J.P. Szafranski, BridgeTower Media Newswires
How many times have you heard or said the word “weird” so far in 2020? It might be the word of the year.
Plenty of adjectives can describe the recent onslaught of collectively experienced events. Scary. Confusing. Frustrating. Upsetting. For today, let’s stick with weird.
This year’s financial markets are next-level weird. Stock markets speedily trekked from complacent, boundless optimism in January, to absolute panic and end of days Armageddon market action in March, all the way back to some strange sort of euphoria as we enter the summer months.
You may have heard that Hertz filed for Chapter 11 bankruptcy recently. Given the rental company’s significant debt and obvious linkage to travel, it shouldn’t be too surprising. That’s not the weird part.
Chapter 11 bankruptcies are meant to be a reorganizing process where a borrower receives temporary protection from its debt obligations while continuing to operate. Upon filing, anyone owed money by the entity lines up in court to seek repayment. Different types of creditors receive different levels of priority to their claims. Bankruptcy law can be highly complex, but its big-picture principles are quite simple.
Typically, after a Chapter 11 filing, a company will seek new debtor-in-possession financing, which receives absolute priority to be repaid first upon emergence from Chapter 11. After the DIP loan is repaid, all other claims are sorted out. Importantly, all lenders must be repaid in full prior to a company’s stockholders receiving any value. A company’s pre-bankruptcy lenders are typically granted new stock in the fresh, post-bankruptcy entity as a form of loan repayment, often leaving little, if any, value for the old stockholders. Most pre-bankruptcy shareholders end up holding nearly worthless pieces of paper.
Upon filing, Hertz’s stock price fell far below $1 per share. Remarkably, by early June, apparently lifted by a wave of optimism, the stock increased in value by tenfold. This prompted a company plan to forego the typical DIP loan process, instead launching an effort to raise fresh cash by selling up to 176 million brand-new shares of the bankrupt entity to investors willing to line up at the back of the bankruptcy repayment line.
This is wild. In the offering document, the company is very clear about the risks:
• We are in the process of a reorganization under chapter 11 of title 11, or Chapter 11, of the United States Code, or Bankruptcy Code, which has caused and may continue to cause our common stock to decrease in value, or may render our common stock worthless.
• We expect that common stock holders 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, which would require a significant and rapid and currently unanticipated improvement in business conditions to pre-COVID-19 or close to pre-COVID-19 levels.
• They are implying that they have every expectation that what they are selling could quickly end up worthless. Weird.
While unlikely, it is possible for a bankrupt company’s shareholders to end up receiving value. It happened for American Airlines shareholders last decade. Let’s take a quick look at American today. TSA checkpoint numbers show U.S. air traffic has more than doubled in a month, which is great. But even with that growth, June 15 traffic was 80% below the same day last year. American Airlines is a long way from profitability. Its stock price is up nicely since March. At this writing, American’s Enterprise Value (which accounts for total value of net debt and stock) is estimated at $41.8 billion. On Dec. 31 that same (pre-COVID) metric was $41.9 billion. Hmm. Weird.
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J.P. Szafranski is CEO of Meliora Capital in Tulsa (www.melcapital.com).
