• One Hat Research LLC

Why Hertz ($HTZ) is Going to Zero Almost Surely

There is a concept in probability theory called "almost sure convergence" that deals with the probabilistic limit of a random sequence. I borrow from that idea for the title here because Hertz common stock is almost surely converging on $0.

Hertz filed for bankruptcy protection on May 22, 2020, a victim of poor management and the COVID-19 pandemic. By that time, Hertz senior unsecured bonds were already trading at a deep discount reflecting the bond market's belief that unsecured debt would not be paid in full as shown in the following chart.

Notwithstanding the bond market's pricing, Hertz common stock has continued to trade. The following chart shows the stock price of $HTZ, with red corresponding to trading while the bonds are discounted to par as above):

As seen here, stock can continue to trade at positive prices if at least some traders believe a recovery for equity is possible. What is interesting about Hertz stock, however, is how deeply insolvent the company is according to bond prices. The price of Hertz stock likely reflects some small value due to rational belief in a miracle event that renders the company solvent or a miracle bankruptcy deal that leaves some value for shareholders, but also likely reflects the irrational beliefs of many Hertz stockholders that a recovery around the amount discounted in the price is likelier than it is.

Listen to the Bonds, Not the Stock

The question, of course, is whether one should listen to the stock or the bonds. The stock says the equity is worth more than $1/share. The bonds say the stock is worthless.

The bonds are almost surely right and the stock is almost surely wrong. How do we know? The main reason is the relative ease with which bond buyers - who tend to be hedge funds and other institutional investors who are more sophisticated in their tracking and analysis of bankruptcy recoveries than stock traders - could push up the value of Hertz bonds if that was warranted. Betting that the price of Hertz bonds is too low requires only buying more Hertz bonds, which is easy. The fact that the most sophisticated traders could make an easy trade to capture upside if it existed suggests that it does not exist. By contrast, the cost of shorting/buying puts is relatively high and the put market is thin with high bid-ask spreads.


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