Hertz, The Bankruptcy Paradox
Coauthored with Anthony Tan
The 2020 stock market has outdone itself yet again.
Hertz Global Holdings, Inc.’s rental car business took a hit as the COVID-19 pandemic surfaced. Crippled by heavy debt, Hertz filed for Chapter 11 Bankruptcy in late May 2020. Their stock price took a nose-dive as expected but in a turn of events, the price soared afterwards and Hertz seized their unique opportunity to raise USD 1B in equity despite being in the midst of a bankruptcy.
(Update: In yet another turn of events, the Securities and Exchange Commission raised objections to the issuance and the plan was called off until further review)
Confused? Me too…
This timeline should give you a better idea of what happened.
So what drove the stock price up?
A theory is that their stock price was propped up by two types of investors: new investors and high-risk investors.
As Tobias Levkovich, Citi Chief US Equity Strategist, puts it, “Many millennials saw the March market dip as a generational-buying moment but do not have much background in the equity space”. Without fundamental analysis, these new investors practically bought shares as if they were shopping — they saw a familiar name with a low price and they snapped it up.
One of the platforms through which they invested is Robinhood, an online stock brokerage frequently used by millennials (the median age of a Robinhood user is 30, and half of the users are first-time investors.) The trend of investors flooding into the stock post-bankruptcy is nicely illustrated in a chart as shown below.
Of course, not everyone was clueless as to what they were getting themselves into. Investors who were perfectly aware of the high risks might still have chose to buy the stock. This might be fuelled by the so-called “boredom markets hypothesis” as coined by Bloomberg writers. As people get bored during lock-down and with casinos and sports betting off the table, investors turn to the stock market for the rush of a gamble.
An unprecedented opportunity for Hertz
Conventionally, stock prices plunge when firms enter Chapter 11 bankruptcy due to stock-delisting fears and the companies would be forced to accept unfavourable terms from creditors who see this as an extremely risky investment. However, Hertz is presented with this unique opportunity to raise equity. Hertz broke down the benefits of this opportunity in their filing for the issuance:
“Unlike typical debtor-in-possession financing, the common stock issuance would not impose restrictive covenants on the Debtors and … stock issuance would carry no repayment obligations, and the Debtors would not pay any interest or fees..”
But with a huge downside for Investors
The obvious downside is that well, Hertz shares might after all be worthless should they delist from the NYSE. The stock will continue to trade pending the appeal but the stock exchange warned that:
“There can be no assurance that NYSE will grant the Company’s request for continued listing at the hearing and whether there will be equity value in the Company’s common stock.”
In fact, in the equity issuance filing, Hertz explicitly warned investors that:
“…investment in Hertz’s common stock entails significant risks, including the risk that the common stock could ultimately be worthless.”
Also, while Hertz hopes to benefit from this market irrationality, investors are not guaranteed to take up all 246M shares. The market trend might not have reflected this well but fundamentally, investing in a bankrupt company entails extremely high risks. Moreover, it is hard to image any operational excellence since the bulk of the funds raised will go straight into the debtor’s pockets, and Hertz would still be left struggling to manage their huge fleet of depreciating vehicles and at the mercy of next to no revenue during this COVID-19 pandemic.
Furthermore, we know from their 2020 Q1 financials that Hertz has USD 4.3B in debt that is not tied to their vehicles and around USD 1B of cash on hand. Putting aside the doubts and assuming they do raise the full USD 1B, they are still USD 2.5B short — it is no wonder that they were recently downgraded to Ca credit rating by Moody’s, given the dismal prospect of recovery in principal and interest for lenders.
Closing remarks
Maybe Hertz’s issuance will be a huge flop and this last struggle will be their final dance. Or perhaps the market will keep the hype up and support Hertz all the way. With the apparent disconnection between the fundamentals and stock market performance of companies this year, the latter might just be possible.
The saga continues…
On 15th June, Hertz announced that the equity issuance would be put on hold after the Securities and Exchange Commissions (SEC) raised concerns.
Note: This article was originally published on 15th June 2020 and updated to reflect the latest happenings as of 24th June 2020.
