When AMC Entertainment (AMC:NYSE) reported second quarter earnings a few weeks back (4 August) it’s better-than-expected revenues and lower losses were not the only surprise for investors. Chief executive Adam Aron also unveiled plans to issue new preferred stock. This may have left many ordinary shareholders baffled.

What is preferred stock, who gets them, and what the wider implications for the AMC and its share price? Let’s try to explain.

WHAT IS PREFERRED STOCK, AND WHO GETS THEM?

To answer the second part first; all shareholders. Cinemas operator AMC has issued the preferred stock on a one-for-one basis with matching voting rights to all holders of its 516.8 million common stock, including to UK shareholders. This means that for each common stock owned, you’ll now own one common share, one preferred share.

Most preferred stock, or preference shares as they are usually called in the UK, are a sort of equity/bond hybrid. Like an ordinary share (common stock in the US), they trade on the open market and can be bought and sold just like ordinary shares.

They are also like a bond in that they give owners first dibs on dividends, which tend to be fixed, rather than declared alongside results at a level that the board thinks reflects the company’s financial health, as is the case with ordinary share dividends.

Preferred stock also gives holders priority over the company’s assets. This means that if disaster strikes, preferred stock owners sit ahead of ordinary shareholders when it comes to getting your investment back, in part or in full (although behind bond holders in the queue).

Importantly, though, most preference shares don’t carry voting rights, and AMC’s do. So when AMC’s preferred stock began trading on 22 August under the US ticker APE, it had the same effect of a two-for-one share split, hence the sharp fall in the AMC ordinary share price on 22 Aug, from $18.02 to $10.42 at the close (AMC has since fallen to $8.64).

FUNDING CHICANERY

That’s the mechanics. What is more complex, and controversial, is why AMC has chosen to issue preferred stock in the first place.

AMC said wants to use the stock as ‘currency’ that will allow it to raise money to pay down debt and carry out acquisitions and investments. While it didn’t raise any new money with the initial 516.8 million APE stock listed, it has board approval to issue up to one billion APE shares. If the 483.2 million balance were issued at the current $5.11 price, AMC would raise $2.64 billion but dilute existing AMC shareholders by nearly 47%, depending on the issue price.

This can be done without any shareholder approval, and that’s the contentious bit. This is because it was able to rely on authorisation granted to its board by its former owner, China’s Dalian Wanda Group when it listed in 2013. Wanda is no longer an AMC shareholder.

An extra 483.2 million preferred stock being issued without shareholder permission isn’t the worst of it. AMC’s board has the right to issue up to five billion preferred shares, all with voting rights and without any say so from existing shareholders.

AMC has given no indication of when it might issue the balance of the one billion preferred stock already authorised, and it said it has no plans to authorise the other four billion as it stands, but the dilutive threat will lurk in the background.

SHORT-TERM TRADING

On the basis that most AMC (and now APE) shareholders were probably lured in as part of the ‘meme’ stock craze that thrust it, GameStop (GME:NYSE), Bed Bath & Beyond (BBBY:NASDAQ) and other previously little-known US stocks into the limelight might imply many AMC shareholders are relatively short-termist. They may be looking to trade their AMC stock over the coming weeks and months – they simply now have two assets to trade for every one previously.

But as Cineworld’s (CINE) financial collapse shows, running cinemas is a treacherous business in a post-pandemic world. Marketscreener data estimates that AMC will have around $4.6 billion of net debt at the end of 2022, so don’t be shocked if more preferred stock is issued sooner rather than later.

Disclaimer: Financial services company AJ Bell referenced in this article owns Shares magazine. The author of this article (Steven Frazer) and the editor (Tom Sieber) own shares in AJ Bell.

Note to AJ Bell users

AMC’s preferred stock (APE) doesn’t show when you search for them on AJ Bell’s platform, but don’t worry, they should still be in your account ready to trade if you wish. This is due to a technical issue with its data provider Morningstar, which doesn’t provide preference stock information.

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