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Should I snap up Cineworld shares at under 5p?

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The Cineworld (LSE: CINE) share price rose on Wednesday afternoon after the debt-laden company said it had filed for Chapter 11 bankruptcy protection in the US.

This step — which was widely expected — will protect Cineworld from legal action by its creditors while it tries to refinance its operations. The company expects its shares to continue trading on the London Stock Exchange, despite the Chapter 11 proceedings.

The success of the last James Bond movie at the end of 2021 gave investors hope that cinemas could bounce back to pre-pandemic levels of activity. Unfortunately, things haven’t turned out that way.

Cineworld says that despite the recovery seen last year, “recent admission levels have been below expectations”. High levels of debt mean it’s struggling to pay its bills.

With net debt of nearly $9bn, the company is also struggling to make scheduled repayments. Two payments due in June were missed.

This has led to the current situation, where Cineworld is using Chapter 11 protection to try and refinance its business while still operating normally.

Emergency funding

To keep cinemas open, it has secured $1.9bn of “debtor-in-possession financing”. My reading of this is that some of the company’s lenders have agreed to provide extra loans, in exchange for effectively taking control of the business.

Its next challenge is to finalise “a significant deleveraging transaction” in order to reduce debt. Negotiations are under way, but management warned that “there is no guarantee of any recovery for holders of existing equity”.

I’d take this warning very seriously. In my view, Cineworld’s existing shareholders are likely to face a near-total loss as part of this refinancing.

In a situation like this, the reality is that if shareholders aren’t contributing fresh cash, they have no rights to future earnings from the business.

Cineworld shares: am I wrong?

In nearly 15 years as an investor, I’ve learned to stay away from companies with serious debt problems. Although nothing is certain in the stock market, I’ve found that these situations are generally very predictable.

What normally happens is that shareholders are wiped out when a company’s lenders take control of the business.

Could I be wrong this time? I can only see two scenarios that might preserve some value for shareholders.

The first is that cinema trading conditions rapidly improve to near-record levels as we head into the autumn. However, the company has already warned of a limited slate of new films until at least November. I think a sudden cinema boom is unlikely.

A second possibility is that that Cineworld’s share price get pushed up by meme traders to a level where the company can sell new shares to raise cash. This actually happened to Cineworld’s US rival AMC Entertainment. However, I’m not sure how likely it is to happen again.

For me, Cineworld shares are too risky and speculative at the moment. I won’t buy them at any price unless the company’s financial situation improves.

The post Should I snap up Cineworld shares at under 5p? appeared first on The Motley Fool UK.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.