Last Tuesday, Hertz (NYSE:HTZ) reached a temporary $650 million deal with its creditors to reduce its fleet, which would save roughly $80 million a month. Hertz stock holders cheered, sending shares of the bankrupt company up almost 30% within a matter of minutes.
Hertz stock sign in Montevrain, France on May 8, 2016.
Source: aureliefrance / Shutterstock.com
These gyrations were just the latest in a months-long saga. Despite declaring bankruptcy on May 22, Hertz has seen a resurgence in retail investor interest. Since then, 125,000 investors on Robinhood, a popular phone-based trading app, have rushed to buy stock in the highly indebted company. As younger, risk-seeking investors have shaken up the market, Hertz has come to signify the dangers of investing in the Robinhood era.
How did this happen, and what should investors do?
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Hertz Stock: How Did a 102-Year-Old Company Go Bankrupt?
In 2012, Hertz acquired Dollar Thrifty for $2.3 billion to compete with larger rival Avis Budget (NASDAQ:CAR). The acquisition saddled Hertz with an ever-growing pile of debt. By 2020, the company held almost $19 billion directly and through a series of financial contracts.
Before the coronavirus pandemic, Hertz’s house of cards was already on the verge of collapse. The near shut down of the travel industry in March and April finished the job.
“All the money spent on overpriced mergers and acquisition, the questionable fleet management,” said Glenn Reynolds, co-founder of research firm CreditSights, “it caught up with them.”
Yet, investors held out for hope. Despite repeated warnings from analysts, retail investors piled into Hertz shares at record rates, pushing the stock from 56 cents on May 26 to $5.53 on June 8.
Pump and Dump, Robinhood Style
Investors jumping into valueless companies is nothing new. From the boiler rooms of the 1980s, to the pump and dump schemes of the 2000s, stock promoters have often found an audience looking to make a quick profit.
How did these schemes work? Stock promoters would often quietly buy up shares of micro-cap companies and then release positive news articles on blogs or websites. The most sophisticated con-artists would also make large buy orders with their own money to temporarily boost share prices.
These schemes often temporarily fooled investors and algorithms alike, creating miniature feeding frenzies over worthless companies. In the hysteria, promoters would quietly sell their shares, leaving unwitting investors holding the bag.
A Case of Mistaken Identity: ZOOM vs. ZM
With the democratization of investing through Robinhood and other free-to-trade apps, stock bubbles have increasingly happened without the help of stock promoters.
In early March, shares of OTC company Zoom Technologies (OTCMKTS:ZOOM) underwent an extreme case of mistaken identity. Company shares, with the ticker ZOOM, rose 1,800% before the SEC froze trading. Investors were presumably trying to buy shares of video-conference company Zoom Video Communications (NASDAQ:ZM). When the hapless OTC company resumed trading two weeks later under the new ticker ZTNO, prices fell back under $1.
Other cases of mistaken identity have happened before. According to the New York Society of CPAs, mistaken identities in stock tickers cost investors $1 million annually. But as trades like ZOOM/ZM become more common, the impact will undoubtedly rise*.
Hertz Stock – Confusion between ZOOM vs ZM graph
Source: Data courtesy of WSJ Markets
Hertz Becomes the Center of Attention
Considering this backdrop, it’s hardly surprising that stock in Hertz became an attraction for return-hungry investors. The day after Hertz’s bankruptcy, 11,000 new Robinhood investors bought shares. And just like investors in pump-and-dump schemes of decades before, traders got swept up as interest grew.
In a self-reinforcing cycle, shares continued to rise as more investors piled in, causing even more significant gains. In the weeks following Hertz’s bankruptcy, shares shot up 900%.
Professional investors watched in horror. With a high debt load and multiple senior creditors, Hertz was unlikely to have any cash left for common shareholders. “We moved our Base Case to $0 after the equity issuance was cancelled,” Morgan Stanley automotive analyst Adam Jonas wrote on June 22. “The company may exhaust available cash to run the business by the end of 2020, potentially leaving the equity with little or no residual claim.”
Eventually, the warnings of professional analysts proved right. As the flow of new investors dried up, Hertz’s shares started to falter. By July, HTZ had sunk back to $1.45, wiping out $580 million of investor capital.
Where Robinhood Day Traders Leave Regular Investors
How did the market get Hertz wrong? A lack of sellers was undoubtedly a key factor.
Sudden spikes in share prices make short-selling risky, even for professional traders. No short-seller ever wants to find themselves in a “short squeeze,” a situation where rising prices force traders to cover positions at a loss. With no investors willing to sell, markets begin to lose price discovery: the ability of markets to work out a stock’s value. As day trading becomes cheaper and more prevalent, investors should expect higher volatility in big-name stocks.
So what can investors do? Here are three essential tips. First, don’t get caught up in the mania. It’s tough to sit still, especially when you’re watching others make money. But it’s the right thing to do. Second, don’t short-sell companies in the news; even famed short-seller Carson Block won’t short Tesla because of its upside risk. “Markets can remain irrational longer than you can remain solvent,” famed economist John Maynard Keynes once quipped. And finally, invest for the long term. The Hertz saga might have been the most recent speculation case to unnerve experienced investors, but it’s certainly not going to be the last.
*While it’s impossible to know how much Robinhood investors lost in fees and slippage due to the trading platform’s opaque disclosures on payment for order flow, we do know that the confusion generated $100 million of trading in ZOOM shares. Slippage rates in OTC stock companies can be as high as 5.5%, suggesting in losses approaching $5.5 million in the worst case. At 0.5% slippage, $500,000 would still have been lost.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing. As of this writing, he did not hold a position in any of the aforementioned securities.
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