So, what’s behind this huge share price spike? And is Cineworld stock worth buying for my portfolio now that it’s on the up?

Why Cineworld’s share price just spiked

The main reason the share price has skyrocketed today is that yesterday, Cineworld (which recently advised that it was seeking to implement a de-leveraging transaction to reduce its debt and capitalise on its business strategy as part of its Chapter 11 case) announced a bankruptcy settlement with its landlords and lenders. This will allow the cinema operator to borrow an additional $150m and make a $1bn debt repayment.

Previously, landlords and creditors had been opposed to the company’s billion dollar debt repayment plan. However, they dropped their opposition to the plan after Cineworld agreed to pay at least $20m in rent that will accrue after 30 September 2022. It had previously said that it didn’t intend to make any post-September rent payments until the end of its bankruptcy.

Cineworld also agreed to look into a potential sale of the company, and allow creditor input on its business plan going forward.

Did Cineworld just do a GameStop?

As for the magnitude of the share price increase (it’s not often you see a stock rise 200%+ in a single day!), I suspect there may have been a bit of a GameStop-like ‘short squeeze’ here.

According to my data provider, there were 23.4m Cineworld shares on loan as of yesterday. With the share price rising sharply this morning on the back of the bankruptcy settlement news, short sellers betting against the stock will have scrambled to buy Cineworld shares to close out their short positions. This will have pushed the share price up even higher.

Should I buy Cineworld shares today?

As for whether I’d buy Cineworld shares today, I’m not convinced that they offer an attractive risk/reward proposition from here.

No doubt, the bankruptcy settlement news is a positive development. The settlement means that Cineworld, and its shareholders, live to fight another day.

However, this development doesn’t change my view that Cineworld is a risky stock.

Debt on the balance sheet remains worryingly high. At 30 June, bank and other loans amounted to just under $5bn while net debt was $8.8bn. It’s fair to say that Cineworld is going to have its work cut out to service this level of debt (especially with interest rates rising).

Meanwhile, I think it’s likely that the Cineworld share price will be very volatile going forward. It’s worth noting that after hitting 9p earlier today, the stock then fell back below 6p (a 30%+ decline). This kind of stomach-churning volatility isn’t for me.

So, I’m going to leave Cineworld shares on my watchlist for now and focus on other stocks. All things considered, I think there are better stocks to invest in today.

Shareholders will be looking for news on any bankruptcy and rescue progress. On that front, the company commenced Chapter 11 bankruptcy proceedings on 7 September, in the Southern District of Texas.

Cineworld confirmed that it “with the expected support of its secured lenders, will seek to implement a de-leveraging transaction that will significantly reduce the Group’s debt, [and] strengthen its balance sheet“.

That mention of lenders gives us a timely reminder. They’re higher up the food chain than shareholders, and get priority treatment.

Chapter 11

The bankruptcy court has granted access to the first $785m from a $1.94bn debtor-in-possession financing facility. There’s some operational cash and cash reserves too. And the board reckons this should “provide sufficient short-term liquidity for the group to meet its ongoing obligations, including post-petition obligations to vendors and suppliers, as well as employee wages, salaries and benefits programs“.

In other words, the lights are staying on. And that’s the essential purpose of Chapter 11 bankruptcy. It gives a company breathing space to tackle its financial problems. It’s hard to do that while struggling to keep heads above water.

First-half figures

On the financial front, Cineworld tells us its “results have been positively impacted by the easing of all remaining COVID restrictions in Q1 2022“.

It added that cash burn of $145m in the period however, “reflects the slower-than-expected recovery in H1 2022“.

Revenue for the half came in at $1,515m. That’s a good deal higher than the first half of 2021, which brought revenue of just $293m.

Profits

We also saw gross profit of $425m in the half, and an operating profit of $57.3m. That’s better than a tiny $9.6m gross profit a year previously, and a sizeable $209m operating loss. As well as rising admission numbers, ticket prices and customer spend have been increasing.

