There are many ways to make money in the market. Some investors are short-term investors and some are long-term investors. Some use quantitative inputs, some use fundamental analysis. Regardless of the strategy, the key to making money consistently is that you have a strategy that works.
AMC Cinemas (AMC.N) is a perfect example of how different strategies can be successful by investing in time horizons and risk tolerance.
Gamma Squeeze / The Big Fool Theory
The current surge in AMC stock has nothing to do with the fundamentals of the business. It also has nothing to do with a “squeeze/squeeze”. Volatility in stocks is another classic example of a Gamma Squeeze caused by options market activity.
What is Gamma Squeeze?
A gamma squeeze occurs when the price of the underlying stock begins to rise rapidly within a short period. As stock prices rise and more options go into the money, broker-dealers must manage their exposure, so Traders must start buying stocks on the open market. At times, a gamma squeeze can also trigger a short squeeze, as we saw earlier this year with GameStop, AMC Theaters, and other Reddit stocks.
You can see the gamma squeeze happening on AMC Cinemas below, as AMC Cinemas has the most actively traded options contracts on the market.
As we’ve seen recently, speculating on a gamma squeeze can be a very profitable strategy. The only problem is that it only works if the stock price rises and incremental capital is put into the options market. In this regard, gamma squeezes, especially driven by retail hype, have more in common with Ponzi schemes than investments, because 1) the appreciation of investments is not supported by the fundamentals of the company; 2) the appreciation of Depends on increased positive capital flows; 3) Significant losses occur when capital flows stop. Of course, any short-term and highly speculative momentum trading strategy can be considered a Ponzi scheme by this standard. To avoid confusion, most industry insiders refer to it as the “big fool theory” of investing.
Investing like this requires investors to have a deep understanding of market psychology, and few market players can time it well, but if you’re one of the few, you’re more motivated.
Intrinsic value/fundamental investing
If you read this and don’t know what a gamma squeeze is, and think AMC Cinemas is a great company and go long on this stock, then you’re probably the one most likely to suffer significant losses. The following content you should pay attention to.
US-Hong Kong Telecom published an article on Monday, “Market Views: Retail Investors Rebound, Beware of AMC’s Bubble Burst”, which introduced the challenges faced by the theater industry, the poor capital structure of AMC’s theaters, and the company’s existing pre- pandemic conditions. operational challenges, and its staggeringly low free cash flow. Another touchstone for measuring value is replacement cost, especially for distressed assets. In other words, how much would I spend to rebuild AMC theaters?
The simple and rude approach is to take only the total assets of AMC theaters, about 10.5 billion US dollars, deduct intangible assets (2.65 billion US dollars), and the remaining about 8 billion US dollars are tangible operating assets. Of course, this simplistic approach doesn’t take into account the intangible brand value of AMC Cinemas, and even if it exists in the movie theater business, it doesn’t take into account accelerated depreciation, which could lead to GAAP underestimating replacement costs. Even if we add back intangible assets and use only declared assets, AMC’s $21 billion enterprise value is twice the total assets. Typically, you’ll only find such multiples in high-return, high-barrier-to-entry industries. Unfortunately for AMC Cinemas, building or leasing new theaters is not impossible. This analysis may be too simplistic.
Another strategy is to take a look at the detailed form of the cinema expansion. One franchised theater operator provides this information in their Franchise Disclosure Document (aka FDD). Here’s an estimated theater start-up cost based on the 2020 FDD for Alamo Drafthouse theaters, a theater complex of similar size to the AMC theater chain:
For AMC’s cost estimates to be fully consistent, we must deduct the franchise fee. As a result, the construction cost of a 10-screen rental cinema is estimated at $5.1-7.9 million. On a per-screen basis, this equates to a start-up investment cost of $510,000-790,000 per screen.
How does this compare to the valuation per screen of AMC Cinemas? As of 2020, the company has 10,543 screens, according to AMC Cinemas’ 10k filing. If we divide the $21 billion enterprise value by the total number of screens, we get a value of $2 million per screen. That means AMC theaters are trading at three times their replacement cost.
For investors willing to ride out the current frenzy, shorting AMC Cinemas at these levels could be very lucrative (AMC is only worth about $5.5/share at the high end of its replacement value). Be careful not to overextend your short positions, as the stock could move sharply higher before a correction. Fundamental investors often need to be patient with their thesis, so don’t panic unless the fundamentals are flawed in some way.
To answer the two points mentioned earlier in the article:
1) How do we know it’s not a short squeeze/short squeeze?
AMC Cinemas has a large short position (over 20%), but not a large amount of coverage to cause the stock to rise sharply. We know this for the following reasons:
The short position of this stock has not been significantly reduced; various brokerages still have stocks for investors to borrow securities; the number of short-covering days is too low. With the stock’s current volume, short-covering days may be less than a day.
2) How do we know that stocks are not trading based on fundamentals?
There are plenty of signs that the AMC Cinemas deal isn’t based on fundamentals.
Volume – AMC Cinemas’ stock volume in recent trading days represents more than 100% of the company’s total outstanding shares. Unlike the Reddit section, the name involves a lot of day traders/speculators.
Trading price inconsistent with news — AMC Cinemas sells shares to dilute shareholders, but shares rise. The largest shareholder of AMC Cinemas has withdrawn its capital, and the stock price is also rising. AMC Cinemas began warning investors about potential losses from “short squeeze” ” speculation, and stocks also rose. Investment firm Mudrick Capital bought AMC’s shares and sold them the same day, allegedly telling clients that AMC’s value was “significantly overvalued” and that the stock was still rising.
Whether it’s the price-to-sales ratio, discounted free cash flow, price-to-earnings ratio, or replacement cost, AMC’s share price is expensive on every metric in any period relative to peer valuation analysis. This is not trading on fundamentals.
If you’re going to invest in AMC theaters, plan well. You can make money speculating on short-term momentum, but if the stock trades back to near replacement cost, a better strategy might be to short the stock.