Cinema operator Cineworld (OTCPK:CNNWQ) has had a dramatic fall in the past few years but it is not over yet. While the business has the makings of a profit machine, its balance sheet is a disaster. I think there is a good chance that the shares will ultimately go to zero and rate them as a strong sell.
I have been consistently bullish about Cineworld. My last piece on the name was in July (Cineworld: Revenues Are Recovering But The Debt Weighs A Tonne) when I rated it as a strong sell.
The basic problem
Cineworld has had two problems over the past three years. The proximate one is the havoc wreaked by the pandemic and pandemic-related government restrictions on people’s ability and willingness to go to a movie theatre. The other problem, which has been exacerbated by the first, is the balance sheet. Cineworld entered the pandemic in gung ho borrowing mode, and is paying for it now.
An analysis of the company could look at the speed of recovery of customer demand and indeed I have done this in some previous analysis. But it now seems increasingly irrelevant. Even in a good year before the pandemic, in this case 2018, the company’s post tax profit was $284m. That is dwarfed by the net debt at the end of last year of $8.9bn.
The proposed solution
The company has spent the past year trying to circle the square.
In September it announced that Cineworld and certain subsidiaries had entered Chapter 11 proceedings. The company has warned shareholders on multiple occasions that its restructuring may leave nothing on the table for them. Back in September, for example (when the shares were selling for 4-5p each), it said that:
As previously announced, it is expected that any de-leveraging transaction will result in very significant dilution of existing equity interests in the Group and there is no guarantee of any recovery for holders of existing equity interests.
This week the company announced its latest plan. It has struck a deal with lenders holding and controlling approximately 83% of the Group’s term loans due 2025 and 2026 and revolving credit facility due 2023.
That will reduce the “Chapter 11 companies’ funded indebtedness by approximately $4.53 billion”, raise $800 million in aggregate gross proceeds through several equity offerings to lenders and provide $1.46bn in new debt financing to the entities once they emerge from Chapter 11.
Cineworld lives to fight another day. What does the proposed deal mean for the shareholders? In the words of the announcement:
Consistent with the Company’s announcement on 24 February 2023, in light of the level of existing debt that is expected to be released under the Plan, the Proposed Restructuring does not provide for any recovery for holders of Cineworld’s existing equity interests.
In other words, if the deal goes through, the shares are likely going to be wiped out. Despite that, the shares have not yet gone to zero but are hovering between 1p and 2p, giving the company a market capitalisation of £25m. That is miniscule given the size of the company’s operations and its debt, but it is not nothing. That £25m looks set to get wiped out yet the share price does not yet fully reflect that.
Massive risk
That presumably reflects optimism among some shareholders at least that the deal may fall through or be in some way amended, and they may be thrown a bone.
That does not match Cineworld’s consistently hard-nosed modus operandi, in my view. The company has been loud and clear about the risks for equity holders. The latest announcement spells out that if the deal goes through (which seems likely, as it has been hammered out with a lot of creditors), equity interests will be wiped out.
Even if the deal does not proceed as planned for some reason, for the shares to have any value at all, Cineworld would somehow need to resolve its debt problem in another way. It has been trying to do that for several years and meanwhile, the challenge only gets greater as interest mounts and business levels remain well below pre-pandemic levels. So I see no prospect of Cineworld landing an alternative deal down the line which allows for shareholder recovery. I expect the shares to end up at zero and the only real question is when. Accordingly I see them as a strong sell.
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