Retail investors are pouring into AMC Entertainment Holdings (NYSE:AMC) as part of a marketwide attempt to trigger short squeezes -- which is what happens when a chain reaction of short-covering actions causes an equity price to skyrocket. The rally has sent AMC stock up 525% year to date. 

But those who currently own shares in this movie theater operator should consider jumping ship. AMC faces massive losses and a potentially broken business model. The stock price bubble could pop at any moment. Here are three reasons why.

Closeup of money burning

Image source: Getty Images.

1. AMC looks stunningly overvalued 

According to The Wall Street Journal, retail investors are coordinating on social media to drive up the price of heavily shorted stocks. The trend started with GameStop and spread to other easy targets like AMC, which had a short interest of 24% as of Jan. 27. The company now boasts a valuation that is wildly out of line with its fundamentals. 

With a closing price of $13.23 a share on Jan. 29, AMC's market cap is $4.5 billion. And with revenue of $2.26 billion over the trailing 12 months (as of the third-quarter report), the stock has a price-to-sales (P/S) ratio of roughly two. That multiple is not bad compared to the S&P 500's average of 2.72. But AMC's P/S ratio only tells half of the story without factoring in profit margins and top-line growth -- both of which the company lacks. 

Third-quarter revenue plummeted 91% to $120 million because of a collapse in movie ticket sales amid the coronavirus pandemic. The company has lost roughly $3.6 billion so far this year. And management expressed significant doubt about AMC's ability to continue as a going concern because of its cash-burning operations. 

2. Management seems too optimistic 

But despite the grim wording in AMC's third-quarter SEC filing, CEO Adam Aron sounds more optimistic in more recent public statements. He is confident that AMC can keep its doors open in 2021 because it has raised $917 million in new equity and debt capital since December. The surge in AMC stock may have bought the company even more time. 

In January, Silver Lake Group (a major AMC investor) converted $600 million of its convertible notes to stock at $13.51 per share. This move could dilute investors, but it will ease AMC's debt burden, which stands at $5.8 billion as of the third quarter. The company also faces operating lease liabilities (deferred rent for its locations) totaling $4.9 billion. 

Right now, AMC wants to chug along until enough of the general public gets vaccinated to end the coronavirus pandemic. So far, 22 million Americans have received at least one shot, and National Institute of Allergy and Infectious Diseases Director Dr. Anthony Fauci believes things could return to normal by the end of 2021. But herd immunity might not be the panacea for AMC's problems.  

3. Studios are moving to on-demand streaming 

Even if AMC outlives the pandemic, its stock isn't necessarily a good investment for equity holders, who will face substantial dilution and a high debt load. These factors will be a long-term drag on earnings per share (EPS) and cash flow because of a higher number of shares outstanding, interest expense, and debt amortization. 

More importantly, the movie theater business may never return to its former glory. The industry was already in decline, with box office sales falling at a compound annual growth rate (CAGR) of negative 1.4% from 2002 to 2019. And the coronavirus pandemic may have accelerated this trend by encouraging studios to build up their streaming platforms. 

In October, Walt Disney announced plans to reorganize its media division around streaming instead of theatrical releases. Universal Studios pushed the envelope in July by signing a deal with AMC allowing it to release movies on demand within just three weeks of their theatrical debut (down from the previous 75–90 days). 

The AMC bubble could pop

It's tempting to hop on a bandwagon in the hope of life-changing returns in the stock market, but if it looks too good to be true, it probably is. In the near term, AMC Entertainment may continue rising because of speculative momentum. But the hype train may end in a crash because of the stock's overvaluation, poor business performance, and the secular decline in the movie theater industry. Don't be left holding the bag. 

 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.