AMC Preferred Equity (NYSE:APE) was launched with much fanfare back in August amid expectations that the security would serve as a watershed moment by once and for all exposing the manipulative practices that allegedly keep a lid on AMC’s (NYSE:AMC) stock price, as per the belief of the meme stock’s bulls. Alas, APE has failed to live up to its hype, with the preferred equity now underperforming the AMC ordinary shares by a whopping 56 percent. As a refresher, AMC had announced a special dividend while revealing its Q2 2022 earnings. This dividend took the form of preferred shares, with 1 APE awarded for every AMC common share. Bear in mind that each APE entails the same rights as those conferred by the company’s common stock. Moreover, such units might be convertible into common shares at some point in the future, pending shareholder approval.
— Adam Aron (@CEOAdam) August 4, 2022 AMC’s Adam Aron had explained a while back that the purpose behind the issuance of APE was to conduct a “share count” of sorts in order to provide a verifiable accounting of the company’s outstanding shares, as per the demand of many of AMC’s most ardent bulls who believe that the stock is being manipulated via financial wizardry.
AMC Stock Is Currently Trading at $8.06 While Its APE Counterpart Is Hovering at $3.51, Corresponding to a Discount of Around 56 Percent
Under the efficient market hypothesis, such a huge arbitrage between these two securities should not exist, even if we were to account for their liquidity differential. For AMC bulls, the answer is obvious: Failures to Deliver (FTDs). For the uninitiated, FTDs occur when an investor is under a contractual obligation to buy and deliver specific shares but fails to do so due to a shortage of funds. FTDs might also occur in the case of naked short selling – an illegal practice where a short trade is opened by selling shares that have not been affirmatively determined to exist. AMC bulls vehemently maintain that naked short selling has been keeping a lid on the stock’s price explosion. Bear in mind that funds with outstanding FTDs are mandated by the SEC to find and deliver the requisite shares to a buyer within a grace window. Previously, there was a loophole that allowed institutional investors to resolve these FTDs by purchasing deep-in-the-money call options, which were then exercised immediately to acquire and deliver the requisite shares. This resolved the FTDs without compelling such funds to close their naked shorts. However, this practice has now been banned by the SEC. Nonetheless, there is yet another loophole – dark pools. A dark pool is a private exchange where trades are settled between counterparties. The price at which such trades are settled is never reported, thereby ensuring that these trades don’t affect the stock price. Crucially, the close-out requirement for FTDs is only applicable on regulated exchanges and not dark pools. The chart above details the FTDs pertaining to the AMC Preferred Equity. As is evident, the security’s FTDs have declined precipitously over the past few weeks, tumbling from over 43 million on the 24th of August to just 5.6 million on the 31st of August – the last date for which this data is available right now. Bear in mind that the reporting of FTDs is on a cumulative basis, with each day’s tabulation consisting of all outstanding FTDs until that day, plus new fails that occur during that day, less the fails that settle on that day.
— Clifford Asness (@CliffordAsness) September 22, 2022 As to the astronomical nature of the initial FTDs in AMC Preferred Equity, Clifford Asness – a known AMC bear – seems to think that the “plumbing screwup” in the issuance phase was the stimulant. AMC bulls, however, disagree and continue to point their fingers at naked short selling as well as dark pool activity. Regardless of the impetus, it is a fact that the price divergence between AMC common shares and preferred shares is highly aberrant. To me, it is even more striking that sophisticated investors are not stepping in en masse to take advantage of this huge arbitrage opportunity to win riskless profits, assuming that the prices of both of these two securities converge, as is to be expected in an efficient market. Of course, Jim Chanos of Kynikos Associates did take such a trade back in early September, but the arbitrage opportunity persists. Consequently, given the pricing discrepancy between the two instruments, an attractive proposition would be to go long on APE while shorting AMC, thereby betting on a price convergence somewhere in the middle of the current $3.51 to $8.06 price range.
Update: Another Downward Force on APE Emerges
In a new shelf filing, AMC has intimated that it might sell up to 425 million APE units at market prices. Given the limited liquidty profile of APE units, this offering will exert a sizable downward pressure on the preferred share price, thereby further aggravating the discrepancy with respect to AMC ordinary shares.
