Are AMC and APE Setting Up for a Pre-April 27 Short-Squeeze?

There are many ways to “play” AMC Entertainment (NYSE:AMC), but one that may be piquing the interest of retail traders today has to do with the latest news regarding the conversion of AMC Preferred Shares (NYSE:APE) into common shares of AMC stock.

As you may be aware, there has been some legal controversy regarding the planned APE stock conversion. Unsuccessful in its efforts to settle this litigation earlier this month, this conversion implementation has been delayed.

This has been frustrating for management and frustrating for “smart money” investors trying to arbitrage the transaction (more below), However, everyday individual investors, in theory, may have a chance to make a quick profit from this latest twist of events. That’s because these events may result in yet another “short squeeze” for shares.

However, whether it is worthwhile to make this trade is another question entirely. Here’s why.

A New Reason to Buy AMC Stock

Before entering the potential trade that has emerged with AMC Entertainment, let’s look at the backstory. On Feb. 20, a group of AMC investors filed suit against the company in Delaware Chancery Court.

In the suit, these shareholders allege that the company created and sold the APE equity units to implement further heavy shareholder dilution. Additionally, the company did this without having to obtain the support of existing shareholders. They argue that due to the prior sale of additional common shares of AMC stock, the company hit its authorized share count limit.

AMC was able to obtain shareholder support for the APE conversion plan, along with approval for its project to reverse-split the stock (enabling the conversion to happen and for AMC to continue with dilutive capital raises). However, the company cannot proceed with the rest of its plans until the litigation is settled.

Again, management attempted to settle this suit. In fact, on Apr. 4, it appeared as if the plaintiffs were willing to accept their offer. However, a Delaware Chancery Court quashed the settlement plan two days later. This means the “APE Saga” continues, which may have created a new reason to buy AMC shares.

The Trade

So, how exactly can average investors potentially profit from the turn above of events? It all has to do with the arbitrageurs I mentioned above. APE was initially issued on a one-to-one basis with AMC stock. However, the preferred shares have traded at a sharp discount to the common shares.

As a result, risk arbitrage investors, like hedge funds, have entered long positions in APE and short positions in AMC. When the conversion is completed, they’re hoping to pocket the massive spread (AMC trades for around $5 per share versus $1.53 per share for APE).

Yet, while this seems like easy money on paper, in practice, it’s a bit more complicated than that. Borrowing fees short-sellers need to pay are at triple-digit percentage levels. That’s actually down in recent days, which tells investors all they need to know about shorting either of these names. Additionally, further roadblocks to the conversion, such as this litigation, dampen the appeal of the trade.

Adverse developments, such as the quashing of the settlement plan on Apr. 6, resulted in some arbitrageurs unwinding their positions. This corresponded to a squeeze higher for AMC stock. Another such reduction may be on the cards for Apr. 27. That’s when the next scheduled court hearing is expected to occur.

Why You May Still Want to Skip It

If the outcome of next week’s court hearing signals further delays in the share conversion, another squeeze may be in the cards for AMC stock. However, while this may sound like a fast money opportunity, remember that, like the arbitrage trade, it has its own caveats.

For one, the Apr. 6 quashing of the settlement offer was more of a surprise for the market, explaining the resultant 21% surge for AMC that trading day. Subsequent developments from the Apr. 27 hearing may be less-surprising, and result in a much smaller jump (if any) for the stock.

In addition, the next twist of events could always be favorable for APE conversion chances. This will bring arbs back into the other trade, pushing AMC lower.

Given that it is uncertain whether this event will spike or sinks AMC stock, it’s best to stay away.

On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.