If you bought $1,000 worth of AMC Entertainment Holdings (AMC 0.45%) stock at its all-time high of $62 in June 2021, you would have roughly $100 today -- a decline of 90%. While the movie theater operator seems to be recovering nicely from the COVID-19 pandemic in 2020 and 2021, massive levels of equity dilution could leave investors holding the bag. 

A difficult past could become a diluted future. 

Few industries were harder hit by the COVID-19 pandemic than the cinema industry. Not only did consumers avoid the tight spaces and poor ventilation of crowded theaters -- major studios like Walt Disney postponed major films or moved them to their streaming platforms. At the height of the crisis in 2020, AMC's revenue collapsed by 77% to $1.24 billion against the prior year, and it lost $4.59 billion. 

AMC's stock was later caught up in the meme stock movement, which involved retail investors buying up heavily shorted companies to try to trigger short squeezes. The company skillfully took advantage of this situation. Instead of over-relying on debt to raise capital during the crisis, it issued new shares at their inflated valuation. As of the second quarter of 2022, AMC has 517 million shares outstanding compared to just 52 million this time in 2019 -- an almost tenfold increase in just three years. 

On the surface, equity dilution can look like a great way out of a bind. And in AMC's case, management may have made the correct decision to sell more shares instead of only relying on debt that could have posed a bankruptcy risk.

That said, there is no free lunch. And AMC's shareholders may end up paying the tab. The more stock a company issues, the less each is worth relative to future earnings. Each share of AMC only represents one-tenth of its prior value, dramatically limiting the stock's potential upside for investors. 

What's next for AMC?

AMC's second-quarter results highlight its rapid recovery from the COVID-19 pandemic. Revenue jumped 162% year over year to $1.17 billion, while net losses narrowed from $344 million to $121.6 million. And although the company hasn't provided firm guidance, management is optimistic about the rest of the year as blockbuster sequels to Black Panther and Avatar hit the box office in the fourth quarter. 

Stock chart flashing the word sell in red.

Image source: Getty Images.

But despite the positive momentum, AMC investors still face significant challenges. On Aug. 4, the company announced a special dividend of one publicly traded AMC Preferred Equity (APE) unit per share of AMC common stock (roughly 517 million units). In September, management inked an agreement to sell an additional 425 million of these new shares. 

These new APE shares look like a sneaky way to dilute equity without touching AMC's already massively diluted common stock. Investors should see this as a red flag because APE shares have equal voting rights as common stock and will become convertible to common stock in the future if equity investors (including APE holders) approve. 

Selling AMC is the right move 

AMC Entertainment's movie theater business is enjoying a massive rebound after the initial COVID-19 pandemic. But investors could still be left holding the short end of the stick. Shares outstanding have increased almost tenfold in the previous three years, and the issuance of the new APE preferred shares could make that dilution significantly worse over the long term. Investors should strongly consider selling this stock.