Initial bankruptcy offering
A really interesting event happened recently on the stock market, the rental car company Hertz filed for bankruptcy then some time after this wanted to release new stock to the market. The Hertz corporation, which trades on the NSYE as HTZ, owns many brands including Hertz, Dollar, Thrifty, Firefly, Hertz Car Sales, and Donlen.
The most mind blowing part to me is that people actually bought up NYSE: HTZ stock given this situation and we saw some price increases. The easy thing to do here would be to just say that these individual investors made a stupid decision, and while I think this is true, it's the structural events that made this situation possible at all are far more interesting. Just the fact that a company in bankruptcy proceedings would wish to release more stock is entirely unprecedented and provides us with an amazing opportunity to look at the context in which any of this is possible at all. Is this all just a simple matter of irrational exuberance on the part of investors or is something else happening here too?
The stock market in 2020
Many of the interesting financial events that have occurred in 2020 have had causes that started before this year. For example the yield curve inverted in 2019, which had people commenting back in 2019 about how a recession in 2020 was a growing possibility, and this was before the virus pandemic situation had started at all.
A lot of interesting things have happened in the last few years, one of the most interesting developments has been the decreasing cost of trading shares in the stock market accompanied by an increase in the number of people who are engaged in the market. The growth of platforms like Robinhood have been both indicative and part of a wider trend in more access to markets by retail investors. Many platforms have sprung up that allow individuals to directly buy stock in the markets without needing a broker or any contact with financial advisors. Culturally this has led to a bunch of interesting things like the WallStreetBets subreddit and a far larger audience that is interested in both investing and speculation in the markets. However this cultural trend of a wider interest in financial markets started a long time before these apps and has seen acceleration with the invention of the Internet and more recently the Internet enabled trading platforms. I remember a discussion with some people of my parents generation which was sparked by watching the news one day, the fact that this news broadcast had a finance segment at all was noteworthy because as they pointed out this news segment didn't exist when they were much younger. Also it would seem that financial discussions in general were far more private in the past and discussions about the stock market would have been relevant to a smaller percentage of the population.
A large part of this stems from monetary policy that has deliberately tried to use negative interest rates to coerce people into reinvesting or spending their savings by diminishing the purchasing power of their money over time. The old "wisdom" of saving money and invest it in "safe" things is deliberately being made difficult by modern policy and at some level a lot of people who might have otherwise just put their money in the bank or in simple investments like term deposits feel these pressures to invest in risker things. What this has meant is that if you know you can't save money in the bank due to negative interest rates you will have a strong structural incentive to look into other forms of investments to preserve your purchasing power. With the growing accessibility of stock market investing this has been a place that people have decided to place some of their money.
Around the end of 2019 and start of 2020 I remember having talks with various people about how the stock market seemed overheated and perhaps at the top of a cycle. These sorts of discussions were happening before the pandemic was on anyone's minds. When the events of the COVID pandemic started to become obvious there was a massive fall in global stock markets as the sentiment collapsed. Due to the COVID situation we stated seeing things like a spike of margin calls and a massive increase in volatility. In the last 2 weeks of March 2020 the US federal reserve bought \$250 billion dollars of mortgages. Buying these bonds pushed their prices up but like many things in this situation there's a lot of counterintuitive second order effects when you do things like this. For example the Fed buying bonds related to home loans was causing pain to mortgage lenders due to the hedges they had dramatically falling in value.
What followed the initial crash surprised a lot of people, myself included, when the stock market very quickly recovered to levels not far below the all time peak despite the underlying business fundamentals remaining especially weak. What I underestimated was the impact of the US Federal Reserve starting to buy Exchange Traded Funds (ETFs) since this placed an enormous amount of upwards pressure on share prices. The US Federal reserve balance sheet has hit new record highs due to large amounts of quantitative easing. At the same time so much helicopter money was being dropped that we were getting into Skycrane heavy lift territory:
Adapted from source: https://en.wikipedia.org/wiki/File:Air-Crane_Water_Drop_-Flickr-_Beige_Alert.jpg
We had a situation where huge amounts of cash had been created and needed somewhere to go. And just like other times in history when lots of money started to enter the stock market share prices have a tendency to go up in the short term.
Speaking of business fundamentals, I think looking at what happened with Hertz, the vehicle rental company, is particularly interesting.
I'd taken a bit of an interest in the operations of Hertz as a company after hearing about the complete debacle that was their web modernization project that they outsourced to Accenture. Hertz spent over 32 million dollars on a revamp of it's online presence by hiring Accenture to do a modernization project. Hertz got so little value out of the project that they ended up opening legal proceedings against Accenture. I'd been keenly looking forward to the resolution of the Hertz vs Accenture legal proceedings because I think they had the potential to really shift the narrative with big IT procurement projects, especially the ones that have a strong tendency to go massively overbudget and overtime while underdelivering. This particular project went both overtime and overbudget while delivering less than expected. The fact that the project went this badly is really only possible with a massive failing of project management combined with a number of very poor choices surrounding the strategy1. This project was high profile enough that people made case studies about it and sparked a lot of discussion about the state of the industry. An interesting thing about this lawsuit is that it provided a window into a big IT procurement project that many outsiders to the industry never see. Discussions of this fiasco also revealed more of the inner workings:
People are talking about building in-house talent. I was part of the in-house talent at Hertz. We were executing the strategic initiatives (at some level we came up with them), and we were doing a damn fine job at it.
In early 2016, they fired us all. We were made to train up our replacements (at IBM in India) in order to receive severance packages. Later we found out that Accenture had picked up the initiative. And now the world knows the rest of the story.
