Retail Investors Take Hertz for a Spin

When Hertz Global Holdings Inc, the cornerstone of the car rental industry, declared bankruptcy on May 22nd as the latest victim of COVID-19’s devastation to the travel sector, its stock predictably plummeted to a record-low of 56 cents per share. By June 8th, this price had inexplicably skyrocketed to $5.53. As every institutional investor knows and the SEC reiterates, buying stocks of Chapter 11 bankrupt companies is “extremely risky and likely to lead to financial loss,” as the enterprise’s obligation to pay back creditors before shareholders usually results in a substantial dilution or cancellation of existing equities barring a quick and significant comeback. Reeling from this never-before-seen spike in demand for Hertz’s most likely worthless share, analysts quickly discovered the culprit of this bizarre behavior: welcome to the world of Robinhood, the facilitator for the retail investor.

Founded in 2014 by two Stanford roommates, the app Robinhood proposed a plan to democratize the stock market by eliminating the costly trading fees for the amateur investor and providing an accessible platform to entice young consumers, with an average customer age of 26. Quarantined at home, users quickly increased activity on the site as the March 2020 market crash enticed many to buy-in while prices were low. Although rife with glitches and controversy, novice traders continued employing bullish and risky strategies on the platform, leading to a string of bizarre market trends. When Hertz declared bankruptcy, Robinhood users holding stock in the car-rental giant increased by 96,000 according to Robintrack, which monitors the holdings of Robinhood users but is not affiliated with Robinhood, raising the total number of holders from 37,000 to 159,000 in a little over a month.

Although the reasoning behind this surge varies, the name recognition of Hertz might have enticed novice Robinhood traders, some of whom jumped at the chance to buy cheap shares in a well-known company without reading into the state of its proceedings, and others who were willing to bank on the chance that Hertz would make a full recovery without considering the consequences to the travel industry of a nearly guaranteed second-wave of COVID-19. This resulted in investors playing musical chairs, scrambling to buy and sell higher before Hertz shares inevitably hit rock bottom, leaving those still holding stock facing a significant loss. As sales increased, more and more swarmed the stock, compounding the sky-rocketing price and inflating the value of the bankrupt company in a self-fulfilling prophecy fueled by Reddit threads and bullish attitudes.

This unusual stock rally gave Hertz an unprecedented idea – with hundreds of thousands of newly self-proclaimed day-traders rushing to buy into the surging market, the company petitioned to sell over $500 million dollars of soon-to-be worthless shares to the public. The bankruptcy judge, ruling in the interests of the creditors, approved the plan. As a requirement for the SEC, Hertz released a prospectus disclosing details of the offering as well as performance, strategy, objectives, and other information about the company – usually a pitch to demonstrate the value of the share sale to investors. However, this prospectus served as more of a buy at your own risk disclaimer indicating shares might well be wiped-out. In a six page “Risk Factors” declaration, Hertz reiterates again and again that its stock will likely fall to zero, writing: “there is a significant risk that the holders of our common stock, including purchasers in this offering, will receive no recovery under the Chapter 11 Cases and that our common stock will be worthless.” But Hertz understood that the band of eager retail investors would most likely never read this disclosure or just buy the shares with a hope to sell higher, so the company banked on potentially wiping out an entire cohort of Robinhood amateurs to raise funds for its creditors. 

That is, until the SEC stepped in. Although not blatantly illicit, the share sale raised some eyebrows. As attorney Thomas J. Salerno, who represented the owners of the bankrupted Phoenix Coyotes Hockey team, puts it in an interview with Bloomberg: “There is a reason this hasn’t been done before. How can you sell stock then take the position later that you can’t pay all your creditors? It’s either fraud in plain sight, or an admission the company isn’t really insolvent.” Under SEC scrutiny, Hertz halted its cynical–although admittedly brilliant - ploy.

While some cite the recovery of the used car industry and an increase in air travel as a potential path to profitability for Hertz and with it a hope that maybe retail investors are not “dumb money” after all, there is a reason hedge fund billionaire Carl Icahn sold his 39% stake in Hertz, taking a $1.6 billion dollar hit. With Hertz admitting in their prospectus that they “have not yet negotiated a plan of reorganization with our creditors,” the company risks moving to a case under Chapter 7 bankruptcy, which would result in a complete liquidation of assets and no payout for shareholders. Barring a miraculous comeback, Hertz may have reached the end of a century-long run as one of the most notable car rental agencies in the industry. But Robinhood and its cohort of retail investors are just getting started on their retail buying frenzy.