AMC must ‘dramatically’ change for it to stay in business: asset manager

Changebridge Capital runs two active ESG ETFs and is shorting AMC and Gamestop in its Long / Short ETF. Ross Klein, Founder and CIO Changebridge Capital, joins Yahoo Finance's Brian Sozzi and Julie Hyman discuss the market action and outlook for the companies.

Video Transcript

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BRIAN SOZZI: The meme stock faithful, may have something to say about our next guest calls on-- over on Twitter here. Ross Klein, is the founder and CIO at Changebridge Capital, and joins us now. So Ross, you are-- you have active shorts on AMC and GameStop. Let's start with AMC. What's your fair value estimate on AMC, and why are you shorting it?

ROSS KLEIN: Oh, sure, Well, by means of a quick background, CBLS, our active ETF is currently short GameStop and AMC. AMC has been a roller coaster for the last year and a half. From the verge of bankruptcy in December, to a $45 billion enterprise value in June, investors would be hard-pressed to find a faster and more extreme reversal of paper fortunes.

So despite becoming a retail darling, wisely raising capital at opportune times to keep the business afloat, AMC still remains a theater chain in a world that is quickly moving towards digital movie releases, tighter theatrical windows, and higher quality TV and internet video content.

You had asked us about a target price or a valuation. If we consider where AMC was prior to COVID 19, they entered 2020 with $235 million in operating income, and $340 million in interest expense. It's not a recipe for solvency. All of this is before a global pandemic hits, that not only strengthens the theater chain streaming competition, but also reduces the likelihood that folks return to a crowded indoor space.

Fast forward to today, the situation has likely worsened. Disney is a leading film studio that has begun to offer movies direct to consumers, on its Disney Plus platform. Warner Brothers has followed suit, and a number of other theatrical windows are starting to do the same. Disney recently did say, that they would--

BRIAN SOZZI: Ross, let me-- let me-- Ross, let me hop in there real quick. Let me go back to what you said on solvency. So is your main-- one of your key points on your thesis, is that AMC may no longer be in business on the other side of the pandemic?

ROSS KLEIN: It's hard to see a situation where the environment has improved for them, and they were insolvent prior to COVID 19. So if we were to assume that AMC can get back to their 2018 EBITDA which would be optimistic, and gave them a 10 times multiple for business that likely isn't growing, again, generous, that would be a $9 billion enterprise value.

That doesn't even surpass the levels of current debt and operating leases on the balance sheet today. Something dramatically has to change, for this to be a business that has equity value remaining, after their leases and debt are considered.

JULIE HYMAN: Hey Ross, it's Julie here. I can't imagine the amount of hate mail you must get on Twitter from the so-called apes from AMC, but you know, something that we have talked a lot about on the show, and I think Brian Sozzi has sort of fulfilled the fundamental argument role here, is it, it doesn't really matter to a certain degree right?

It hasn't mattered up until now. Even if what you say is true, if people keep buying the stock, it doesn't matter. And that this has given the company a lifeline to continue, to try to find new and creative ways to continue to exist. So how do you sort of factor that into a model or an equation, when it doesn't necessarily have to do with rational argument?

ROSS KLEIN: It's a great question, and one that's at the top of most investors' minds today. We maintain in our CBLS long/short equity ETF position sizing disciplines. The position sizing for AMC and GameStop are both at levels where we are comfortable with the underlying risks.

For instance, we were short GameStop, shortly after the initial short squeeze in the beginning of the year. We gradually added to the position as the stock declined in value, eventually covering it all together, returning to it more recently. These are positions that we know well. We watch them every single day. We trade to maintain risk tolerances in our portfolios.

But to your question about valuation, every time that AMC goes out and raises stock, we have to up our internal valuation metrics, because they're raising equity-- they're raising cash, using equity that we believe to be inflated. And so that is a rational decision for them, and one that we frankly applaud the CEO for doing. We think that it's the right thing for him to do for his business.

BRIAN SOZZI: And Ross, you're also, I believe short GameStop. Is part of the call there as well, that new management really doesn't have any plan to save the retailer?

ROSS KLEIN: I will certainly not say that they have no plan. I'm sure they have a plan, and I'm sure they're excited about it, And they've put together a team of people who are potentially quite capable of executing it. Where we struggle is, the world of-- of gaming has evolved from physical distribution to digital.

And that transition is well underway. GameStop's reason for existence thus far, has been because certain consumers still want physical games. If GameStop's plan is to transition from physical to digital, their reason for existence becomes obsolete.

And so if you're a software provider or gaming provider, and you have an option to distribute direct to your consumer at a higher margin or through a middleman, what are you going to do? I think you're going direct to consumer. And so it remains to be seen what GameStop's actual plan is.

But I will say, if the plan is to be a digital first distributor of games and console, and we look out to the-- to the competitive landscape of other stocks that are out there. Wayfair for instance, a digital first retailer of home goods. Trades at 1.8 times next year's EV to revenue.

GameStop's already over 2 times next year's EV to revenue. And so it's trading as if it's already going to have a very successful transition, which is something that we just find to be incredibly difficult.

JULIE HYMAN: Hey, Ross I want to take a little bit of a left turn. Since you run a long/short ETF overall, you know, we talk about AMC and GameStop so much, I think that the arguments are pretty well known and well understood on both of those. What do you think is the-- the most underappreciated short perhaps in the market then? What's the-- what's the one that people are not talking about?

ROSS KLEIN: Well, we-- we run a portfolio that is very, very high active share. We don't overlap with the S&P very much. In both our long only CBSE, and our long short CBLS. But one short that I think in particular is worth talking a little bit about, is Dave and Buster's play-- PLAY. They reported earnings fairly recently. It was actually a solid quarter.

The issues that we have here, though, are this is a business that was actually in secular decline prior to COVID-19. Same store sales had declined for three straight years in advance of COVID. EBIT had declined for three straight years in advance of COVID.

That is not a recipe for success, when you enter into a world where folks are less inclined to go in to a high venue location, than they were prior to the onset of this pandemic. Secondarily, 2/3 of their-- of their gross profit comes from entertainment.

That is not something that you can deliver through Grubhub or DoorDash. And so they're in a really difficult spot, and the expectations into the next few years from the sell side, are that they will get back to and exceed prior levels of revenue and operating margins. Not to mention, nearly a quarter of their revenue is expensed in employees.

Wages are going up around the country. Especially as we approach the minimum wage levels, which is largely where Dave and Buster's employee base lies. And so we think that there are a lot of different reasons for investors to be cautious around the security. It's one of our largest shorts currently.

BRIAN SOZZI: Ross, but they're out there touting a new menu and new games. That could be pretty big in terms of their earnings, no?

[LAUGHS]

ROSS KLEIN: Look I'm-- I'm-- I'm a fan of people being able to get back to their lives. I'm rooting for that sincerely. But we do have a hard time at Changebridge believing that a new menu and new games, are going to weigh more heavily in people's minds than the potential risks that are involved in going to a location that is high volume, and has a lot of different folks running through it.

We're still optimistic for reopening. We have securities alongside of our portfolio, Expedia being one that would benefit from a reopening. But this is a business that was declining prior to COVID-19.

BRIAN SOZZI: Point well taken. We'll leave it there. Ross Klein, the CIO and founder of Changebridge Capital. Good to see you. Have a great rest of the week.