On October 16, Hertz Global Holdings (HTZ) traded over 1 billion shares as the stock price soared 143% from $1.03 per share to $2.50 and traded as high as $2.86 because of irrational trading. Robinhood speculators and program traders are being blamed. There was a major news story about the $1.65 billion DIP financing, but DIP financing news is, in my opinion, actually a negative. Another possible reason for the stock price action is that the HTZ shares were not delisted from the NYSE.
Deja Vu All Over Again – Irrational Trading
Hertz stock soared on volume of 1,032,229,000 shares on Friday. Even other bankrupt companies, such as Chesapeake Energy (OTCPK:CHKAQ) +25%, and potential bankrupt companies’ stock prices rose sharply in sympathy with the HTZ trading. Evidently, speculators, who most likely include many who trade on the Robinhood platform, interpreted the $1.65 billion DIP filing as good news that banks and funds are willing to loan to bankrupt Hertz. The reality is it is bad news. It means Hertz is burning cash and could be Ch.11 for a very long time. It shows that Hertz needs cash – a lot of cash. In addition, most program trading models do not even factor in court filings and other news in their trading decisions, which accelerates irrational trading by other speculators.
DIP Financing Terms
The terms of the expected DIP financing (docket 1523) was filed on October 16. The amount of $1.65 billion was higher than expected. It was even higher than the September “DIP Overview Materials” (8-K) estimates of either $1.1 billion, using 250k vehicles by end of 2020 or $1.5 billion, using 310k vehicles by the end of 2020.
The interest rate of LIBOR+7.25% is in line with other DIP rates and there isn’t anything unusual about covenants or other terms. While they had to go through the process of trying to get the best deal, the group associated with 1lien debt holders, as usual, were selected, because Hertz needed 1lien’s consent for priming the DIP loan liens on 1lien’s collateral.
An interesting milestone is that they must “file a Chapter 11 Plan with the Bankruptcy Court by no later than August 1, 2021.” While this does not necessarily mean they will wait until August 1, 2021, to file, it does imply that the primary parties are expecting a long time before they finally file a plan.
A hearing to approve the DIP is currently set for October 29. It will be interesting to see which stakeholders, if any, file objections and what they are specifically objecting to in the DIP agreement. There is also a hearing set for October 20 to approve the Key Employee Incentive Plan (docket 1153), when there could be discussion about the new DIP financing filing.
Reasons For DIP Financing
There are basically two primary reasons for the $1.65 billion DIP loan. First, they are burning cash. Second, they need money to replace older vehicles. As Hertz’s investment banker stated, “The Debtors have limited cash available to maintain current day-to-day operations and currently project that they will have insufficient available cash to fund their working capital needs by December 2020.” (docket 1524). This is in stark contrast to when they filed for bankruptcy on May 22 and did not try to get any new cash from DIP financing because they thought that they had enough cash available.
While these two monthly operating reports – MORs – are a little old, they do give some insight into the cash burn. Hertz burned through $242 million during August alone by comparing the two different total ending monthly cash balances.
Source: August MOR docket 1394
Source: July MOR docket 1313
The $1.65 billion DIP financing plus the cash currently on hand is “projected to provide the Debtors with the necessary liquidity to continue operations through 2021.” (Docket 1523). I have doubts about this projection. If the $999 million cash at the end of August will be burned by December (just a 3-4 month period), how can $1.65 billion get Hertz through 12 months, especially after factoring in the additional interest on the actual DIP cash borrowed that must be paid during that period?
Uses Of DIP Funds
According to the terms of the DIP agreement, Hertz can “use of up to $800 million of the $1.65 billion DIP Facility for working capital and general corporate purposes” and “up to $1.0 billion can be used for equity toward new interim fleet financing, giving the Debtors the future ability to replenish their fleet of cars.”
On page 74 of 81 of docket 1523-3, there is a more detailed description of new fleet financing allowed. Hertz can use the DIP “to fund ongoing ABS fleet lease payments, purchase fleet Vehicles, provide additional liquidity and to contribute capital into new fleet acquisition Special Purpose Subsidiaries.” They, therefore, seem to have quite a bit of flexibility. What I find interesting is that The Hertz Corporation, that actual borrowing entity, can directly buy vehicles and does not have to indirectly use “special purpose entities” to buy them and lease them back.
