Typically, companies go bankrupt when their liabilities exceed their assets. A bankrupt firm is liquidated or restructured and the proceeds of that process are used to repay the firm’s creditors to the extent possible. On rare occasions, a bankruptcy goes so well that this process generates more than enough money to pay the creditors in full, and what’s left over then goes to the stockholders. This is sort of what happened to General Growth Properties, a major owner of shopping malls that went bankrupt in 2009 and emerged in 2010 with a plan that gave the old company’s stockholders billions of dollars worth of equity in a new version of the company. But almost always, the old stockholders come out of a bankruptcy with nothing, which is why the stocks of bankrupt companies trade at or close to $0.
Yet Hertz, which has already gone bankrupt, is as of Friday morning trading over $3 per share, suggesting that the company’s equity is somehow still worth nearly $500 million. Why? It’s true that the rental-car business fell through the floor with the arrival of the coronavirus pandemic, and that the company couldn’t make payments that were due under its agreement to finance most of the cars in its North American fleet. But there have since been promising signs about the economic recovery and about the value of used cars. Maybe investors believe that the outlook for Hertz’s future business and the liquidation value of its fleet of cars has improved — or will improve — so much that the bankruptcy reorganization process will satisfy all of Hertz’s debts and leave money over for the shareholders.
The more conventional way for an investor to bet on a relatively successful bankruptcy process is to buy a company’s bonds, not its stock. It is typical for bondholders to get something out of the bankruptcy process since they are ahead of the stockholders in line. And the price at which Hertz’s unsecured bonds have been trading — about 40 cents on the dollar — provides an opportunity to clean up if the reorganization is a big success and the unsecured bondholders get paid in whole. (Unsecured debt is debt backed only by a promise to repay, not by specific collateral like real estate or vehicles.) This price also reflects the fact that bond market participants think there probably won’t be enough proceeds from the bankruptcy to pay the unsecured bondholders in full, let alone to pay the stockholders at all.
Some observers have pointed to this combination of indicators — unsecured bonds trading at a deep discount while the stock trades above zero — as an indication of irrationality in the stock market, driven by bored retail investors with extra cash on their hands and little to do as the coronavirus has closed restaurants and canceled sporting events. But I would note that these bond and stock prices are not inherently incompatible. As of the start of the year, Hertz had nearly $4 billion in non-vehicle debt, including its unsecured bonds, and it had over $13 billion in debt secured directly by vehicles. The secured vehicle debt is in line to get paid before unsecured obligations, so the low price of Hertz unsecured bonds could reflect a range of possible outcomes, including some in which the unsecured bondholders get paid little or nothing because secured lenders get all the money, and others where secured lenders and unsecured bondholders are made whole and there’s money left over for the stockholders.
Given the wide range of possible epidemiological outcomes right now, and the wide range of possible recovery tracks for the travel and automotive markets those outcomes imply, this seems like an especially appropriate time for securities prices to contemplate an especially wide range of possible results. So it is possible to square a highly distressed unsecured bond price with a positive stock price. But you have to squint a little, and I have to say I find the bored-investors-on-Robinhood theory to be plausible.
And that possibility makes somewhat awkward what Hertz management has asked a judge to let it do: sell equity shares while in bankruptcy. Ordinarily, companies don’t do equity offerings while bankrupt because equity in such a company is worthless. But now, there is demonstrated demand in the market for Hertz stock, and Hertz needs cash — so why wouldn’t it try to sell some stock? (Relatedly, Hertz has been fighting the New York Stock Exchange’s moves to delist its stock, as the exchange typically does with bankrupt firms; Hertz needs an active market in its stock in order to make this offering.) If the offering is just going to entail dumb/bored retail investors effectively handing money over to Hertz’s creditors, that doesn’t seem like a socially desirable outcome. But investors can already do that more directly in the bond market, by offering a high price to buy Hertz’s bonds. At a time when the Chainsmokers are raising a venture-capital fund, it may be impossible to stamp out incongruous-seeming optimism in the markets.
