2017 was not a kind year to AMC Entertainment (NYSE:AMC) shareholders, with the stock plummeting 53.8% versus a 21.25% gain for the S&P 500.
The culprits? Fears concerning long-term declines in movie-going, combined with AMC's sky-high debt load. In 2017, AMC's debt ballooned to $4.89 billion, giving the company a debt-to-equity ratio of 2.24, which is four to five times higher than its U.S. competitors:
One would think that with investor sentiment so low, the company would address its big problem area, using all available cash flow to pay down this heavy debt load -- right?
Wrong. In fact, not only does AMC not plan to pay down its debt anytime soon, but paying off debt actually seems to be the company's lowest priority right now. Here's why.
Recline to grow
AMC plans to spend most of its cash flow (and then some) installing its trademark luxury recliner seats across more theaters. The company was the first chain to implement the recliner seating strategy, and returns have proved so successful that other cinema chains are now following suit.
To stay ahead of the pack, AMC then acquired three theater chains in late 2016/early 2017, none of which had installed recliners: Odeon and Nordic in Europe, and Carmike in the U.S. Management's strategy was not only to take on significant debt to purchase these companies, but then also invest most of its EBITDA (about $500 million out of the $822.5 million in 2017 adjusted EBITDA) in order to quickly upgrade the new chains.
CEO Adam Aron reassured investors that the returns on the first recliner seats in Europe were "through the roof," and that the company plans on renovating another 55 theaters this year (the same number as 2017): One third in Europe (which made up roughly 27% of AMC's 2017 revenue), and much of the rest across Carmike.
Given the greater than 25% returns we are achieving on the recliner renovations in the United States and recliner returns far superior to that in Europe and in the former Carmike theaters, we continue to believe that the reinvestment of free cash flow back into the business is a better deleveraging tool than paying down debt, carrying roughly 6% fixed interest rates and with stretched out maturities.
Borrowing money at 6% to create 25%-plus growth seems like a no-brainer to Aron and his team, even though the company's debt load is clearly weighing on investor sentiment.
Management expects this year's renovations to only cost about $450-500 million net of landlord contributions, less than last year's $500 million, due to lower costs in Europe and Carmike's presence in smaller markets. Eventually, the company will have renovated its best targets by 2020 or 2021, after which it will harvest more cash flow, and then pay down debt... or will it?
Dividends, repurchases, and... VR?
You might think after recliner investments, the company would next turn to paying down debt. You would be wrong. In fact, the company spent its remaining cash on three other priorities in 2017, despite a challenging summer box office.
First, management has maintained its $0.20 quarterly dividend, which amounts to roughly $100 million annually. Investors shouldn't expect this to change, as management has repeatedly stressed the importance of maintaining this payout.
Next, the company spent even more cash on its new share repurchase program, approved back in August. In light of the stock's precipitous decline during last summer, the board approved a $100 million repurchase program, and through the fourth quarter the company bought 3.2 million shares for $47.5 million at an average price of $14.86.
But wait, there's more! AMC also invested $10 million virtual reality start-up Dreamscape and Central Services Studios, Inc. in 2017, following that up with yet another $10 million investment in January.
Dancing with debt
AMC made roughly $822.5 million in adjusted EBITDA in 2017 and ended the year with net debt of $4.58 billion, for a net debt-to-EBITDA ratio (a common measure of company leverage) of 5.56, which is quite high. Clearly, the company believes the theater business will improve in 2018, and that it will be less levered in the future thanks to growing profits rather than decreasing debt.
That's all to say that if 2018 winds up being a lackluster year for the theater industry or if management's plans don't pan out, AMC will be stretched very thin.
The company does have a fallback option, though, having previously mentioned a potential IPO of its European theaters. European theater chains currently garner higher valuations than those in the U.S., and if the company can raise enough cash at good valuations, it could pay off some (though not even close to all) of its debt. Of course, selling the assets would also mean foregoing the attractive returns the European theaters are apparently generating.
So far, the 2018 box office has been strong, exceeding even last year's record first quarter by 11.9% on the back of breakout hit Black Panther. With the aggressive reinvestment plan AMC is undertaking, the company had better hope things stay that way.