Cineworld’s debt dominates the financial picture right now. Net external borrowings as of 30 June stood at $5.2bn, up a little from December. That seems like a lot for a company with a market-cap of just £42.7m ($47.7m.)

There’s no real progress to report on the legal battle with Cineplex, as the appeal process “remains ongoing“. Cineplex, it seems, filed for relief against any Chapter 11 stay in the process, but the court has denied it.

Mixed outlook

Third-quarter cinema admissions have been below expectations. The fourth quarter, though, should be stronger. But the the company still expects admissions in 2023 and 2024 to remain below pre-pandemic days.

What else can we say at this point? Chief executive Mooky Greidinger was not exaggerating when he said: “This has been a challenging period for Cineworld.”

He reiterated that the Chapter 11 process was needed so the company can “implement a de‐leveraging transaction that will provide the financial strength and flexibility to accelerate and capitalise on, Cineworld’s strategy.“

In doing that it has raised the prospect of heavily diluting existing shareholders. Combined with ongoing challenges in luring cinemagoers back to the silver screen, that has pushed the Cineworld share price down to pennies.

After losing 93% of their value over the past year, Cineworld shares are now cheap – but does that mean they are good value as a potential addition to my portfolio?

Price and value

An important principle when it comes to investing is understanding the difference between price and value. As legendary investor Warren Buffett puts it, price is what you pay and value is what you get.

At face value, the Cineworld share price of less than 5p may look cheap. Indeed, the market capitalisation of the whole company is just £62m now. In theory, that means someone could buy the whole show for £62m. But if someone paid that amount for Cineworld right now, they would also have to take on responsibility for its debts. With $8.9bn of net debt at the end of last year, that is a massive undertaking.

If nobody offers to buy the chain, what will happen to shareholders? There is a fair chance that Cineworld will agree with its creditors some new arrangement, such as forgiving some of the debt, or pushing out its due date, in exchange for shares. Indeed, the company has said it is currently in negotiations with its lenders.

This week, Cineworld filed for bankruptcy protection in the US, something it described as “a court-supervised process that will provide a forum for efficient reorganisation of the Group’s business and balance sheet”.

Shareholders could well end up with nothing, or very close to nothing. I see Cineworld as a very risky share to buy at the moment and would not consider owning it in my portfolio. Despite the apparently cheap Cineworld share price, I do not think it is good value.

Could the Cineworld share price bounce back?

From a risk management perspective alone, there is no way I would buy Cineworld shares now. But is there a chance the current Cineworld share price could turn out to be a bargain if the business restructures its debts? After all, it operates thousands of screens and has a well-known brand.

In theory, the share price could rise from here. To limit shareholder protests, the group’s creditors may agree to leave something on the table for them during negotiations.

But why should they? The creditors include ruthless, highly sophisticated financial institutions whose only interest is getting their own money back.

Cineworld’s business may improve but that will not come fast enough to help shareholders, in my view. They are now at the mercy of debt negotiations in which they have little or no voice and effectively no negotiating power.

I do not expect the Cineworld share price to recover on a sustained basis in either the short or long term. The rewards here are uncertain but the risks are clear – and far too big for my appetite.

This step — which was widely expected — will protect Cineworld from legal action by its creditors while it tries to refinance its operations. The company expects its shares to continue trading on the London Stock Exchange, despite the Chapter 11 proceedings.

The success of the last James Bond movie at the end of 2021 gave investors hope that cinemas could bounce back to pre-pandemic levels of activity. Unfortunately, things haven’t turned out that way.

Cineworld says that despite the recovery seen last year, “recent admission levels have been below expectations”. High levels of debt mean it’s struggling to pay its bills.

With net debt of nearly $9bn, the company is also struggling to make scheduled repayments. Two payments due in June were missed.

This has led to the current situation, where Cineworld is using Chapter 11 protection to try and refinance its business while still operating normally.

Emergency funding

To keep cinemas open, it has secured $1.9bn of “debtor-in-possession financing”. My reading of this is that some of the company’s lenders have agreed to provide extra loans, in exchange for effectively taking control of the business.

