The Cineworld (LSE: CINE) share price fell by more than 25% on Wednesday morning after the FTSE 250 cinema operator said it may have to pay C$1.23 billion in legal damages. The court ruling adds to pressure on the company from the impact of Omicron restrictions.
A big setback
Today’s legal news relates to a court case brought against Cineworld by Canadian cinema group Cineplex. Cineworld agreed to pay C$2.8bn to acquire Cineplex in 2019, but abandoned the deal when the pandemic struck last year.
Cineplex is suing Cineworld for up to C$2.2bn in damages, claiming the FTSE 250 company has breached its obligations and duty of good faith. An Ontario court has found in favour of Cineplex and has dismissed Cineworld’s counter claim. The court awarded damages of C$1.23 billion to Cineplex for “lost synergies” — cost savings and profit gains that were expected to come from the acquisition.
Unsurprisingly, Cineworld says that it “disagrees with this judgement and will appeal the decision”. The company does not expect to have to pay the damages while the appeal is ongoing.
Is this the end for Cineworld?
An appeal should provide some breathing room — but Cineworld may have to find more than C$1bn. To put this in context, Cineworld’s market-cap today is just £465m (C$788m). Based on my reading of the company’s accounts, finding that much cash is likely to be very difficult.
As a result, I think Cineworld will be in a very serious position if it loses the Cineplex appeal. Cineworld already has net debt of $8.4bn and does not have many assets it can borrow against. For example, the group’s land and buildings were valued at just $395m at the end of June.
To find cash for the damages, I think that Cineworld CEO Mooky Greidinger would probably have to carry out a big rights issue. He might also need to find new equity investors to take a majority stake in the business. Existing shareholders could face heavy dilution.
A buying opportunity?
What I’ve discussed above is the worst-case scenario. I can see several more positive ways of looking at this situation. Today’s crash might even be a buying opportunity.
The best outcome would be if Cineworld wins its appeal and no longer has to pay damages.
Even if the company loses its appeal, the time it will take for this legal process to complete could be very helpful. Broker forecasts suggest that Cineworld’s trading will return to near-normal levels in 2022. If this is correct, the business should start to generate surplus cash again. This might help to fund the cost of any damages that become payable.
Finally, I think it’s worth remembering that Greidinger and his brother Israel are Cineworld’s largest shareholders, with a 20% stake. They have a very strong incentive to rescue this business without wiping out existing shareholders.
Would I buy Cineworld shares? No. This situation is too speculative for me. But I’m not ruling out Cineworld just yet.