Why the collapse of Cineworld shares was predictable

How Cineworld became a horror movie for shareholders.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Risk reward ratio / risk management concept

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Back at the start of 2022, I discussed the question of how much company debt is too much.
I also suggested it would be a good learning experience for readers to follow an unfolding situation in real time. And recommended closely watching developments at cinemas group Cineworld in 2022.
The company’s share price has collapsed in the way I predicted, so now seems a good time to review how and why this happened. I’ll also give you a shortcut for avoiding companies with too much debt in future.


Let me briefly recap Cineworld’s position when I was writing in January. The company had last reported net debt of $4.6bn. It was facing a debt covenant test at 30 June 2022, requiring net debt to be no more than five times trailing 12-month EBITDA (earnings before interest, tax, depreciation and amortisation).
It had made a loss in four out of the first five of those months. I said it had “a snowball’s chance in hell” of meeting the covenant test and that its level of debt was unsustainable.
I thought it possible that debt holders could push the company into administration or, only slightly better for shareholders, force it into a financial restructuring involving a debt-for-equity swap. This is where lenders write off a significant portion of debt and are issued with new shares instead.
I wrote: “At 32p a share, Cineworld’s current shareholders are collectively sitting on value of £440m. Based on experience, I’d expect to see this drop to somewhere in the region of £20m-£40m (1.5p-3p per share) in a debt-for-equity restructuring.”

Plot development

Let’s look at some of the key developments since January (I haven’t got space to cover them all). Industry box office numbers through the first months of the year suggested Cineworld’s financial position was only getting worse.

The company’s annual results, issued in March, confirmed this. And the directors said uncertainties around future admission levels and the film slate created “a material uncertainty that may cast significant doubt upon the group’s ability to continue to operate as a going concern.”

Net debt had increased a further $200m in the space of six months to $4.8bn.

Horror movie

Lenders had twice waived Cineworld’s debt covenants during the pandemic. These waivers were both announced a month before the test dates. There was no announcement a month ahead of the 30 June 2022 test, and the test date itself came, went and disappeared in the rear-view mirror with still no news lenders had agreed a waiver.
On 17 August, management announced it was considering a number of strategic options, including a financial restructuring that would “likely result in very significant dilution of existing equity interests in Cineworld.”
Five days later, following a weekend report in the Wall Street Journal that Cineworld was preparing to file for bankruptcy within weeks, the company issued another update. It confirmed that one of the options it was considering was a Chapter 11 bankruptcy filing in the US and similar proceedings in its other markets.
In the wake of this announcement, Cineworld’s shares slumped again to trade in that 1.5p-3p area I referred to in January.

Did you see the ending coming?

Predicting the collapse of Cineworld required a number of things. These included an understanding of what industry box office figures meant for the company’s financial performance. Also, knowledge of its debt structure, and the mindset and likely behaviour of lenders. And experience of comparable situations to appreciate what its shares might be worth.
Of course, many small private investors don’t have competencies and experience in such areas. However, sophisticated hedge funds do. And they 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 share price falling. They’re required to disclose a position of 0.5% or more to the Financial Conduct Authority (FCA). The FCA publishes a daily spreadsheet, but the website shorttracker.co.uk presents the information in a far more digestible way.
Now, not all stocks are shorted because of debt. However, if you have any concerns on the debt front, checking shorttracker is a smart move. Significant short interest in a stock is often a good indicator that the company’s debt may be too high.

Closing credit

As a wise man once told me: “If you can avoid stocks with extreme downside risk, the upside for your shares portfolio will take care of itself.”

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

2 overlooked cheap shares I’m tipping to eventually soar

These two cheap shares may not be obvious bargains, but our writer explains the investment case behind buying them for…

Read more »

Investing Articles

1 no-brainer pick I’d love to buy for my Stocks & Shares ISA!

A Stocks & Shares ISA is a great investment vehicle for our writer. Here she explains why, and one stock…

Read more »

Shot of a senior man drinking coffee and looking thoughtfully out of a window
Investing Articles

Just released: our 3 best dividend-focused stocks to buy before May [PREMIUM PICKS]

Our goal here is to highlight some of our past recommendations that we think are of particular interest today, due…

Read more »

Investing Articles

Will the Rolls-Royce share price keep rising in 2024?

With the Rolls-Royce share price going on a surge, this Fool wants to look forward to where it could potentially…

Read more »

Investing Articles

£10k in an ISA? Here’s how I’d target a regular £30k+ second income stream

Reliable dividends can help provide a lot more financial freedom. Here's how I'd aim for a substantial second income inside…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

Lloyds share price hanging on to 50p ahead of Wednesday’s Q1 earnings report. Where to now?

Down in April and with low earnings expected this week, Mark David Hartley investigates where the Lloyds share price might…

Read more »

artificial intelligence investing algorithms
Investing Articles

Everyone’s talking about AI! Here’s 1 FTSE stock to consider buying for exposure

A hot topic right now is artificial intelligence (AI). This Fool explains how this FTSE stock could offer investors an…

Read more »

British Pennies on a Pound Note
Investing Articles

1 penny stock I’d buy today while it is 99p

Ben McPoland highlights Windward (AIM:WNWD), a fast-growing penny stock that could benefit from the artificial intelligence revolution.

Read more »