Its next challenge is to finalise “a significant deleveraging transaction” in order to reduce debt. Negotiations are under way, but management warned that “there is no guarantee of any recovery for holders of existing equity”.

I’d take this warning very seriously. In my view, Cineworld’s existing shareholders are likely to face a near-total loss as part of this refinancing.

In a situation like this, the reality is that if shareholders aren’t contributing fresh cash, they have no rights to future earnings from the business.

Cineworld shares: am I wrong?

In nearly 15 years as an investor, I’ve learned to stay away from companies with serious debt problems. Although nothing is certain in the stock market, I’ve found that these situations are generally very predictable.

What normally happens is that shareholders are wiped out when a company’s lenders take control of the business.

Could I be wrong this time? I can only see two scenarios that might preserve some value for shareholders.

The first is that cinema trading conditions rapidly improve to near-record levels as we head into the autumn. However, the company has already warned of a limited slate of new films until at least November. I think a sudden cinema boom is unlikely.

A second possibility is that that Cineworld’s share price get pushed up by meme traders to a level where the company can sell new shares to raise cash. This actually happened to Cineworld’s US rival AMC Entertainment. However, I’m not sure how likely it is to happen again.

For me, Cineworld shares are too risky and speculative at the moment. I won’t buy them at any price unless the company’s financial situation improves.

At market close Tuesday, the shares ended at 3.9p, still more than twice their low point.

If Cineworld is rising from the ashes, are we looking at the kind of stock recovery that had seemed so far out of reach?

Cineworld’s shock warning revealed it’s in severe financial trouble. A lack of movie blockbusters, people not flocking back to cinemas, and sufficient revenue is just not coming in.

We heard that any deleveraging rescue package would “result in very significant dilution of existing equity interests in Cineworld“. Bankruptcy is also one possible way.

All sorted?

So done and dusted. Find a rescuer who wants the assets, sell out and pay off debt. Nothing left for existing shareholders. Or, at least, that’s what many investors assumed.

But clearly someone has been buying again, pushing Cineworld shares back upwards once more. I can think of a few reasons why investors might do that.

Firstly, when the stock market responds to a major story, it usually overreacts. And when there’s bad news, the rush for the exit often leads to overselling and a share price falling too far. It can then even up and find its new level in the coming weeks.

Fair value?

So maybe institutional investors have done their sums and come to the conclusion that the higher price represents a fair valuation for Cineworld shares. When the company spoke of dilution, that was before the share price crashed.

So perhaps, after checking all the assets and debt on the balance sheet, it looks like today’s price already represents the most likely level of dilution.

Some could be thinking that the board was preparing us for the worst. And maybe a rescue package will be found that leads to less dilution than feared. We haven’t heard any more news on an attempted financial bailout yet. So might optimistic investors think no news is good news?

Board holdings

There’s been another minor twist in recent days. The company has confirmed that the Greidinger family have beneficial ownership of approximately 20% of the issued share capital of Cineworld. Mooky Greidinger is CEO and Israel Greidinger is deputy CEO.

That, presumably, helps align the interests of the Greidingers more closely with the interests of private shareholders. Might it mean there’ll be extra impetus in finding a deal that’s as kind to shareholders as possible?

I know I like to see board members having significant holdings in companies I invest in. I think it helps keep us all on the same side.

Penny shares

I really don’t know if any of this has any bearing on what might happen next. And I see one major caution. With a small-cap stock down in low penny share territory, it doesn’t take much buying or selling to influence the price significantly.

So I’d be wary of reading too much into these recent movements. Would I buy now? No, because nothing has really changed. And I don’t buy on speculation and guesswork.

Still, even after that dramatic price action, the shares have lost over 90% of their value in the past year. The share price chart is not a pretty sight.

Does yesterday’s jump suggest that the shares could be a bargain for my portfolio, hiding in plain sight?

How to value shares

In short, I do not think so.

A bargain is something that I can buy for less than it is worth. At the moment, Cineworld shares change hands for pennies. But that alone is not enough to make me see them as a bargain. Instead, I need to compare the price to what I think the company is worth.