All the points made here (ie warning signs, organic initiative) were passionately made at the time to Hertz brass. But someone, no doubt on a golf course somewhere, sold them the idea that they can save millions on paper. And, on paper, they were right: Shortly after firing us all, the CIO received a $7 million bonus. Unfortunately for everyone involved (except the CIO, of course), paper doesn't reflect reality.
These sorts of things hint at a company that was struggling to modernize in part because it outsourced the necessary skills to execute on a digital modernization project. Despite this it seemed that Hertz was able to run a profitable company for the time being and had a large amount of cash reserves from which it could draw upon. While this IT modernization project was a disaster I think a reasonable argument can be made that the digital arm of a car rental company shouldn't be taken as representative of the whole companies performance. After all some public companies in the transport space with really nice apps and cutting edge tech are losing astronomical amounts of money every quarter.
In general the rental car industry is quite complex and is the largest single buyer of new vehicles in many markets. I don't claim to understand all the subtleties of this industry, but the absolute collapse in demand that happened in 2020 was anything but subtle. Companies with a strong reliance on travel were hit very hard by the pandemic. Hopefully when the pandemic situation is over there can be a strong recovery with these companies.
Initial bankruptcy offering
Due to the complete collapse in demand following the COVID pandemic Hertz was starting to have some very sudden and unprecedented problems. Many companies who would have had fleet rental arrangements were suddenly subject to shelter in place orders that restricted their travel and reduced their ability to use any rental vehicles. Hertz approached government for direct support but didn't find itself receiving any. Things were obviously looking grim and on May 22, 2020 Hertz filed for Chapter 11 bankruptcy proceedings.
All this led to something I thought I'd never see, Hertz wanted to release a new round of stock while in the middle of bankruptcy proceedings.
Yes you read this right, a public company that had filed for bankruptcy created a stock market offering while still in bankruptcy proceedings. When the U.S. Securities and Exchange Commission expressed concerns about this offering Hertz put the breaks on the offering. And people started to buy HTZ shares, pushing the price up!
It's hard to get exact data but I suspect that the majority of the people who were be buying these shares in these circumstances would have been retail investors. The institutional investors I know said they wouldn't touch this stock and this particular share offering was more the topic of jokes than any serious deliberations about buying it. But the fact that this stock offering was even a thing at all is quite remarkable because it indicates an assessment that people would buy and honestly I think such an assessment isn't too far off. From the perspective of Hertz if people are willing to buy then making a new offering isn't a bad move.
I find the implications of this highly disturbing though. Effectively this seems like it will just a transfer of wealth away from the retail investors straight into the hands of Hertz's bondholders. But I suspect a lot of the retail investors who would have bought this stock wouldn't have had the understanding of the markets necessary to realize the enormous amount of risk they were taking on here. In a sense many penny stocks have a lot of risk because of the chances of bankruptcy significantly impact the overall value of the investment, however in this case bankruptcy proceedings had already began. As far as I know in these Chapter 11 bankruptcy proceedings the bond holders are the first in line to get the proceeds of a liquidation, stock holders can easily get nothing.
Of course such a pandemic offers a once in a decade excuse for poor performance that is a PR departments dream for justifying a decline and many PR departments have jumped on this. Unfortunately the events of the pandemic have substantially muddied the waters for outsiders, like retail investors, who are trying to determine the value of companies to invest in. The reason is that companies that had structural causes for their decline that started pre-pandemic won't rebound as quickly post-pandemic, if they survive at all, compared to companies who are only temporarily impacted just as a result of the pandemic. If you are thinking of investing large amounts into the stock market please learn about the way in which the market works and do your due diligence.
Where to from here
In my opinion a very important, if not the most important, aspect of the stock market is in enabling price discovery. With stocks of bankrupt companies issuing new shares due to demand it's clear that some of the price discovery function is not working as well as it should. Some people have argued that in an unprecedented time of crisis like this that perhaps it's best to suspend the market if price discovery has become impossible. A passage from that Bloomberg article stood out to me:
Or more broadly still, a lot of the Federal Reserve’s actions in the current crisis are of the form “everyone is selling everything so we will just buy everything and hold on to it for safekeeping until everyone comes to their senses.” It is not quite a market pause, but it has a little of the same effect; the effect is to sort of sedate the market and transport it quietly from today’s craziness to a hoped-for calmer future. You could very bluntly achieve a similar effect—in particular financial markets, mind you, not, like, in the world—by shutting down markets; if no one is allowed to sell anything, then the Fed wouldn’t have to buy it.
Given the Federal Reserve is buying lots of stuff at the moment, including ETFs and bonds, there is some sense in investors buying distressed stocks in order to cash in on the money that is being printed and placed in the market by the trillions. This is the sentiment embodied in the phrase "don't bet against the Fed". In this particular crisis this concerns me greatly for a few reasons:
- Many retail investors won't have a good sense of the risk that they are entering into by buying these stocks since the price movement is so divorced from business fundamentals. These retail investors are likely to be the ones with the most utility to be lost from such risks.
- This enables a large amount of moral hazard if, as the incentives strongly push people towards, company management starts getting into a "too big to fail mindset" where they expect to get bailed out when there's troubles. If the downside risk of too much leverage is transferred to the general populace this will strongly incentivize being over leveraged. The potential for an increase in the number of zombie companies is not a good thing for our society and also isn't good for the longer term economic health.
- The disruption to ability of the markets to discover prices will lead to less efficient allocations of resources and the creation of more zombie companies.
We have seen an initial bankrupt stock offering, hopefully this is the last and things get more sane in the future.
The best practices approach for almost all IT projects of this sort is to deliver value in as continuous a manner as possible. Due to their nature tech modernization projects generally speaking have a large number of unknown-unknowns at the start that you can only really learn about as you go about the project. By incrementally delivering value you enable an important feedback loop that allows you to learn as you go which then allows the project to gain efficiencies from the knowledge learned along the way. ↩