Why it is important, now more than ever, to understand financial accounting.
By: Pamela Martinez, JBS Corp. & Rob Aquino, JBS Corp.
The U.S. is officially in a recession. On June 8th, 2020, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) reported that the peak in the U.S. economy in February 2020 “marks the end of the expansion that began in June 2009 and the beginning of a recession”.
COVID-19 has forced businesses across the country to shut their doors. Unfortunately, many of the impacted businesses cannot afford to stay afloat with closed doors—forcing them into bankruptcy.
The Hertz Corporation (known as Hertz Car Rental) has provided Americans with rental car services for 102 years. On May 22nd, 2020, the $24.6 billion company filed for chapter 11 bankruptcy as a result of their inability to pay $400 million worth of debt. Shortly after, on June 12th, 2020, Hertz announced that they would be selling up to $1 billion worth of shares of their common stock. Why?!
To answer this question, we have to understand bankruptcy. Bankruptcy is a judicial proceeding through which individuals or businesses who are unable to pay unresolved debts seek relief from federal courts. If granted by a Judge, filing for bankruptcy essentially absolves an individual or company from repaying their debt—specifics vary for each type of bankruptcy:
- Chapter 7 – Liquidation Bankruptcy
- Chapter 13 – Repayment Plan
- Chapter 11 – Large Reorganization
- Chapter 12 – Family Farmers
- Chapter 15 – Used in Foreign Cases
- Chapter 9 – Municipalities
Relevant to this article, we will focus on the most complex type of bankruptcy, Chapter 11 Bankruptcy, which is commonly used to reorganize a business or corporation debt. The reorganization of debt in chapter 11 bankruptcy refers to the restructuring of a business’s debt in efforts to pay back creditors over time. In a chapter 11 bankruptcy proceeding, a company is allotted approximately four months (can be extended up to 18 months) to file a reorganization plan. Once a reorganization plan has been agreed upon by both parties (debtor and creditor), and litigation has concluded, there is an order of liquidation (i.e., who gets paid out first):
- Creditors (people or entities owed money)
- Stakeholders (Clients, employees, staff, general business expenses to be paid)
- Shareholders (Investors holding common stock in the company)
So, why is Hertz doing this?
Hertz is the first company in history to file for bankruptcy and attempt to sell stocks through what is being coined an Initial Bankruptcy Offering (IBO). U.S. Bankruptcy Court Judge, Mary F. Walrath of Delaware, signed off Hertz’s plan to sell up to $1 billion in stock as an attempt to pay back their debts. This diabolical approach was developed by Hertz to raise cash by taking advantage of the retail investor—you and me.
This kind of tactic illustrates the urgency for financial literacy—here’s why: the fundamentals of investing teach us that when buying stock, we want to make sure we are only investing in companies that demonstrate high earning abilities and potential for future growth. Using this strategy to analyze Hertz’s market summary, we can conclude that the stock is essentially worthless, and investing in it will likely bear negative results.
Utilizing public information that is readily available using tools like Yahoo Finance to analyze Hertz’s market summary, we can very quickly see that Hertz has been struggling for several years. Its liabilities (debts) continue to climb, and its cash position does not strengthen. We can see from the state of Cash Flow that Hertz is burning approx. $11 Billion of cash per year!
Below is a more straightforward illustration of Hertz’s current market summary: We can see the over 90% drop in the company’s stock price, just from February 21st, 2020, to date. This is where everyday investors like you and I can get confused. We think to ourselves that if Hertz can go back to pre-COVID trading levels, then we stand to make a fortune, but it will take much more than a post-COVID society for this company to rebound.
On June 12th, 2020, Hertz released a Prospectus Supplement in which they disclosed: “We are in the process of Chapter 11 reorganization cases under the Bankruptcy Code, which may cause our common stock to decrease in values, or may render our common stock worthless.”. They know the stock is worthless and have no remorse for those retail investors who will be cheated out of money.
Thankfully, One of the many requirements a company has to meet to sell stock in the public market is disclosure. During a CNBC interview, the U.S. Securities and Exchange Commission (SEC) Chairman, Jay Clayton stated the SEC had informed Hertz that they have comments regarding Hertz’s disclosure. This means that the sales of Hertz stock will come to a halt until further investigation is conducted, and the SEC’s comments are resolved. As a result, Hertz suspended its plan. Though Hertz’s plan is suspended, the company’s stock is STILL worth approximately $250M—so just because they are not issuing new stock does not mean people aren’t buying. Especially those retail investors who unfortunately do not know the tricks of the trade.
Readers beware. The stock market is still and has always been one of the best places to grow and maintain wealth. Even so, it is done through diligent investing, diversification, and patience, NOT by purchasing shares in a bankrupt company.