It is not always easy deciding how to value shares. But one thing we know about Cineworld is that it is sitting under a massive debt pile. It ended last year with $8.9bn in net debt. That matters because if the company needs to use any profits it makes to service debt, it is not able to fund dividends. The Cineworld dividend is still cancelled and I expect that to be the case for the foreseeable future.

But what if the business does not even earn enough money to service its debts? That could force it into bankruptcy. Alternatively, it could negotiate with its creditors to come to an alternative arrangement. For example, it could dilute existing shareholders to issue new equity in exchange for reducing debt. That is exactly what it has been working on lately.

So although it is hard to pin a value on Cineworld shares, I think there is a chance they could end up being worth nothing, or close to it. Restructuring such a large debt could wipe out existing shareholders.

Soaring Cineworld share price

So why did the Cineworld share price jump by a quarter yesterday?

I think there are a few possible explanations. Some investors may expect creditors to sweeten a restructuring deal in a way that means existing shareholders are not completely wiped out. Speculators may also be seeing Cineworld as a meme share, like cinema chain AMC was before it.

On top of that, I do think the basic bones of the Cineworld business remain attractive: it has thousands of screens worldwide and cinema audiences are set to continue recovering. The issue is less with the basic business and more with its balance sheet.

Are the shares a bargain?

However, that balance sheet alarms me. It also makes it very difficult to value Cineworld shares.

Buying them therefore feels to me like speculation, not investment. The long-term trend in the Cineworld share price has been disastrous. Despite yesterday’s jump, I think the shares could still end up going to zero. I do not see them as a bargain and in fact fear that even though selling for pennies, they could still be a value trap. I will not be adding them to my portfolio.

However, there appears to be more to this story than meets the eye. Let’s take a closer look. 

Some worrying news

The company recently released a statement saying that sales hadn’t recovered at the required pace, and that it would have to deleverage in order to survive. This essentially means issuing more equity to reduce debt.

As a shareholder, this was worrying because it means that my current holding may be diluted and be worth even less than it was before.

Shortly after it said it was potentially filing for bankruptcy in the US. This is another indication that the firm could be on the verge of financial destruction.

The market understandably interpreted both of these news stories negatively and the share price plunged from around 25p to 2p. At the time of writing, the shares are trading at 5.7p.

Financial woes

The pandemic and its associated restrictions forced the closure of cinemas worldwide. This had a devastating impact on the firm, and it slumped to significant pre-tax losses in both 2020 and 2021.

With dwindling revenue, it decided to take on more debt in order to continue its operations. This debt pile now stands at $9.23bn with a cash balance of just $354m.

The bad state of affairs that Cineworld now finds itself in started earlier, however. It tried to expand aggressively, buying Regal cinemas in the US and attempting to acquire Cineplex of Canada. 

The latter deal was botched, and a lawsuit is ongoing. The result could determine whether Cineworld has to pay $1bn in damages.

Why I’m not selling

While most of the news about the company is negative, I don’t see much point in selling all my shares at the moment. 

There are a few reasons for this. One is that there’s an attractive movie slate on the horizon, with films like Avatar 2 scheduled for release. 

Also, there’s no telling what could happen in the coming weeks and months. While a takeover by a rival, like AMC Entertainment, is speculation at this moment in time, it’s not outside the realms of possibility.

Finally, I’m down so much on my initial investment already, I might as well wait and see if there’s any good news that can come from the business. 

Overall, I wouldn’t yet say that my shares are worthless. I do admit, however, that this might become a reality soon. The business doesn’t appear to be healthy, and it may even be dying. So, while I won’t be selling my shares in a panic, I certainly won’t be adding to my current holding. 

So is the Cineworld share price a bargain that could soar further?

Dramatic price action

Part of the issue when a share trades for pennies is that the price can swing wildly. We have seen that today with the Cineworld share price. But on a longer-term timeframe, the company has been a disastrous investment. Even after today’s movement, the shares are worth barely a 10th of what they were a year ago.

