Gong Show
“The secret to film is that it’s an illusion.” – George Lucas
As crazy as this might sound, it used to be that stocks traded based on the quantity and quality of the underlying company’s earnings. While stock prices were generally forward-looking, it was understood that how a company had done in its recent past was instructive, both as to its prospects and to the quality of its management. Investors would analyze companies for their future profit potential, compare their assessment with that of the market using simple tools like price-to-earnings multiples, and make buy or sell decisions accordingly. Broadly speaking, well-run companies with attractive outlooks traded for higher multiples than their less accomplished peers.
Management teams understood that their behavior was an important input into how their company would be perceived by the investment community. They mostly acted accordingly. As shepherds of shareholder capital, company leaders usually took care to act with prudence and integrity, aware that failing to do so would be punished by the markets. While management certainly did better financially than front-line workers, they tended to only do obscenely well if they succeeded in creating disproportionate value for their investors. They also paid close attention to shareholder dilution, operating within the rubric that earnings per share were important to the price per share assigned by the market.
A natural policing mechanism of markets kicked in when companies needed to raise fresh capital – either to fund growth or to respond to unexpected market developments. Blue chip investment banks competed to help the best companies raise money and worked to place shares in the hands of long-term holders, recognizing that the quality of the investors on the capital table was a parameter worth optimizing. Concurrently, management strove to be represented by high-quality banks, understanding the positive signaling power such an engagement would represent. The joint objective was to raise the required amount of money at the highest stock price possible, thereby limiting shareholder dilution. Companies that were shunned by the big banks might be reduced to executing so-called “at-the-market” offerings with the help of second-tier banks – hardly a sign of strength – or denied access to the capital markets altogether.
While our retelling of how things used to be is undoubtedly a tad idealized, to the extent that capital markets approached that ideal, they were better able to execute their primary mission of directing capital to businesses that deserved it and away from businesses that didn’t. This extremely important activity is core to the proper functioning of a capitalist economy, and its relative absence from today’s environment has led to a proliferation of zombie companies that should have exited stage left long ago. Wall Street has dissolved into a chaotic get-yours-while-the-getting-is-good casino, where traditionally valued standards are tossed aside, executive management gorges at the buffet of stock-based compensation, and underlying companies are mere afterthoughts in the Great Financialization of Everything™ game. Use whatever word you would like to describe the current US economy – just don’t call it capitalism.
While examples of the debasement of our capital markets abound, we can think of none better than the crazy shenanigans occurring at AMC Entertainment Holdings (AMC), a company we have written about on several occasions. Our fascination with AMC and its grandiloquent CEO, Adam Aron, stem not from any financial interest – no member of the Doomberg team holds any position in the company – but instead from what the perpetuation of this financial freakshow means for the broader markets. In a piece we wrote last August called “A Very Special Dividend,” we made the case that Aron was scheming to dilute existing common shareholders into oblivion, despite their specific disapproval of his desire to do so. We further predicted that he would get away with the gambit, enriching himself and his well-heeled debt investors along the way. We closed the piece as follows: “As long as there is fresh money to be heaved into this zombie company’s furnace, we can’t be anywhere near a market bottom.”
Recent developments in the AMC saga have shown that piece to be prescient, but like any hyperinflating currency, Aron is quickly experiencing diminished returns on printing. The dilution so far has been staggering, but it is far from over. Just how much more (ultimately worthless) paper does Aron intend to fling onto the market, and what does the future hold for AMC’s luckless retail shareholder base? Let’s dig in.