AMC Arbitrage Traders Face Big Question: Will Preferred Equity Get Converted Into Common Stock?

Common shares of AMC Entertainment Holdings Inc AMC closed 22.84% higher on Monday. The company will face a hearing on April 27 in a lawsuit alleging it circumvented shareholders who were against adding more shares, according to a Reuters report.

Also Read: How To Short A Stock

What Happened: Vice Chancellor Morgan Zurn is scheduled to hear from AMC investors who have accused the company and several directors of violating state law by creating preferred shares in order to “eviscerate” the voting power of common stockholders who had not supported issuing new shares, reported Reuters.

Meanwhile, shareholders will vote on March 14 over whether to convert the preferred equity to common shares and authorize the company to increase its common stock. The common shareholders who sued AMC on Feb. 20 have agreed the vote can go forward but that AMC will not act to increase shares before the ruling, reported Reuters.

Why It Matters: If the decision to convert the preferred equity into common stock goes through without any legal hassles, those who have taken a bet on the arbitrage between the share prices would gain heavily. The common stock is currently trading at $7.61, while the preferred equity AMC Entertainment Hldg APE is trading close to $2.05. 

Arbitrage trade here means traders are betting the common stock will come down and the preferred equity price will rise and converge at some point.

However, arbitrage traders are facing a big challenge with their trade because, with the hearing date scheduled for late April, the cost of holding short positions will be too high.

Cabot Henderson, who focuses on merger arbitrage and special situations at JonesTrading, told Bloomberg the preliminary injunction hearing on April 27 extends the time that investors have to hold long APE/short AMC by at least a month and a half. Given the horrifically high cost of borrowing, this is a painful outcome for arbitragers.

Benzinga Pro data shows that over 22% of AMC's float was shorted as per early February data. However, the common stock has risen over 51% in the last month. 

This could possibly mean at least some of the traders who had held short positions at the beginning of the month may have been forced to square off, given the high borrowing costs of carrying such positions.

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