Avis/Pentwater
If
you run a public company and you want to raise money, you can sell
stock, but you probably won’t. Many companies feel a certain
squeamishness about selling stock, and we have talked a couple of times
recently about the “de-equitization” of public companies over the last
few decades. Companies mostly buy back stock; they don’t sell it.
One
problem with selling stock is the price. If you run a public company,
you probably think your stock price is too low. If you sell stock to new
shareholders, you are diluting your existing shareholders: You are
selling too cheap, transferring some of the company’s existing value to
new shareholders at the expense of old ones.
Occasionally, though, a public company will think its stock price is too high: The
stock price is above the present value of all the cash flows that
management expects the company to have. This is a more pleasant problem:
If you sell overpriced stock to new shareholders, that is accretive for your existing shareholders. But it is still, I think, a problem. You are in some sense ripping off the new shareholders,
selling them stock for more than it is worth. You might feel some sense
of fiduciary duty to them too, and feel bad about giving them a bad
deal. In the big meme-stock wave of 2021, companies were initially
nervous about selling stock into meme frenzies: Are you even allowed to sell stock at prices you know are too high?
The
ideal, most pleasant solution would be to sell overpriced stock to
non-shareholders, people to whom you have no fiduciary responsibilities
and whom you don’t mind ripping off. (“I would tax foreigners living
abroad” is Monty Python’s ideal tax policy.)
For
instance: Your stock is trading at around $100 per share, though you
think it’s really worth more like $200. Then magic occurs, and for a
little while you have the opportunity to sell stock at $700 per share.
If you sold stock at $700 to nice enthusiastic retail investors who love
your company, you’d feel bad: They’re overpaying for the stock and will
lose a lot of money when the magic ceases and the stock reverts to
$100, or perhaps to $200. But what if you sold stock at $700 to evil
hedge funds who hate your company? Evil hedge funds who have shorted your
stock to bet that it will go down: They’re not shareholders; they’re
the opposite of shareholders. Wouldn’t that be nice? You’d get money by
selling stock at high prices, which is accretive to your real long-term
shareholders. The short-selling hedge funds would lose money by buying
the stock at high prices, but you want that.
Everybody wins, except the people who should lose. It’s a perfect
trade. All you have to do is figure out how to make the magic occur.
Avis
Budget Group Inc. figured it out! I mean, by accident; the magic here
is less “they did deep research into dusty old spellbooks and found the
right incantations to say” and more “an itinerant wizard showed up at
their front gate.” But that did happen. Bloomberg’s Jordan Fitzgerald reports:
Avis
Budget Group Inc. is set to receive $650 million in cash as part of a
settlement agreement with Pentwater Capital Management to resolve a
lawsuit regarding short-swing profits, according to a filing. Shares in
the car rental company gained 6.5% in postmarket trading Monday. Payment
is subject to court approval, based on the filing. Earlier this year,
Avis surged more than 600% across one month to a record high, after
Pentwater Capital disclosed that it had amassed a large stake. But
shares fell quicker than they went up, wiping out roughly 70% of that
rally in just two days, which Avis leadership attributed to sales action
from Pentwater.
We talked about Avis’s rally in April, and then a few weeks later we talked about Pentwater’s sales. The bones of the story are:
- Avis’s stock traded down from around $130 at the start of the year to around $100 in mid-March.
- Pentwater had been buying Avis stock for a while; it was a 6.8% shareholder last year. This April, it announced
that, between its stock and derivative positions, Pentwater owned a bit
more than 50% of Avis’s stock, around 18 million shares.
- Another
big shareholder — SRS Investment Management, a fund run by an Avis
board member — also owned more than 50% of the stock. So more than 100%
of the stock was owned by two big insiders.
- How is this possible? There were a lot of short sellers who were betting against the stock; something like 49% of the float was shorted as of mid-March. Pentwater and SRS owned, roughly speaking, all of the outstanding shares plus some of the shares that had been borrowed and shorted.
- This
was alarming news for short sellers: If all of the stock is owned by a
few big insiders, there could be a short squeeze in which stock lenders
demand their stock back and short sellers have to buy it back at any
price.
- And so, in fact, Avis’s stock shot up, closing as high as $713.97 on April 21, as short sellers bought back stock.
- Then Pentwater, over a few days at the height of the short squeeze, sold about 4.3 million shares for about $1.75 billion,
an average price of around $400 per share. If you assume that its
average purchase price was $100 per share or so, then it made a profit
of more than $1 billion on those 4.3 million shares.
