A little over a week ago, I wrote an article on the Cineworld (LSE: CINE) share price, exploring the outlook for the stock in 2022.
In it, I concluded I was cautiously optimistic for the year ahead, based on recent consumer spending data. I speculated that if consumer spending continues to grow, the company could start to make a dent in its debt pile and move on from the pandemic.
Since then, a lot has changed. New pandemic restrictions have dented consumer confidence, and a court ruling in the US has put the company’s very future at stake.
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The Cineworld share price slumps
Yesterday, the company revealed in a stock exchange announcement that the Ontario Superior Court of Justice had awarded substantial damages to the Cineplex chain of cinemas regarding the merger agreement between the two entities, which fell apart in June of last year.
Cineworld initially terminated the merger agreement as the transaction no longer made sense during the pandemic. That seemed to be the right decision at the time. With the company fighting for its life, the last thing Cineworld needed was more debt and more screens to manage.
However, Cineplex has argued that Cineworld breached the terms of its agreement by withdrawing. The two parties have levied several accusations against each other, resulting in a court battle.
The court has now found in favour of Cineplex. It has awarded the company damages of C$1.2bn for lost synergies to Cineplex and C$5.5m for lost transaction costs. At current exchange rates, this judgement could cost Cineworld £700m. The firm’s current market capitalisation is just £623m.
Cineworld has said it will appeal the judgement. In the meantime, it will not be paying any settlement.
A threat to survival
I think this judgement could threaten the company’s survival. Not only could the business be on the hook for more than £700m in legal penalties, but it is also responsible for £3.5bn of other debts.
Even though it is appealing the judgement, Cineworld’s legal battles may make it harder for the corporation to find new financing and sustain its current obligations.
Creditors may baulk at the idea of providing the company with more funding if it is at risk of having to pay what can only be described as a vast sum to Cineplex. It could be the end of the road for the Cineworld share price if it pulls the plug.
Having said all of the above, in the background, it is clear that the company’s trading outlook is improving. Although recent restrictions will impact consumer confidence, it seems likely Cineworld will be able to capitalise on the economic recovery over the next 12 months. This will provide the establishment with much-needed cash flow to service its debts.
If the recovery is more robust than expected, it may also convince creditors to provide the business with more capital. So there is a chance the company could escape from its current predicaments.
However, considering the scale of the company’s challenges, I am no longer interested in buying the stock. I think the potential risks of owning the shares are now are higher than the potential rewards. And there are plenty of other attractive investments for me to buy.
