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In the year In early 2022, I discussed the question of how much company debt is too much.
I also suggested that it would be a good learning experience for readers to observe a real situation in real time. And it is recommended to look closely at the developments in the cinema group Cineworld In 2022
The company’s stock price has fallen the way I predicted, so now seems like a good time to review how and why this happened. I’ll give you a shortcut to avoid companies with a lot of debt in the future.
Let me briefly touch on Cineworld’s position when I wrote in January. The company last reported net debt of $4.6 billion. In the year It faces a debt covenant test of net debt not exceeding five times trailing 12-month EBITDA (earnings before interest, taxes, depreciation and amortization) on June 30, 2022.
It has posted losses in four of the first five months. I said to him “Snowball’s Chance in Hell” Meeting the covenant test and that the debt level is unsustainable.
I thought debt holders could force the company into administration or, slightly better for shareholders, a financial restructuring involving a debt-for-equity swap. It’s where creditors write off a significant portion of the debt and get new shares instead.
I wrote: “At 32p a share, Cineworld’s current shareholders are valued at £440m. Based on experience, I would expect to see this fall to somewhere in the £20m-£40m (1.5p-3p per share) range in a debt-to-equity restructuring.
Let’s take a look at some of the key developments since January (I don’t have space to cover them all). Industry box office numbers in the first few months of the year indicated that Cineworld’s financial situation was deteriorating.
The company’s annual results released in March confirmed this. And the directors said that there is uncertainty about the future entry levels and the resulting film board “The Group’s concern is material instability that could create significant doubt about its ability to continue as a going concern.”
Net debt increased by a further $200m to $4.8bn in the six-month period.
Creditors reneged on Cineworld’s debt covenants twice during the pandemic. These failures were both announced a month before the start of the exam dates. A month before the 30 June 2022 exam, there is no announcement, and the exam date itself has come, gone and disappeared in the rear-view mirror, with no news lenders agreeing to any bail requests yet.
In the year On August 17, management announced that it would consider several strategic options, including financial restructuring. “It could result in a very significant addition to the equity interests in Cineworld.”
Five days later, following a report at the end of the week Wall Street Journal With Cineworld preparing to file for bankruptcy within weeks, the company issued another update. One of the options they are considering is a Chapter 11 bankruptcy filing in the U.S. and other similar markets.
After this announcement, Cineworld shares fell again to trade in the 1.5p-3p range I mentioned in January.
Did you see the end?
Predicting the failure of Cineworld required several factors. These include understanding what industry box office figures mean for a company’s financial performance. Also, knowledge of the debt structure, and the mindset and likely behavior of creditors. and experience of similar situations to appreciate what his shares might be worth.
Of course, many small private investors lack the skills and experience in such areas. However, sophisticated hedge funds do. And you can provide a useful hack to the question of whether a company has too much debt.
Hedge funds can make a profit by taking a ‘short’ position in a stock – a bet on the stock price. Anywhere 0.5% or more is required to be reported to the Financial Conduct Authority (FCA). The FCA publishes a daily spreadsheet, but the website shorttracker.co.uk provides the information in a more digestible form.
Now, not all stocks are shorted because of debt. However, if you have concerns on the debt front, checking out a short tracker is a smart move. Significant short interest in a stock is usually a good indicator that a company’s debt may be too high.
As a wise man once told me: “If you can avoid stocks with high risk exposure, your stock portfolio gains will take care of themselves.”