AMC Entertainment (APE) – Share Class Arbitrage – 30% Upside

Current Price: $2.26 + $0.76

Target Price: $4

Upside: 30%

Expiration Date: March 14

 

I am writing this post mostly as a reach-out to SSI subscribers in order to understand why this 30% fully hedged spread between APE and AMC exists when both stocks are set to convert into a single one by mid-March. The arbitrage trade I am referring to is fairly simple. Here is one example:

• Long APE at a cost of $2.26/share.
• Long $4 AMC March Put at a cost of $0.76/share.
• Total investment of $3.02/share.
• Total pay-off of $4/share after the Put option gets exercised and APE converts into AMC.
• That’s 30% return in a month.

That looks too good to be true for a widely-covered situation, and I would love to understand why this spread exists. A similar setup can be achieved with different option exercise prices and expirations.

I have covered the early days of this arb back in September, noting that it was unactionable at the time due to expensive borrow/options and lack of catalyst for the spread to collapse. But now the situation has changed with the shareholders set to approve the conversion of all of APE into AMC on the 14th of March and this way eliminate the spread between the two. For more background leading to this arbitrage opportunity, please refer to a really well-written piece by Andrew Walker. In a nutshell, AMC and APE are economically identical securities and have equal voting rights. APE has traded well-below AMC as the former was continuously used as currency to raise fresh equity, whereas the latter is a meme stock with zero borrow availability. But then in Dec’22, creditor Antara agreed to exchange $100m of debt into APE shares. In return, the company agreed to hold a vote to collapse the share class structure and convert APEs into AMCs. The vote is sure to pass as there are almost 2x more APE shares than AMCs and the non-votes count is favorable to APE holders. The meeting date has now also been set and the case appears to be fully derisked.

The spread on this trade (long APE + long AMC puts) has temporarily widened on several occasions but mostly stood at low single-digit percentages. Over the last few days, it has shot up again with the increases in AMC price. 

My theory for the spread is that the spread is wide due to uncertain timing till new AMC shares are delivered to the current APE shareholders. In other words, arbitrageurs might be unable to close their long APE and short AMC (through options) positions at the same time. The vote is set for the 14th of March and the proxy indicates that:

We expect the APEs to cease trading and be delisted from the New York Stock Exchange (the “NYSE”) shortly after the effective time of the Charter Amendment Proposals. If the Charter Amendment Proposals are approved, we currently expect the last day of trading of the APEs to be March 14, 2023.
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If the Share Increase Amendment is adopted, it will become effective upon the filing of a certificate of amendment to our Certificate of Incorporation with the Secretary of State of the State of Delaware.
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If the Reverse Split Proposal is adopted, it will become effective upon the filing of a certificate of amendment to our Certificate of Incorporation with the Secretary of State of the State of Delaware.

The exact date of when new AMC shares will be delivered in exchange for APE is not indicated anywhere in the proxy. I have no idea if the filling of the above-mentioned Certificate of Incorporation has to be done promptly after the vote or if the company has a few days/weeks of leeway. The certificate of the amendment itself is already included at the bottom of the proxy with the date left blank. And even if the certificated is filed promptly, how long would it take for the company to convert shares? E.g. in split-off transactions, the conversion of shares from one company to another normally takes about a week. Not sure if the same timeline might apply here as it is te same company, just different classes of shares.

If the new AMC shares are not received by the 17th of March (the option expiration date), the whole arbitrage might blow up. In the money put options would get converted into a short AMC position, but as there is no AMC borrow (and the fee stands at 600%), this short AMC position would simply get closed at market prices. And we might see the very last squeeze that AMC hodlers are dreaming about.

Buying options with longer expirations reduces this problem, but the spread also narrows significantly. The table below indicates spreads with various option expiration dates as well as different exercise prices.

Even the 5%-9% spread for April expiration seems juicy enough for a two-month holding period if this were really a risk-free trade. And till the 21st of April there seems to be plenty of time to receive the newly issued AMC shares and closed this arb.

Any other thoughts on why the spread is so wide here?