It has been a very tough week for shareholders in Cineworld (LSE: CINE). The market reacted poorly to a profit warning and the shares lost half their value, although they have since recovered some ground. Still, the Cineworld share price has fallen by more than 80% over the past year. They are now worth only 3% of their price just five years ago.
Yet despite Cineworld shares trading for pennies, I actually think they look expensive. I am therefore avoiding them. Here is why.
It can be a costly mistake to confuse a good business with a rewarding investment.
Imagine that I have a machine that allows me to make jewellery from metal. For every piece of metal I pay 50p and I can sell each item of jewellery for £1. That sounds like a good business. But what if the machine cost me thousands of pounds to buy? If I borrowed the money to buy it, I could end up using all of my profits to service the loan – and that might still not be enough.
That is basically what is happening at Cineworld. As the operator of thousands of cinemas, I think Cineworld has a potentially very lucrative business. However, in the past few years the company has saddled itself with enormous amounts of debt. While its market capitalisation is only around £150m, the firm’s net debt at the end of its last financial year stood at $8.9bn (approximately £7.4bn).
The Cineworld share price is in pennies
Value, as an investor, involves buying something for less than it is worth or will be worth in the future. At 10p a share, Cineworld may look cheap. But I do not think it offers me value.
Cineworld may have the bones of a good business, but it also has an enormous amount of debt. Customer numbers remain far below where they stood before the pandemic, which could reduce the company’s ability to generate the cash it needs to pay its debt. Indeed, Cineworld said yesterday that “recent admission levels have been below expectations”.
In its announcement, Cineworld also explained that it is looking at ways of servicing its debt by raising new funds.
That could be good news for the business. It might free up working capital, and reduce future interest payments. Both of those could help restore the business to a healthier state of affairs. If Cineworld can clean up its balance sheet that may help its long-term survival prospects.
But in order to raise those funds, the company may issue vast amounts of new shares, diluting existing shareholders. In fact the company did not pull its punches in the potential consequences of this, noting that any transaction to reduce its debt “will likely result in very significant dilution of existing equity interests in Cineworld”.
In other words, current shareholders could see their stake in the company slashed. I think it is possible shareholders may even end up with nothing and the Cineworld share price could go to zero. I am not touching the shares with a bargepole.
The post Even at 10p, I see the Cineworld share price as expensive. Here’s why appeared first on The Motley Fool UK.
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