Latest Financial Results
The latest detailed operating results are contained in the August Monthly Operating Report – MOR (docket 1394) filed on September 30. (It is important to remember that MORs do not follow GAAP reporting requirements.) While the August operating report shows some improvement from July (docket 1313), when there were more widespread travel and business opening restrictions, there still were large losses at the Hertz Corp. level of ($100 million) and at the total Debtor entities level of ($48 million).
Source: August MOR docket 1394
Source: July MOR docket 1313
Projections were included in the “Dip Overview Material.” Often these types of sales promotional material are, in my opinion, not reliable and are unrealistic.
(Note: “Lower-for-Longer Scenario” assumes 250K vehicles by end of 2020.)
I think the financial projections for 2021 are not realistic at all. The utilization rate of 79% is only slightly lower than 80% in 2019 and 81% in 2018 (Source:10-K). While the fleet will be smaller in 2021 than in prior years, I just can’t imagine that they will be able to manage their fleet locations at that high level. In 2021, there still could be constant changes in various business openings and travel restrictions from one area of the country to another. You could have a lot of vehicles in a specific area, expecting high demand, and then that area gets some new restrictions, especially early in 2021.
Impact On Noteholders
Not only are the HTZ shareholders being irrational about pricing, I think buyers of both the 2lien notes and unsecured notes are also being irrational. It is important for note buyers to remember that the current price of the notes may not reflect what they actually receive as a recovery under Ch.11 reorganization plans. For example, the recovery for the $1.235 billion 2lien noteholders of Windstream Holdings was only “cash in an amount equal to $0.00125 for each $1.00 of Allowed Second Lien Claims.” (Windstream Holdings disclosure statement docket 1813). Those Windstream 2lien notes were trading in the low 70’s about 8 months prior to the filing of their Ch.11 reorganization plan. I am not asserting Hertz 2lien noteholders will only get pennies, I am suggesting caution.
At the time of the Hertz bankruptcy filing, there was about $1.271 billion in 1lien claims with priority over 2lien notes (Plus, there will be significant bankruptcy administrative claims that will also have priority.) In addition, there was about $350 million in 2lien notes that will have priority over the $2.727 billion in unsecured note claims, but there will also be a significant amount of general unsecured claims that most likely will have the same priority status as the unsecured notes. The problem for noteholders is now there could be $1.65 billion additional more claims that have priority status. So instead of $1.271 billion (plus administrative claims) there could be up to $3.921 billion (plus administrative claims) ahead of 2lien note claim holders.
There could be some “gifting” to the lower priority classes of 2lien note claim holders and unsecured note claim holders, but I do not recommend investing in debt securities hoping for a gift as part of the recoveries under a Ch.11 reorganization plan.
October 15 Delisting Hearing
Hertz appealed the delisting notice they received because the company “is no longer suitable for listing pursuant to NYSE Listed Company Manual Section 802.01” (8-K filing). According to various other filings months ago, there was to be a hearing on October 15 regarding this delisting appeal. There has not been any press releases or notifications regarding if there was a hearing or the results. There was also no delisting update on the NYSE website. Hertz traders, therefore, may have assumed that NYSE would not actually delist HTZ. This could be considered a positive development that motivated speculators to bid up HTZ on October 16. There also could be some traders who shorted HTZ anticipating a delisting notification after the October 15 hearing, and closed their positions after there was no such notification posted.
In the past, when I tried to get information from the NYSE about Hertz and potential delisting, I received the typical “we do not make comments.”
Ad Hoc First Lien Group
Source: Docket 1520
I do not think too many people were shocked that irrational trading in HTZ stock and stocks of other bankrupt companies happened again. The problem is that no regulatory body does anything. I personally have concluded that opening of new positions in securities of bankrupt companies should be restricted to only accredited investors and institutional investors. Retail investors should only be allowed to close their positions.
I think the huge $1.65 billion DIP financing is a major negative that indicates that Hertz will continue to burn cash well into next year. Their projections for 2021 are unrealistic in part because they assume a 79% utilization rate. The additional $1.65 billion pushes lower priority claim holders further under water for any recovery. I rate all Hertz securities a sell.
Disclosure: I am/we are long CHK NOTES. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.