A New Share Offering to Raise $500 Million — From a Company Worth Zero
On June 15, the 2020 Lockdown Mania reached new heights of insanity.
With the milestone achieved on that day, the mania cemented its place in financial history books.
And speaking of history books: If you’ve been around markets long enough, you have likely heard about wacky schemes from centuries past, designed to fleece speculators at the peak of a frenzy.
For example, near the peak of the South Sea Bubble in the early 1700s — a mania that pulled in Isaac Newton — a deluge of joint-stock companies issued shares to a ravenous public.
These newly formed companies, with their sales pitches and hastily formed business plans, were the initial public offerings (IPOs) of the day.
The most famous offering — and most famously brazen one — was marketed as: “For carrying on an undertaking of great advantage; but nobody to know what it is.”
Or fast forward a hundred years later, to the world’s first emerging-market debt bubble.
In the 1820s, the frenzy among British investors to lend to Latin America was so great — think “reaching for yield” — that a Scottish con artist named Gregor MacGregor invented an entire fictitious country, the Kingdom of Poyais, for the purpose of fake debt issuance.
The scheme was hugely successful, netting the modern-day equivalent of billions of dollars. In fact, MacGregor, the self-declared Prince of Poyais, was so skillful in his pitch that hundreds of Scottish citizens decided to uproot their lives and set sail for Central America, where Poyais was supposedly located. Upon arrival, they found a mosquito-infested swamp.
The temptation is to assume such schemes are “old-timey,” and that modern investors are too sophisticated for that kind of thing.
But then we remember Enron, WorldCom, 1Malaysia Development Berhad, and Bernie Madoff — all massive schemes of a modern vintage — and the feeling of superiority vanishes.
And now we have the nuttiness of June 15, 2020, in which a company worth zero served up a new share offering worth $500 million.
To quickly review, Hertz Global Holdings — symbol HTZ on the NYSE — is a rental-car company that had long been struggling, and finally went bust as a result of the pandemic.
On May 22, Hertz filed for Chapter 11 bankruptcy. This meant that Hertz, with roughly $19 billion in debt and an inventory of 700,000 rental cars, would cease to exist as a business, and would distribute its assets to creditors in lieu of repaying the debt.
In a Chapter 11 bankruptcy, the deceased company typically conducts a fire sale, and the creditors are first in line for repayment from that fire sale.
If all the assets are distributed before the creditors are paid off — if, for example, the bond holders only receive 30 cents on the dollar by the time the assets are all gone — then equity holders get nothing.
This is why, in general terms, the share price of a company in Chapter 11 bankruptcy should be zero. There are rare exceptions where the shares of a bankrupt company can retain value, even after bankruptcy proceedings are completed.
But this only happens if the realized value of the assets post-bankruptcy exceeds the total amount owed to creditors. That almost never happens ever.
With Hertz, the odds are essentially zero — there is basically no way the company’s remaining assets will cover $19 billion worth of creditor claims.
That means the value of Hertz shares should be zero, too, barring a bizarre miracle, and it explains why investing legend Carl Icahn dumped his sizable Hertz stake for a painful 10-figure loss.
Except — and here comes the twist — in the magical land of Robinhood, a zero-commission stock-trading app, an army of retail investors has congregated to bid up the value of Hertz shares.
In recent days, HTZ and a handful of other Chapter 11 names have seen their share prices register stratospheric share-price gains — all because of speculative retail buying, with a concentrated portion of that buying tied to Robinhood.
HTZ in particular went from a May 26 low of 40 cents to a June 8 high of $6.25.
This surge of more than 1,400% was based entirely on the “greater fool” theory — the plan of selling out to the next guy, who is hopefully a bigger fool — because at no point had the situation actually changed.
As a result of Chapter 11 bankruptcy, under the weight of huge debts, Hertz shares had a realistic terminal value of zero; when Robinhood traders started using HTZ as a football, that value did not change.
And now we get to the events of June 15, in which the 2020 Lockdown Mania officially gained a footing in financial history books.
The creditors of Hertz, who are facing a nasty loss, but still want to claw back as much of their $19 billion as possible, asked a reasonable question: “If these Robinhood types are willing to bid up HTZ shares worth nothing, why not sell them even more HTZ shares worth nothing?”
And so, on June 12, Hertz received approval to issue up to $1 billion in new equity shares — for a company that is — still — worth zero, because all of the value will likely be assigned to creditors.
Hertz management decided to go with $500 million worth of new issuance rather than the full $1 billion. We don’t know why — to avoid overwhelming the market, perhaps — but either way, the deal is going through.
In a rational configuration of the market, no bankrupt company with a massive debt overhang would ever issue new equity shares — because no rational investor would ever purchase those shares. What would be the point? The business no longer exists. With Chapter 11 bankruptcy under way, an asset fire-sale plan is already being drawn up. New investor funds would just go to creditors, helping to make the creditors more whole.
The Hertz creditors know this.
But they also know that Robinhood investors — or some other group of investors out there — appear willing to buy HTZ for no reason at all, or for reasons having to do with memes and chat rooms — but nothing that is tied to net asset value.
In a very real way, this is the most brazen and ridiculous event in the history of all financial markets.
Because, at least with all the other manias and bubbles and schemes, the speculators were chasing an implied opportunity to profit.
In every other case, there was at least the hypothetical chance of making a lot of money, or the implied promise of such, if the investment actually worked out.
But with the Hertz offering, there is no chance of making money, and no promise of gain whatsoever.
Instead, it is just a straight-up wager that those now punting HTZ will keep on punting it, no matter what, and that if someone yells in their ears, “Why are you buying this stock? It is literally worth nothing!” They will either not hear, or refuse to care, or buy more just for fun.
In all the schemes that came before, there was a hypothetical pot of gold at the end of the rainbow.
Now, there isn’t even a need for gold, or a rainbow, or a pot. And the whole thing is legal.
“As an intellectual proposition, most securities experts had always thought you could offer garbage for sale to the public as long as you said, ‘We are offering you garbage and you really shouldn’t buy this, but you have a chance to buy it,’” said former Securities and Exchange Commission head Harvey Pitt. “No one ever really anticipated that people would be gullible enough to do that.”
Well, here we are. Hertz spells it right out in the legal language.
In the June 15 prospectus — which you can see here — there is a section that reads:
“We expect that common stockholders would not receive a recovery through any plan unless the holders of more senior claims and interests, such as secured and unsecured indebtedness (which is currently trading at a significant discount), are paid in full.”
In plain English, that more or less means: “Unless the creditors are made whole, you (the equity holder) are signing up to get zero — and the way the debt is trading, it is forecasting shares worth zero. Enjoy!”
In these truly remarkable times, the creditors of Hertz are channeling the spirit of Canada Bill Jones: “It’s immoral to let a sucker keep his money.”
Can you blame them though? $500 million is no small sum. Except, perhaps, to Robinhooders.