanotechnologies, or other productive initiatives. We now consider that it is not just AMC. Zombies are everywhere and get capital that could be used with more productive means.
China gets the joke
Rampant speculation has negative economic and sociological impacts. Perhaps of equal importance, it seems that our main economic antagonist takes a different stance by encouraging productive investment at the expense of non-productive firms.
Noah Smith, a Bloomberg blogger and opinion writer, wrote recently Why is China destroying its technical industry?. He believes the recent punishment of “tech” companies like Alibaba, Ant Financial, Tencent and Didi is not based on the same monopolistic concerns that occur in the United States. Noah believes there is so much more to the story.
According to his article:So when Chinese leaders analyze what kind of technologies they want the country’s engineers and entrepreneurs to spend their effort on, they probably don’t want them to spend that effort on things that are just for fun and convenience. They probably took a look at their internet sector for consumers and decided that the link between that sector and geopolitical power had become simply too tenuous to continue throwing in capital and highly skilled labor. And, therefore, in the classic fashion of the PCC, it was time to crush ”.
Noah argues that China promotes productivity growth rather than profit. If true, China is playing the long game that will benefit its nation. While here it is much less likely to be banned or even punished in internet businesses, we should notice.
The Fed does not directly promote AMC, although its shares create an environment that allows AMC shares to increase its precious capital despite unconvincing valuations. Therefore, this capital is not available for more productive investments.
It can be fun to watch and / or trade zombie companies, but the cost of this entertainment is more expensive than most people realize.
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