Why Hertz’s Warrants Look More Attractive Than Its Stock

Based on an estimated exercise price of about $13.80 on the warrants, they trade below intrinsic value of $12.20 ($26 minus $13.80), which is befuddling derivatives traders on Wall Street. The theoretical value of the warrants assuming underlying annual volatility on Hertz shares of 25% is estimated around $20.

The warrants look like a more attractive play on Hertz than the stock. The warrants are structured with a very long maturity of 30 years, against an original maturity of seven years for one from Occidental Petroleum (OXY/WS). The long maturity should increase their value.They also protect holders in case Hertz pays dividends to common holders as well as takeover protection in the case of a cash deal.

Hertz stock had a strong debut Thursday as investors enthused over strong pricing in the rental car market this summer amid a vehicle shortage. AAA estimates that rental pricing is up 85% year over year. Hertz is getting $275 a day for SUVs in popular markets, compared with an average vehicle rate of under $50 in the first quarter.

The company exited bankruptcy carrying a strong balance sheet with little or no net corporate debt. The company is now valued at around $12 billion, more than double that of rival Avis Budget Group (CAR), whose stock was down 1.5% at $80.63.

The seemingly low price on the warrants could reflect several factors. Hertz has yet to officially confirm that the strike price is $13.80. It’s believed to be very difficult or impossible to short new Hertz stock, meaning that arbitrageurs can’t buy the warrants and short the stock.

It’s also possible that the new stock is overpriced and that the warrants may be indicating a truer value for the company. Some institutional trading in unregistered Hertz stock apparently occurred Thursday at a discount to the public market.

The bulk of Hertz’s estimated 471 million shares outstanding are held by the group led by Knighthead Capital and Certares Management that took Hertz out of bankruptcy, as well as other institutional investors. These buyers paid $10 a share for their Hertz stock.

There are an estimated 85 million to 90 million new warrants outstanding that were given to Hertz’s old shareholders as part of a package that also included cash and new stock.

Hertz’s restructuring statement notes that the exercise price of the warrants is a $6.5 billion equity value for the company divided by the company’s shares outstanding, which are about 471 million, Barron’s estimates based on other disclosure information.

“Our strategy team looked at the terms and estimates that the HTZWW strike price for will come in at ~$13.80,” Susquehanna Financial Group told Barron’s in an email. “We are not focused on warrants, we are focused on listed equity, index, and ETF options, but we looked at the warrant terms.”

Old Hertz shareholders who held stock under the HTZGQ ticker are due to receive a package of cash, new stock and warrants.

The cash portion is $1.53 per old share. Barron’s estimates that old holders will get nearly a tenth of a share of new stock and almost two-thirds of a warrant per old share. That package is worth about $11 a share based on the old stock, Barron’s estimates, compared with a closing price of $8.74 Wednesday.

Here is what Hertz said in one of its restructuring documents about the warrants:

“The exercise price (as the same may be adjusted from time to time, the “Exercise Price”) for each Warrant Share shall be equal to (i) a total equity value of $6,500,000,000 of the Issuer (“Strike Equity Value”) divided by (ii) the number of Reorganized Hertz Parent Common Interests issued under the Plan on the Effective Date.”

Write to Andrew Bary at [email protected]