- The stock
dropped as Pentwater sold; it ended April at $180.67, and has mostly
been in the $145 to $190 range since. (It closed yesterday at $186.28
and was up this morning.)
One somewhat perverse thing to take from this story might be that Pentwater caused Avis’s stock price to drop, from the $700s to the $180s. That is Avis’s takeaway, Fitzgerald notes:
“Given
the quantum of shares sold in such a short span of time, our stock
price experienced a significant decline,” Avis CEO Brian Choi said on
the in April. “It seems the only insider active during this period of excess volatility was Pentwater Capital.”
Another, more informative thing to take from this story is that Pentwater caused Avis’s stock price to rise,
from the $100s to the $700s. It’s still in the $180s! Avis’s stock
price is durably higher than it was before Pentwater’s intervention.
Seems weird for Avis to be like “ugh they drove down our stock price.”
But as we also discussed, there is a problem with these trades. The problem is that US securities law — the “short-swing profit rules” of Section 16
— do not allow Pentwater to (1) buy a ton of stock in Avis, (2) sell it
a few weeks later at a profit and (3) keep the profit. Once Pentwater
became a 10% holder of Avis’s stock, it was an “insider” for purposes of
these rules, and it could not keep any profit it made on “short-swing”
trades (buying and selling within six months). It could make the profit — it could buy at $100, or $200, and sell at $400, or $700 — but it would have to give up the profit to the company.
Still,
you can work with that. Pentwater bought a bunch of stock in the $100
to $200 range, which had the effect of igniting a short squeeze and
pushing the stock to $700. Then it sold a bunch of stock in the $400
range, which had the effect of defusing the short squeeze and making,
like, a billion dollars of profit. So far, so good. And then the third
stage of the trade is returning the profit to Avis.
But,
you know. For one thing, the Section 16 rules are sort of complicated,
and Pentwater had an argument that it didn’t actually owe Avis much of
its profits. It argued that it bought the stock in some funds and accounts that it managed, and sold the stock out of other funds
and accounts that it managed, and you couldn’t “match” most of the buys
and sells under the Section 16 rules. When it initially announced its
sales, Pentwater said
that it was “engaged in discussion with the Issuer and [has] agreed to
voluntarily disgorge to the Issuer any short-swing profits realized from
these matchable transactions.” But it also said that most of its trades
were not matchable transactions: Only about 94,000 shares,
in its telling, violated the short-swing profit rules and thus had to
give up their profits — on the order of tens of millions of dollars —
to Avis. The rest— on the order of $1 billion of profits — were
Pentwater’s to keep. Avis apparently disagreed, but that was a starting
point for negotiations.
For
another thing, Pentwater’s pitch, in those negotiations, was pretty
good. It goes something like this: “Hi. We have created a billion
dollars of profit from nothing. We did it by trading your stock, buying it low and selling it high. But we sold it high to short sellers,
whom you should hate. This trade cost you nothing: no money, no
dilution. And it cost your shareholders nothing: When we sold at $700,
it was to evil short sellers who got squeezed, not to your good and
loyal long-term shareholders. This is just a free transfer of a billion
dollars from your enemies to … well, to us. And you. We’ll give you most
of it. But we want a few hundred million dollars as a tip for raising
all this free money for you.”
This
pitch is not entirely provably true: Who knows who was buying at $700?
Every “short squeeze” is some combination of (1) short sellers actually
feeling squeezed and being forced to buy back stock and (2) retail
traders (and momentum-trading professionals) betting that short sellers
will get squeezed and buying stock themselves. But the pitch is probably
roughly true and quite appealing. “Short squeeze as a service,” a
reader called it in an email to me in April; I think that’s right.
Anyway Avis said in April that it “will go after every last dollar that our shareholders are owed,” and it said yesterday
that the $650 million settlement “is subject to court approval,” which
will require a court to find that “the Company has diligently pursued
the claims raised in the Section 16(b) Action and that the Settlement
Amount is fair, reasonable and adequate.”
Is
$650 million every dollar of profit that Pentwater made on this trade? I
hope not! It’s a great trade and they deserve to make money from it. Is
$650 million a good and fair result for Avis? Absolutely! That’s like
10% of its market capitalization! Avis didn’t even do anything!
Pentwater just extracted a billion dollars from short sellers and gave
Avis some of it. A perfect financing trade, a non-dilutive sale of
overpriced stock to short sellers. I don’t know if Pentwater is going to
run this trade for (on?) other companies, or if bankers are going
around pitching it to other companies, but they should.
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