The bond side. Credit. Who really owns a company? These are questions that seem to elude so many newer investors that it is worth talking about, if only to make sure you don't throw your money away on a whim, or a newsletter, or a pump-and-dump Twitter scheme.
Right now, we are seeing a ridiculous game played out with the stock of Hertz (HTZ) .
Hertz has a ton of debt, $19 billion dollars' worth. It filed for bankruptcy a little more than a month ago, because it could not afford to pay the interest on that debt.
Carl Icahn, a brilliant investor, labored as a shareholder, a 38% shareholder at that, to try to help turn the No. 1 car rental business around. But he couldn't. So, he knew to throw in the towel when there was still a towel to throw in, selling 55 million shares at 72 cents a share after holding on for six years.
Believe me, if that common stock were going to be worth anything, after six years of holding on, he would have stuck around.
But there is a pecking order in bankruptcy court where if a company is heavily indebted the owners of the debt are typically entitled to everything, especially the common stock, which is usually made worthless by the court, so a new common stock can be created for the bond holder to try to make them as whole as possible. That common stock that Icahn sold? It is most likely going to be wiped out by the time the bankruptcy gets rolling.
Now, the process of bankruptcy is messy. The bondholders often don't know where they stand. There are often senior bondholders and junior bondholders. At times, there are mortgage bondholders. All have a chance at getting a piece of the new company that will be Hertz, because it is highly unlikely that Hertz goes away. It's got too much worth. But the common stock holders have almost zero chance of getting a piece of the company.
This means that $5 stock that people are trading will most likely be cancelled. The fact that it hasn't been cancelled yet is a travesty, because it truly is just a matter of time before it happens. If I were running the bankruptcy court, I would issue an edict that says the darned thing can't trade, which would keep people from losing money on it. But I don't run the court. So it isn't going to happen.
The same thing is playing out with Chesapeake (CHK) , the heavily indebted oil and gas company. It's going to file for bankruptcy, because it can't cover the interest charges. The bond holders will repossess the company in the same way that a bank will repossess your house if you don't pay the mortgage.
Again, it's ridiculous that this stock trades. It's just a hot potato and someone is going to get stuck holding it. In my 40 years of writing, I can count on one hand the stories of when the common stock was worth something. But the bonds? They can be great investments if the company ends up with no debt.
That's not always the case. If you want to read about how wrong this can go, take a gander at "Confessions of a Street Addict," when Karen Cramer and I battled a stock called Memorex-Telex, which went bankrupt and reorganized with new bonds and a new common stock. We bought the common stock pretty much every day, betting the business would turn around. It didn't. It filed for bankruptcy a second time and we lost everything. We bought a ton of stock at 5/8ths of a dollar thinking, so what if it goes out worthless.
It felt awful.
Hertz and Chesapeake common stock will feel awful, too, when their sagas are over. My motive in telling you this? Is it to spoil the party? No, it is to keep you from having your own Memorex-Telex. Read it, and weep.