Holding Hertz To $0? Here's Why Short Covering At These Levels Is Wise

Summary

• Senior Hertz Debt Trades Close to 80 Cents.
• Subordinated Debt Remains Around 40 Cents.
• What Does This Mean For Hertz Equity?
• A Surprising Source of Value For Hertz Shareholders.

Source: FINRA

     A snapshot of Hertz bonds taken shortly after the close of trading on July 8th reveals that the most senior issues have come close to crossing above 80 cents and that most of the remaining issues still remain below 40 cents. While this is a massive improvement from their recent post-bankruptcy nadir, they still imply an impairment of over $1.7 Billion (plus accumulated interest and legal fees).

     At the close of trading July 8, 2020 Hertz was trading at $1.48 up 8% on the day and nearly 14% from it's morning low of $1.30. In order for the equity to be worth anything all debt holders would have to be made whole. Which means that unless Hertz can come up with a way to pay back the full value of these bonds Hertz equity is worthless. The activity in bankrupt and nearly insolvent equities continues to be disconnected from the economic value of the companies. Hertz is part of this phenomenon.

     So what accounts for the extraordinary action in Hertz stock that continues to value the company at ~$200 Million and is it worthwhile to hold or initiate a short position at these levels?

     While many analysts have pointed to the nearly 150,000 RobinHood account holders long the stock as the major reason for the continued irrational pricing that is likely only a small part of the answer. Few RobinHooders have the capability of buying blocks in excess of 25,000 shares even at Hertz's depressed price of $1.48. Blocks of that size (and larger) continue to routinely trade throughout the course of the day. Who is behind them and why would anyone with any significant capital continue to own Hertz?

The Value of Stock Lending

     The answer to these questions may originate from the amount of shares held short and the cost of carrying short positions. As of June 25 42.46% of Hertz stock was held short. While easily borrowed ETF's and stocks such as SPY, QQQ, AAPL, AMZN, GOOG, FB, MSFT and many others cost little or nothing to borrow in order to short, hard to borrow stock like TSLA and in this case HTZ cost quite a bit. A recent quote from my TD Ameritrade account revealed that the interest rate to borrow shares of Hertz was a staggering 132.75% based on a $2 stock value. That makes the actual interest rate based on the July 8th close 179.38%! What that means is that even if the actual economic value of the company's equity is $0 the cost of holding a short position is around 22 cents a share for a month. Holding a short position until the company cancels its common stock is therefore an expensive proposition. At current prices cancellation would have to come in the less than seven months for the position to be profitable. As the Hertz bankruptcy has taken its' many twists and turns the timetable for the cancellation of the common stock has been pushed back. In addition, while cancellation may occur within seven months, the risk of being short in the unlikely event that the company finds a way to bail out its common equity holders is far too large for the small profit of holding to 0.

     Stock lending can be a profitable business. Most large brokerage houses operate a stock loan unit to take advantage of situations just like this one. RobinHood is likely making a small fortune on lending out the stock held by the 150,000 account holders who continue to maintain their holdings. Therefore, while the company likely has no economic value, the equity still maintains some value for this purpose. This is why when the stock has dropped below $1.50 many shorts (myself included) closed their positions. The risk/reward ratio just isn't there. The cost to borrow HTZ when I originally shorted it was 63.25%. At current rates it does not make sense to hold a short position for the minor satisfaction of saying I covered at 0.

     Due to these factors, it is likely the rally July 8th was triggered by short covering since shares held short overnight on Wednesday accrue three days of stock lending fees. Covering below $1.41 (July 8th VWAP) represents a rational decision to manage a short position and does not represent a belief that Hertz the company has actual equity value. Additionally, the increasingly less liquid, and lower vega options are making it more difficult to recover the cost of carrying the short to 0.

Conclusion

     Should you hold your short position and wait for the cancellation of the equity? While the rally in the bonds represents a greater likelihood of the bondholders being made closer to whole, it still appears to show that Hertz needs $2 Billion in additional value in order for there to be an equity recovery. However, the likely cost of holding a short position exceeds the potential value of the decrease in price to 0. Moreover the reduction in volatility premiums on the options makes it increasingly more difficult to cover these costs by selling puts. Therefore the recommendation is that you cover your position below $1.50