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Officially, Cineworld and Cineplex say they remain committed to tying the knot, on the agreed terms.Aaron Vincent Elkaim/The Canadian Press

Like a thriller with unexpected twists and turns, the planned $2.8-billion Cineplex Inc. takeover is running into new roadblocks as it moves closer to closing, a situation that hedge funds are exploiting as they take a stake in the proposed deal.

Cineplex agreed to a friendly, $34-a-share takeover offer from London-based Cineworld Group Inc. in December, an era best described as the pre-COVID-19 period. A pandemic that threatens to shut down theatres – along with broad swaths of society – for an unknown period of time puts this deal in doubt. After trading near the takeover price for several months, Cineplex stock closed on Friday at $20.41, down 18 per cent on a day when equity markets were rebounding.

The massive gap between what Cineworld is offering and where Cineplex stock is trading reflects growing concerns over whether the deal gets done. The issues are being broadcast by investors such as Hindenburg Research, which is betting that the takeover fails or is at least reworked. In early March, after release of the latest James Bond film was postponed, New York-based Hindenburg said Cineplex’s stock was “horrendously mis-priced,” largely because of doubts around the significant loans needed to finance the transaction.

In a series of posts on Twitter, Hindenburg said: “The market significantly [is] underestimating the desperation with which we think Cineworld will seek to break or modify the deal.” Hindenburg, prescient in pointing out problems in Canadian transactions in the past, predicted Cineplex’s stock price would drop to $15 if the takeover fails.

Officially, Cineworld and Cineplex say they remain committed to tying the knot, on the agreed terms. However, as companies everywhere struggle to deal with the impact of the new coronavirus on their finances, the two theatre chains face unexpected challenges.

To pay for Canadian expansion, Cineworld arranged a bridge loan with banks and agreed to specific terms – known as covenants – on the debt. Last Thursday, the British company released quarterly financial results, and analyst Julian Easthope at RBC Dominion Securities Inc. said in a report on Friday that if COVID-19 shrinks audiences or shuts down theatres, Cineworld’s cash flow will drop and the company will breach those debt covenants, “hence the concern about the deal. Should COVID-19 be this bad globally, we suspect there will be many companies in the same boat.”

Later that day, rival U.S. chain AMC Theatres announced plans to allow for “social distancing” by cutting in half the seating capacity at every one of its 11,000 screens – effectively cutting future ticket sales by 50 per cent. That day, both Cineplex and Cineworld’s stock prices swooned. Cineworld stock price is down by more than 77 per cent since it launched the takeover. On Friday, Cineplex announced additional cleaning at all of its facilities, but did not restrict ticket sales.

For its part, Cineplex pledged to keep its debt below $725-million as a condition of the takeover. Cineworld can break the deal if the Canadian company’s borrowing rises about this level. At the end of 2019, Cineplex owed lenders $625-million. Hedge funds betting against this deal say Cineplex is going to need to step up borrowing if studios keep delaying film releases or theatres are closed, pushing through the debt threshold.

In another twist, the Cineplex takeover still requires approval from the Canadian government; the company’s shareholders approved the deal in early February. Again, both companies have said they don’t expect to have issues with the federal Liberals. But hedge funds – always quick to embrace conspiracy – whisper that Cineworld may intentionally slow-walk the approval process, betting that delays will translate into additional borrowing by Cineplex, breaking the $725-million barrier and allowing the British chain to walk.

If this takeover does fall apart, each chain has agreed to significant payments. If Cineplex breaks the deal, it owes its potential buyer $55.4-million. Cineworld will pay a $48-million break fee if it kills the transaction.

Cineplex chief executive Ellis Jacob deserves credit for negotiating what seemed an air-tight takeover back in December. Mr. Jacob led the chain through the SARS outbreak in 2003 and included specific language in the deal to ensure that it would close even if a pandemic played out. However, no one has seen the COVID-19 movie before.

North American audiences spent an estimated US$55.3-million on movies tickets over the weekend, down 47 per cent from the previous week and the lowest box office sales in two decades. The hedge-fund crowd is betting a blockbuster deal will fall apart as the virus darkens theatres and boosts debt at either Cineworld or Cineplex.