Hertz declared bankruptcy recently. When a company goes through bankruptcy, a liquidation process typically occurs that allocates remaining company assets to investors. Bondholders are first in line to get paid back, and if there’s anything left, stockholders get something — though it’s typically very little, if anything. It’s not uncommon for stocks of bankrupt companies to end up having no value. Right now, Hertz’s bonds are trading around 35 cents on the dollar, meaning that bondholders of the company are not expecting to be made whole even though they have first dibs on the company’s assets.
This means Hertz’s stock is expected to be worthless.
At first, Hertz’s stock was dumped by major investors and plummeted when the company declared bankruptcy, which is normal, healthy capital market behavior. That is, however, not the current state we are now in. The Federal Reserve has taken unprecedented action to support and stimulate markets in many different forms while we endure our state-mandated coronavirus economic coma. While this has helped stop an utter collapse in stock and bond markets, it has fostered something of a frothy mania in certain parts of markets.
The most glaring example is Hertz’s stock: Retail traders have now bid up the stock of a bankrupt company. More than 160,000 Robinhood accounts (the retail trading platform where much of this buying is coming from) thought it was a good idea to buy an insolvent company and sent Hertz’s stock from 50 cents to around $6 a share. (It’s since fallen back toward $2.)
As if this delirium weren’t silly enough, Hertz is now literally trying to raise capital by selling more stock during a bankruptcy.
It’s difficult to emphasize just how absurd this is. Seizing on the bizarre retail behavior that drove up Hertz’s share price, the investment bank Jeffries has petitioned a bankruptcy judge to allow Hertz to sell what it knows will, in all likelihood, be worthless stock.
Worse, the judge actually approved it.
When a company lists its shares on an index, it’s called an initial public offering. I guess this abomination is an initial bankruptcy offering? Jefferies is essentially exploiting frenzied retail behavior to convince a judge that the equity of Hertz somehow has value because its price has gone up, a form of circular reasoning.
No institutional investor will want anything to do with this, but that doesn’t matter to Jeffries and Hertz. They know their audience: Robinhood retail traders are partaking in what is simply gambling at this point, only buying shares in hope of a greater fool to later pass them off to.
Jared Ellias, a law professor who has studied hundreds of bankruptcies, said he has never before seen a bankrupt company attempt to fund a case by raising equity and commented that “Hertz looks at the market and sees there is a group of irrational traders who are buying the stock, and the response to that is to seek to sell stock to these people in hopes of raising some amounts of money to fund their restructuring.”
How the SEC and other regulators are allowing this is baffling. Hertz will indemnify itself by providing a cautionary statement that the stock being offered may be worth nothing and result in a total loss, but frankly, this is a boilerplate warning that applies to any stock offering. It doesn’t effectively speak to the lunacy of buying stock in a bankrupt company that is undergoing Chapter 11, which has a much higher probability of being worthless than stock issued by a healthy company.
“Unless a genie or a lamp showed up in the collateral pool, we expect the eventual equity value will be zero,” per CreditSights analysts.
2020 has been an outlandish, unconventional, and trying year, so I suppose the clownish Hertz initial bankruptcy offering is simply par for the course. But please, unless there’s a complete turn of events that results in Hertz’s business actually improving, avoid this stock.
Jason Orestes (@market_noises) is a former Wall Street financial analyst who focuses on contemporary political developments affecting economics, markets, and culture. His commentary can be found on TheStreet, MSN Money, the Washington Examiner, RealClearMarkets, and RealClearPolitics.
