If you were baffled by the rumors in recent days that Amazon (AMZN) had held talks about acquiring movie theater giant AMC Entertainment (AMC), you were not alone.
Putting the general strategic rationale for Amazon owning theaters aside, AMC is in serious financial trouble. Loaded with more than $5 billion of debt, the company’s meager free cash flow generation put it on thin ice even before the global pandemic. AMC booked $162 million of free cash flow cumulatively in the decade ended December 31, 2019. The company’s interest expense in 2019 alone was $293 million and they recently added $500 million of high cost debt (10.5% per year) just to stay solvent through the rest of the year.
The idea that Amazon would be dumb enough to make a buyout offer (which would need to top the debt load in dollar terms simply for the equity holders to get anything) during this pandemic is questionable reporting, at best. Given that movie production is shut down, there will be a big delay in new releases even after theaters reopen and consumers get comfortable visiting them. It sure seems like the pandemic is only going to accelerate AMC’s path to bankruptcy, and as a result, Amazon should just wait it out and try to buy the assets during the court proceedings.
Late Tuesday there was a spike in shares of AMC Networks (AMCX), on unconfirmed reports that the content production and distribution company was running a sale process, and that Amazon was actually kicking the tires on that company, not the similarly named theater chain. That rumor makes sense and it was actually nearly 2 years ago that I suggested the combination in an article for Seeking Alpha (Amazon.com Should Buy AMC Networks To Beef Up Content Business). Full Disclosure: I own shares of AMCX personally and for clients, and recently added to the position around $25 per share.
While publicly traded, AMC Networks is controlled by the Dolan family, who have shown a willingness to sell when it makes sense and the price is right. That latter point may be a tricky issue. AMCX brought in free cash flow of $6.60 per share in 2019 but the shares trade in the 20’s, which highlights the reason going private or selling the business makes sense.
As long as AMCX gets a lot of revenue from cable television advertising and distribution fees, Wall Street is likely to continue painting it with the “cord-cutting” brush and mark the stock at a discount to intrinsic value. That discount has only gotten deeper lately, but the Dolans are not dumb; the company bought back $86 million worth of stock during Q1 despite the pandemic and continued buying into April. There aren’t many companies executing buyback programs right now but AMCX’s financial condition is rock solid.
AMCX generates a ton of cash and despite lower ad revenue this year, projected on their Q1 call that free cash flow in 2020 is expected to be above 2019 levels of $377 million. Paused production is helping offset lost revenue and say what you will about the cable business, but per-subscriber fees keep rolling in.
Wall Street is also not paying attention to AMCX’s move into streaming, likely due to the fact that it is a drop in the bucket compared to Netflix or Disney+. Still, AMCX just pushed up the timetable for its goal of 3.5-4.0 million streaming subscribers (across multiple platforms: Acorn, Shudder, Sundance, UMC). Due mostly to the pandemic, the company expects to hit that level by year-end 2020, versus prior expectations of year-end 2022.
If we value those subs similarly to Netflix’s current valuation (AMCX will make a profit on them , whereas Netflix is still losing money), and adjust for the delta in monthly cost (AMCX’s plans run $5-$6 per month), AMCX’s streaming business alone would be worth $1.2-$2.0 billion by the end of the year. Not bad for a company with a current equity market value of $1.5 billion.
The Amazon rumor continues to make perfect strategic sense. They clearly want to beef up their Prime Video offering to compete with Netflix and Disney+ and adding shows like The Walking Dead and Better Call Saul would only help that. Toss in a few million streaming subs, whose plans are already sold on the Prime Video platform, and AMCX instantly bulks up Amazon’s content library and media executive team. Heck, having AMCX CEO Josh Sapan take over the entire Prime Video operation would be a wise move too.
All in all, I am glad there is some speculation that Amazon is kicking the tires on AMCX. I hope that it is not getting more press than it deserves simply because the AMC (no X) rumor didn’t make sense given their precarious balance sheet. If Amazon is willing to pay a fair price, I think the Dolans would sell. As a shareholder in AMCX, it is frustrating to see the public markets mark the stock at such a big discount to any reasonable estimate of intrinsic value.
So what is a reasonable price? It’s a great question, obviously. And a fascinating one given that Amazon likely doesn't want to pay a big premium, even if it is justified on paper. They played hardball negotiating with Whole Foods Market years ago.
This type of deal reminds me of Discovery’s purchase of Scripps a couple years back. Scripps was also heavy into cable, with its ownership of networks like HGTV and Food Network. Still, they were able to get their shareholders a big premium and a decent price of 12x free cash flow and 10x EV/EBITDA. Not sky high prices, but levels that shareholders could live with since the public market was not going to give it to them anymore.
I certainly think that AMCX is worth a similar price on paper, which would come out to at least $80 per share. They won’t get that. Cord cutting has gotten worse in the last 2 years, we have a pandemic right now, and digital video platforms are only getting more competitive. Still, if I were the Dolans I would probably not sell for less than 10x free cash flow or 7.5x EV/EBITDA; which equates to $60-$65 per share.
As you can see, the recent price in the 20’s is kind of silly, but investors are simply uninterested in owning this stock regardless of the profit the business churns out year after year and the streaming products they are building. Hopefully Mr. Bezos will take us out of our misery. If not, we will just wait for the cash flow to come through and fund stock buybacks at insanely cheap prices (having peaked at 74 million in 2014, the share count is now down to 54 million).