INSIGHT-Once a 'stonk,' Hertz reveals dilemma companies face in Reddit frenzy

By Jessica DiNapoli, Mike Spector and Koh Gui Qing

NEW YORK, Feb 8 (Reuters) - Months before the irrationaltrading in GameStop Corp, there was Hertz GlobalHoldings Inc.

Operating under bankruptcy protection last spring once theCOVID-19 pandemic wiped out its business, the car-rental giantconfronted an extraordinary situation: Its stock price wasskyrocketing for no apparent reason.

Conversations at the time among Hertz management anddirectors on its board, reported here for the first time, turnedfrom shock to a vigorous debate about whether the company shouldcapitalize on its unexpected good fortune and sell shares tofund itself during bankruptcy proceedings, according to threepeople familiar with the deliberations.

Raising money through a share sale would be less expensivefor Hertz, which was bleeding cash as travel and car rentalsplunged, than tapping a costly bankruptcy loan that mostcompanies in its situation use to navigate court restructurings.

Directors keen on selling shares fended off concerns fromsome in Hertz’s C-suite and boardroom that such a move riskedmisleading investors who failed to appreciate that creditors arealways paid first in bankruptcy, two of the sources said.

Shareholders, on the other hand, usually lose their shirts.

But Hertz abandoned its plan to sell up to $500 million innew shares after the U.S. Securities and Exchange Commission(SEC) started scrutinizing it. Hertz declined to comment.

Over the past few weeks, soaring stock prices of GameStop -along with movie theater chain AMC Entertainment Holdings Inc, home goods retailer Bed, Bath & Beyond Inc andother companies - on the back of Reddit memes and YouTube videoshave put company leaders in a similar situation.

The internal Hertz deliberations offer a window into thecontours of the ethical and regulatory dilemmas they face.Namely, can they sell stock to raise capital in such a volatilemarket?

Regulators are watching. The acting head of the SEC has saidin recent days that the agency is looking closely at howcompanies are behaving, including whether they are trying toraise money and adequately disclosing risks associated with itto investors.

"Taking advantage of what could potentially be a manipulatedmarket would trigger both reputational and legal concerns,” saidDonald Langevoort, a Georgetown University Law Center professorand former SEC attorney.

The SEC declined to comment.

DIFFERENT APPROACHES

As a social-media-fueled retail trading frenzy has whipsaweda series of "stonks" - a Reddit meme for stocks - over the pastfew weeks, the companies in the eye of the storm have largelykept quiet. But three sources familiar with some of thesecompanies said discussions about surging shares are taking placein their C-suites and boardrooms as well.

Unlike Hertz, these companies are not under bankruptcyprotection. So far, they are taking different approaches.

GameStop, whose shares slumped as much as 84% in the firstweek of February after surging more than 25-fold the previousmonth, has paperwork lined up to sell $100 million worth of newequity but has not yet disclosed whether it has done so.American Airlines Group Inc pulled the trigger on a planto sell more than $1 billion of stock after its shares recentlyrallied as much as 48%.

GameStop and American declined to comment.

AMC, which previously warned it could file for bankruptcyafter the pandemic temporarily closed its cinemas, has raisedroughly $1.2 billion through debt and equity deals. It is nowracing to file papers with regulators to sell shares possiblyworth hundreds of millions of dollars more, two people familiarwith the matter said.

"A company would be silly not to” consider sellingadditional shares, one source close to AMC said. "Any companythat is thinking seriously would want to talk it through anddecide what strategies are available.”

AMC did not respond to a request for comment. In lateJanuary, Chief Executive Adam Aron said recent fundraising meant“any talk of an imminent bankruptcy for AMC is completely offthe table.”

BEFUDDLED BOARD

That was the dilemma Hertz faced last spring. The companyfiled for bankruptcy last May, crumbling under roughly $19billion of debt as the pandemic decimated its business.

Roughly two weeks later, Hertz shares vaulted nearly 16times to a high of $6.25, almost unheard of at the time for anycompany, let alone one under bankruptcy protection. Directors,executives and company advisers were befuddled, three sourcesfamiliar with the matter said. Calling around, there were nosigns that a hedge fund or other large institutional investorwas buying shares, one of the sources said.

An adviser talked with an investor who suggested the tradingapp Robinhood was behind the unexpected rise, the source said.Indeed, Hertz was among the platform’s most popular stocks.“Hertz bankruptcy is CANCELLED by Robinhood ‘investors,’” aReddit commenter called “itsnotshade” wrote at the time. “Goodjob guys.”

Some Hertz directors saw an opportunity to bolster its cashcoffers with a stock sale. But some in the management, alongwith other directors, pushed back over concerns the shares werevirtually worthless and any offering would take advantage ofsmall-time investors unfamiliar with bankruptcy law, the sourcesfamiliar with the discussions at the time said.

Directors favoring a share sale countered that, while rare,shareholders sometimes receive payouts in bankruptcy cases, oneof the sources said. Shares of other companies under bankruptcyprotection, such as J.C. Penney Co Inc and Whiting PetroleumCorp, were also spiking at the time.

Eventually, the board decided to proceed with sellingshares. On June 12, U.S. Bankruptcy Judge Mary Walrath approvedHertz’s plan to sell new shares. In court filings, Hertz toutedthat it would not have to repay the money and that the move wasbetter for its creditors.

Hertz alerted the SEC and warned prospective buyers theywould likely lose all their money.

But the deal was done before it started. In a televisioninterview, then-SEC Chairman Jay Clayton said the agency hadinformed Hertz it had “comments” on the stock offering, and thatmost companies do not go forward after hearing from theregulator until the issues are resolved. Reuters could notdetermine the content of the SEC's feedback on the offering.

The next day, Hertz, not wanting to antagonize regulators,pulled the offering, two of the sources said.(Reporting by Jessica DiNapoli, Mike Spector and Koh Gui Qing;Editing by Paritosh Bansal and Edward Tobin)