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Why AMC's Audacious Growth Strategy Makes Sense

By Timothy Green - Jun 3, 2021 at 6:30AM

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The theater chain needed a growth story, and now it has one.

Movie theater chain AMC (AMC -4.51%) was in rough shape even before the pandemic. The company was bogged down with billions of dollars in debt, partly the result of an acquisition spree that made it the largest U.S. movie theater chain. AMC acquired Carmike Cinemas, Nordic Cinema Group, and Starplex Cinemas between 2015 and 2017.

When the pandemic hit, the collapse in revenue from theater closures left the fragile company in a difficult position. AMC raised $1 billion in cash through equity and debt sales between April and November last year, and it had raised another $917 million by early January of this year. That influx of cash bought the company time, but its business was still broken.

People in a movie theater.

Image source: Getty Images.

AMC was given a gift in January as speculators drove a huge increase in the stock price. Things settled down for a while, but AMC stock is now soaring again. As of this writing, shares of AMC trade right around $40 per share, good for a market capitalization of nearly $18 billion. Even during the best of times, AMC's profits came nowhere close to justifying this kind of valuation. The company earned a net income of just $261 million in 2014, its most profitable year in recent memory.

AMC is using this opportunity to sell more shares and raise more cash. The company raised an additional $230 million by selling new shares to Mudrick Capital Management on June 1. It should be noted that Mudrick quickly sold those shares as the stock price surged.

Acquisitions are back on the table

AMC is not going to use this new cash to simply pay down its debt and try to put itself on a path to financial sustainability. "It is time for AMC to go on the offense again," said CEO Adam Aron in the press release announcing the stock sale. "With this agreement with Mudrick Capital, we have raised funds that will allow us to be aggressive in going after the most valuable theatre assets, as well as to make other strategic investments in our business and to pursue deleveraging opportunities," Aron said.

AMC is going to use its newfound ability to raise equity capital at inflated prices to grow through acquisitions, just like it did in the past. This may seem foolish, given that the alternative is reducing its debilitating interest payments by paying down debt. But it actually makes a lot of sense.

AMC will never be able to justify its current valuation by being conservative. Even if the company were able to raise enough cash to wipe out a big chunk of the debt on its balance sheet, the profit potential for AMC is limited. It's just never been a particularly profitable company, and the recovery of the movie theater industry after the pandemic is still highly uncertain.

Pursuing acquisitions with cash that can be raised thanks to exuberant shareholders gives AMC a shot at growing its way out of its debt problems. It also gives AMC a compelling story to tell its investors. AMC needs to keep its investor base excited about the company, and its stock price elevated, as long as it can. The company likely knows the party won't last forever. It needs a growth story to keep it going.

The longer AMC can keep its stock price in the stratosphere, the more cash it can raise through stock sales. The more cash it raises, the more growth it can buy through acquisitions. The more growth it acquires, the greater the odds its fundamentals will eventually be able to justify its inflated valuation.

My best guess is that AMC will turn out to be a poor investment in the long run, even if the company successfully turns itself around. AMC's growth strategy gives it a fighting chance to prove me wrong.

Timothy Green has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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