Zombie stocks defy bankruptcy logic as meme traders bid them

(Bloomberg) – It seems more and more that corporate finance textbooks need a chapter on memes.

Being on the verge of bankruptcy doesn’t seem to matter much in the US stock market anymore. While this may seem like the start of a uplifting tale of the state of investing in 2021, the reality is far stranger. Redditors have offered so much shares of AMC Entertainment Holdings Inc. and GameStop Corp. that it saved them – for now at least – from serious trouble.

These aren’t the only struggling businesses where social media users are trying to conjure the magic. In a large benchmark of U.S. stocks known as the Russell 3000 Index, there are 726 companies whose earnings do not cover their interest payments, a red flag for the pros, according to data compiled by Bloomberg. These zombies have grown an average of 30% in 2021 – beating the return of 13% for the entire index – and 41 of them have doubled since New Years Eve.

Even explicit warnings don’t seem to register. A bankruptcy plan being considered by GTT Communications Inc. would eliminate shareholders, which is typical in Chapter 11 cases, Bloomberg reported on May 24. Nonetheless, the company’s shares have risen by around 69% since then.

Wall Street is starting to consider the impact of traders generating excitement for stocks on social media and Reddit threads. Theater operator AMC, which was on the verge of bankruptcy last year, now has a “path to a sustainable capital structure,” according to S&P Global Ratings, in part because it was able to sell new shares to the amid huge demand from retail investors. Video game retailer GameStop is now debt free for the same reason.

“When looking at the debt of certain issuers, it becomes difficult not to take into account the valuations of stocks which can seem inflated by trading based on Reddit, especially since companies like AMC are able to monetize these valuations. “said Ben Briggs, a credit analyst at StoneX Financial Inc.

In bankruptcy, shareholders are the last to recover value, only after all debt holders have been paid. Yet investors are cramming in the shares of troubled names – and even companies already in bankruptcy proceedings. Medley Management Inc. has skyrocketed this month. The company’s private debt business filed for Chapter 11 protection in March with the intention of repaying its debt with new stock.

Reddit optimists may point to more than just AMC and GameStop. The survival of car rental company Hertz Global Holdings Inc. was in question a year ago. He tried selling stocks to support himself, but admitted they could be worthless, prompting the Securities and Exchange Commission to block the offer. But its restructuring in Chapter 11 ended up returning shareholder value, which hardly ever happens.

The rallies in AMC and GameStop stocks have gained public attention, but credit markets have also been moved. GameStop is out of debt, but AMC’s obligations have recovered significantly. Its 12% note due in 2026 was deeply distressed in November at 5 cents to the dollar. An incredible turnaround has put them just above par now.

It is no coincidence that some of the most struggling companies are now the ones profiting the most from retail rallies. Their massive debt load, coupled with the devastating impact Covid-19 has had on their ability to generate income, were among the reasons their stocks are so heavily overdrawn in the first place. The redditors specifically targeted stocks with huge bets against them.

“Reddit gatherings are slightly changing the way we approach investing,” said George Schultze, CEO of Schulte Asset Management. “The dynamics of these rallies are certainly interesting and are a clear sign of excess liquidity flowing in the market.”

GTT, an internet infrastructure company, hit an intraday high of $ 4.75 on June 3 after falling to $ 1. The company has caught the attention of traders on Reddit, who have pointed out its small market cap, high short-term interest, and the CEO’s previous trade turnarounds.

The company has repeatedly extended its forbearance agreement with lenders, which has been interpreted in online forums as a lifeline – not a routine part of restructuring negotiations, which it is.

Washington Prime Group Inc., owner of shopping malls reeling from the pandemic, has also attracted retailers. Like GTT, it has a forbearance pact with lenders and is heading to bankruptcy court.

“WPG announces deal this weekend?” Reddit user dbede5 wrote this week. “Abstention agreement extended until midnight Monday, not the usual one week extension !!”

Its stock is up 118% in the past two weeks.

“A lot of retail investors are very smart,” said Christian Lawrence, strategist at Rabobank in New York. “We don’t give them enough credit. But there is no doubt that many do not understand the exact mechanisms surrounding bankruptcy.

How it all ends is up to you to guess. But even as the pros are starting to factor in the craze for meme stocks, it’s clear that the gap between old-fashioned finance and newer ways is big.

“Wall Street and Main Street are not even on the same continent anymore,” Reddit user baddfish2 posted on WallStreetBets on Thursday.

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