Now that Hertz (HTZ +0.00%) has officially filed for bankruptcy, and its stock price has plunged under $1 per share, many investors are asking themselves if it's time to buy shares in hopes that the company restructures and rebounds when travel restrictions related to the coronavirus pandemic are lifted.
Unfortunately, that's not exactly how it works, and if you buy Hertz stock right now, you'll very likely be left holding the bag. Let me explain exactly what's happening with Hertz stock right now and discuss one clear reason why you shouldn't buy.
Should you buy now?
No! You should not buy Hertz stock right now, no matter how tempted you are by its massive plunge in price. If you take only one thing away from this article, it should be not to buy Hertz stock right now.
But why steer clear of Hertz stock? After all, it's not unheard of for companies to rebound after filing for bankruptcy. The explanation starts with understanding Hertz's debt problem. Hertz has roughly $19 billion in debt, and the vast majority of that debt came from bonds issued to purchase its fleet of vehicles. Now, this debt is secured by the vehicle assets, but that means Hertz essentially made a gamble that revenue would continue at a normal rate -- enabling it to operate and service debt payments -- and that the value of its vehicle assets would remain stable.
COVID-19 came out of nowhere and threw a wrench into Hertz's (and the broader automotive industry's) plans. As travel and airports closed, Hertz's revenue plummeted, and as the economy ground to a halt, demand and prices for used vehicles also dropped significantly.
The agreement between Hertz and its major lenders of the secured debt was that if the value of its assets dropped, it would make cash payments to bridge the gap. A rough estimation of this scenario would be a $75 million payment requirement for each 1% drop in vehicle values. For context, Cox Automotive estimated wholesale vehicle values to have declined 10% to 12% just in April.
With revenue falling to the floor and lenders requiring huge payments to offset its lost value of vehicles, Hertz was forced to file for bankruptcy.
Image source: Getty Images.
Not the same stock
What happens next is what most investors misunderstand. Hertz has some time to negotiate with its lenders, but a likely scenario is that the company will liquidate some of its vehicle fleet to satisfy some of its senior debt holders (those that own the debt secured by vehicle assets). The next in line to be satisfied would be lenders of unsecured debt, such as other loans not backed by vehicle assets.
If Hertz is unable to reach an agreement or satisfy the debt at that point, the company could restructure, and in turn, for debt reduction, it could create new Hertz stock and give equity of the new company to those creditors. That new stock is what investors would potentially see rebound, while shareholders of the old stock are essentially wiped out.
Here's one clear example of why you shouldn't buy Hertz stock right now: because one of the best investors in the world just threw in the towel on the stock (for now). It was reported this week that Carl Icahn, who had amassed a 39% stake in the rental company, sold his 55.3 million shares of Hertz at $0.72 per share for a total of just under $40 million -- a massive loss compared to his aggregate price of $1.88 billion, as of a March securities filing.
Carl Icahn said in a statement:
I have been an investor and supporter of Hertz since 2014. Unfortunately because of Covid-19, which has caused an extremely rapid and substantial decrease in travel, Hertz has encountered major financial difficulties, and I support the Board in their conclusion to file for bankruptcy protection. Yesterday I sold my equity position at a significant loss, but this does not mean that I don't continue to have faith in the future of Hertz.
Knowledge is power
It's always enticing for investors to swing in and scoop up shares of oversold stocks, but understanding Hertz's situation, and those in similar bankruptcy scenarios, is hugely important so as to avoid this horrible investment in its current form.
Do not buy shares of Hertz right now; wait to see how the company restructures -- and if it issues new stock in an attempt to continue operations and avoid total liquidation. If even Carl Icahn, who has substantially more power and influence than individual investors, recognizes he might as well sell Hertz stock at a massive loss, you should not be buying.
