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Why is Everyone Freaking Out about Hertz Issuing Equity in Bankruptcy? I Break It Down $HTZ #COVID19
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Well, it happened. Hertz is cleared to issue equity in bankruptcy on Friday, June 12. This is a monumental day (which I live tweeted the hearing process on my twitter for those interested). Companies issue equity all the time – why does anyone care that Hertz is issuing equity in bankruptcy.

To put it simply: because the equity is likely still worthless.

Now, I can back up. Hertz was already highly leveraged coming into the COVID19 crisis, but the economy was good. Perhaps Hertz could manage its way through its debt problem.

When people stopped traveling due to COVID19, that crushed demand for transportation, especially rental cars which are typically picked up at airports. In addition, the pressure on the economy meant that the “residual value” it receives for cars coming off lease was also diminished (i.e. used car sale prices went down).

Here is how Hertz described it in their bankruptcy filing:

Typically, when a company goes bankrupt, its stock will still be listed for a little bit of time, but it will not be worth anything. It will trade, but its  typically much smaller amounts. It is just waiting to be delisted.

There are a few exceptions to this such as W.R. Grace. Grace filed for bankruptcy because of growing asbestos liabilities, but did not have solvency issues. The equity continued to trade and had value. It had value because the value of the business after all liabilities were paid was still greater than zero. There aren’t many other cases I know of like this except maybe General Growth Properties, which Bill Ackman was involved in.

Another example is American Airlines when it last filed for bankruptcy. The equity was initially deemed to be zero, because unsecured creditors were not going to be made whole, but valuations moved up and that created equity value in bankruptcy.

So why is Hertz issuing equity in bankruptcy different?

First, it still seems pretty clear that the market is saying the bonds are not going to be made whole. Let’s look at the trading prices and also discuss the “waterfall.”

Here is a Hertz unsecured bond. You can see that pre-covid, investors essentially deemed it likely that Hertz would pay the money back and they would be made whole. These bonds traded from par to a low of 12 cents on the dollar, but some others traded as low as 9 (before bankruptcy, bonds that mature earlier than others are said to have temporal seniority – i.e. the company will try to take those bonds out first, so you at least have some chance or option value to make out better than later-maturing classes).

Trading at 9-12 cents on the dollar means the bonds are saying that’s likely what their recovery in bankruptcy would be. Pretty simple – bond investors wouldn’t just sell a bond at 10 cents on the dollar for no reason. The coupon on these bonds was 6.25% too so the market with such a low price was implying in March and April already that they wouldn’t pay another coupon.

Here’s an example “waterfall” chart. It’s simplistic, but the point is to say, if there is no value after the secureds are paid off, senior unsecured creditors get nothing.

Here’s another way credit debt investors draw it out. I’m showing 3 scenarios that hopefully are self-explanatory enough:

This math is why it is so crazy to people that Hertz is issuing equity in bankruptcy.

Even with all the positive news (for creditors) that Hertz is issuing up to $1 BILLION in bankruptcy, the bonds are still at less than 50 cents on the dollar. That implies the bonds are still in the hole by 50%. So Hertz may raise a $1 billion of equity that may immediately be worthless.

The  thought that maybe issuing equity increases option value of the equity might be a little crazy too. At this point, it is still hard to argue that the unsecureds are going to be made whole here. Even if they rise to 65, 70 cents on the dollar that is still the case. The market started to improve for GGP from 2009 to 2010, but its bonds also snapped up to 100 cents on the dollar.

It also hard to say right now that the operating environment will improve in such a strong way that Hertz will increase in value. Valuations are conducted on a 5 year view anyway (i.e. no one is valuing Hertz solely on trough 2020 earnings – they essentially do a DCF) so it seems unlikely to me they aren’t already including some strong rebound next year.