The Inefficient Market Hypothesis: How Hertz Became the First Meme Stock

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Over the next few weeks and months, several of my pieces will focus on what I like to call “The Inefficient Market Hypothesis,” where I’ll be covering some of the most ridiculous stories from financial markets over the last few years. This is the first of such pieces, enjoy!

In Monday’s piece, I discussed how retail traders have been dumping millions of dollars into yet another bankrupt company’s stock, turning trucking company “Yellow” into the hottest meme stock on the market.

After finishing that piece, I began to wonder when this pattern of YOLOing one’s money into bankrupt and/or flailing stocks began. I understand the allure of lottery tickets and roulette wheels, but public bankruptcy announcements hardly seem like the right place to risk it all.

Seriously, why would you ever, ever, throw your life savings at a bankrupt stock?

And then it all made sense: the reason that so many “investors” have been willing to go full-send on these bankrupt meme stocks is because three years ago, Hertz went bankrupt, and the investors who weathered that storm got PAID.

Should this have worked? Nope.

Was it ill-advised to invest in a 🗣️ BANKRUPT RENTAL CAR COMPANY DURING A PANDEMIC??🗣️ Absolutely.

Did it work anyway? 100%.

Buckle up for the story of the grandfather of all meme stocks: Hertz.

Let’s turn back the clock to the spring of 2020. The world was coming to an end, air travel had ground to a halt, and no one was leaving their homes. Considering that the only people who rent cars are travelers, and travelers no longer existed, rental car companies were toast.

By the end of April 2020, Hertz was missing lease payments on its fleet. On May 18th, CEO Kathryn Marinello stepped down, on May 22nd, the company filed for Chapter 11 bankruptcy with $18B in debt, and on May 27th, activist investor Carl Icahn took a ~$2B loss by selling his Hertz stock for $0.72 per share.

Why did Icahn sell his shares? Well, typically when companies file for bankruptcy, one of two things happens:

1) The company is liquidated, in which case creditors (first secured, then unsecured) are paid the proceeds from the now-liquidated company, and equity holders are wiped out.

2) The company is reorganized as either the current creditors or a 3rd-party ownership group take control of and continue to operate the bankrupt company, its debt is restructured, and equity holders are once again wiped out.

Tl;dr: when a company files for bankruptcy, equity holders are toast. Icahn saw the writing on the wall, cut his (now enormous) losses, and moved on.

But then something strange happened. A collective group of retail investors, affectionally known to the broader media as “Robinhood traders,” for their propensity to use this gambling app masquerading as an investing platform, decided that a bankrupt rental car company was actually a sound investment!

After bottoming at ~$0.60 per share, Hertz, a company that, in the course of a few weeks, had lost its CEO and biggest investor while filing for bankruptcy, climbed 800%.

Why were they buying the stock? I have no idea. I would speculate that retail investors who weren’t aware of typical bankruptcy proceedings looked around and thought, “Hmmm. Well, it turns out that we aren’t all dead yet, and it looks like people are still driving. And maybe domestic air travel, while on life support, is still sticking around. Let’s buy the stock.”

And a decision was made by relying on vibes and ignoring financial data (such as, you know, the billions in debt obligations that Hertz failed to pay).

Other theories emerged as well, such as investors possibly believing that Hertz was an acquisition target because other rental agencies were looking to buy Hertz’s vehicles (which is quite different from them looking to buy Hertz itself!)

Whatever the reason, Hertz’s management team didn’t seem to care, and they planned to capitalize on this Wall Street Bets-fueled market rally. On June 12th, after the stock had risen nearly 1,000% from its lows in a matter of weeks, the bankrupt company received court approval to raise $1 billion (yes, billion with a “b”) worth of new shares, and three days later, they announced a $500M stock sale.

They also noted in the prospectus that they were “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.”

Basically, “Buy our stock! but it probably won’t be worth much for long.”

An outrageous and incredible move. Chef’s kiss.

Of course, the stock mooned 69% on announcement.

The SEC, realizing that it probably wasn’t great for a company to sell $500M of worthless equity to retail investors, soon intervened, shutting the whole process down before Hertz had raised more than $29M.

Companies that file for bankruptcy are typically delisted from their respective stock exchanges as well. This makes sense, considering that the equity is quickly becoming worthless, and the NYSE doesn’t want a bunch of $0s being traded back and forth.

That’s what crypto exchanges are for!

On October 29th, 2020, Hertz was officially delisted from the New York Stock Exchange and banished to the realm of ‘over-the-counter’ and ‘pink slip’ stocks.

After being delisted, Hertz (now represented by the disgraced HTZ’Q’ ticker) bounced between $1 and $3 per share, until it filed a Plan of Reorganization in March of 2021.

Under the terms of this plan, investment firms Knighthead Capital and Certares would invest up to ~$4.2B at a ~$4.9B enterprise value, and Hertz would continue operating. While the company’s junior bondholders would receive either $0.70 on the dollar in cash or have the opportunity to buy into equity in the new company, current equity shareholders would be wiped out. Hertz shares, now soon-to-be worthless, once again fell below $1.

But the world was looking a little brighter in spring 2021. We had a vaccine, travel mandates were starting to be lifted, and flights began to pick up once again. The Knighthead Capital and Certares deal was starting to look cheap.

Much like a once-unattractive high school senior who now found herself on the homecoming court, Hertz was quickly attracting numerous suitors, and a bidding war emerged.

By mid-April, the car rental company had ditched the Knighthead deal for a new offer from Centerbridge, Warburg Pincus, and Texas billionaire Tom Dundon.

Both sides continued to increase their bids until May, when Hertz ultimately chose a new bid from Knighthead and Certares that included $5.9B of new capital and, amazingly, an ~$8/share payout for existing shareholders.

Yes, shares that were, as of three months earlier, worthless, were now worth $8. And yes, any investor who purchased Hertz’s bankrupt, delisted shares at any point would have realized insane returns, and anyone who bought the ~$0.50 dip in March on the news of the first deal proposal could have received generational wealth.

All you had to do was buy a bankrupt company on the news that they were considering a deal that would send the stock to $0. Seems bullish, no?

The Hertz situation is fascinating because it set the stage for every meme stock that we’ve seen since. The worse the financial situation, the more retail investors want to throw cash at the “moonshot.” If you missed out on Hertz, why not try your luck with Bed Bath & Beyond? Yellow? Some other bankrupt company on the verge of delisting? I mean yeah, it should go to zero. But what if it doesn’t?

Anyways, shill me some companies that are 100% going bankrupt. My personal favorite is Nikola Motors.

- Jack

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