So although a share soaring by 50% may sound like an investor’s dream, for many shareholders Cineworld has been an unmitigated nightmare.

Where could the Cineworld share price go next?

What concerns me about the price movement today is that there is no obvious reason for it. The company did not issue any news that might improve its investment case, such as strong ticket sales, or a debt restructuring agreement.

This looks to me like the low price has attracted speculators to buy Cineworld shares. Some may be investors, but I think a lot could well be traders and meme stock enthusiasts. Financially on its knees but with a well-known brand, Cineworld is reminiscent of some other meme stocks including fellow cinema operator AMC.

But if nothing has changed at the company overnight, can it be worth 50% more than yesterday? On any rational calculation, I do not think so.

Outsized risks

Cineworld is in the process of trying to reach agreement to manage its enormous debt pile. We do not yet know what a final agreement will look like. But there is a fair chance that it will involve existing debtholders swapping at least some of their loans for ownership stakes in the company. That could mean existing shareholders see the relative size of their stake reduced, probably dramatically.

The business has been quite clear about this, telling shareholders last month: “Any deleveraging transaction will likely result in very significant dilution of existing equity interests in Cineworld”.

In other words, even if shareholders are not left with nothing, they could well be left with something close to nothing!

I’m ignoring the Cineworld share price

That means that no matter how wildly the Cineworld share price may move around, I will not be touching the stock with a bargepole. I do not see the share price as a bargain so much as a possible value trap.

Cineworld has thousands of sites and a well-known brand. That could help it grow its revenues again. But it has a huge debt burden and has signalled that shareholders may suffer badly as it attempts to improve its balance sheet. Buying shares in such a situation is speculation not investment. For many shareholders, even if they only pay pennies per share, it could still end badly. I will not be among their number.

Flashback

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.”

On 17 August, the cinema chain operator revealed that it was looking for some kind of rescue plan to shore up its balance sheet. The company warned us that “any deleveraging transaction will likely result in very significant dilution of existing equity interests in Cineworld.“

That sent the share price into a tailspin, and it slumped by 60% on the day. But worse was to follow.

Bankruptcy

As rumours of possible bankruptcy started to circulate, Cineworld shares fell further. Then on 22 August, we had a response to media speculation.

The announcement said: “The strategic options through which Cineworld may achieve its restructuring objectives include a possible voluntary Chapter 11 filing in the United States and associated ancillary proceedings in other jurisdictions.”

The shares fell further. And by market close that day, they were 85% down from where they’d been before the initial warning.

The company added: “Any such filing would be expected to allow the group to access near-term liquidity and support the orderly implementation of a fully funded deleveraging transaction.”

Control

That’s essentially what Chapter 11 bankruptcy does. It allows a struggling company to carry on operating, as it attempts to work out a controlled solution to its problems. So it can defuse a short-term panic, and reassure employees that it’s worth getting up for work tomorrow.

But it might not have much effect on the ultimate outcome. The announcement stressed: “As previously announced, any deleveraging transaction would, however, result in very significant dilution of existing equity interests in Cineworld.”

That’s where things stand at the time of writing, with Cineworld shares closing at 2.9p on 23 August. So what happens now?

Going concern

As part of the bankruptcy process, Cineworld will look for a rescue package. The company said it expects its business to continue operating in the long term, “with no significant impact upon its employees.” The firm’s chain of cinema properties does, after all, represent valuable working assets.

The big question is who will own what at the end of the day. And when it comes to financing a rescue package, shareholders are way down the pecking order for any recompense.

Essentially, creditors will come first. How much debt might a rescued company pay off, and how much might it retain going forward? Well, that’s anybody’s guess.

How much left?

Right now, Cineworld’s market cap stands at approximately 14% of its valuation at market close on 16 August. Will that 14% represent a fair valuation of the equity currently owned by existing shareholders after any possible rescue deal is concluded?

That’s what potential investors have to decide for themselves. They need to try to quantify that “very significant dilution of existing equity interests in Cineworld“.