No unexpectedly, Cumulus Media filed for Chapter 11 bankruptcy/reorganization yesterday evening. As part of the filing, the company stated that “Based upon the terms of the agreement that has been reached with our secured lenders, the Company’s current common stock will be canceled and will not receive a recovery in the restructuring. Once effectuated pursuant to an approved plan of reorganization, our existing secured lenders will become our new majority shareholders.”
The stock recently moved to NASDAQ Over-the-Counter, and yesterday, before the announcement, closed at 15 cents. This morning it quickly dropped to 4.1 cents, but then rallied, hitting 9 cents by 4:00 PM. My question is why didn’t the stock immediately go to zero? The only thing I can think of is that there are a few short-sellers that need to cover their positions, as I can’t imagine why anyone would buy what appears to be now worthless stock.
I remember when a client of ours went Chapter 11 there were a few speculators who bought stock hoping that the liquidation might squeeze out some cash.
I don’t know if that ever works for anyone, but there always seems to be someone who wants to try.
Short sellers may indeed cover now. In theory, they can ride it into bankruptcy, but there are issues with that. If you are short, you owe the shares, and when the stock is delisted, you still have that debt hanging around until the shares are declared worthless and your debt is cancelled. That can take some time. Among other things you are going to get a large capital gain at a date you don’t control. Short sellers may prefer to cover before delisting, and forgo the last few pennies, to definitively close the books on their position. And if there are a lot of shorts, a squeeze can get created at that point, driving the price up.
Short sellers generally do not have to cover their positions in the event a company truly liquidates and ceases to exist. When selling short, the seller’s account is credited - if they never cover they just get to keep the money received at the time of the short sale. That said, there can be reasons a short seller might want to close the position. As has been mentioned, a short squeeze is a possibility. It is not uncommon for stocks in companies that have declared bankruptcy to trade a valuations that make no economic sense. The stock can become a pure trading vehicle and essentially turn into a game of hot potato. Another reason shorts might wish to cover is to avoid paying excessive stock loan fees. Short sellers must borrow shares to sell short. Depending on the number of shares available, the fees can range from close to 0% to 100%+ annualized. When short a bankrupt company, it is possible that the exchange halts trading and a short seller is stuck paying fees on their borrowed shares. The stock locate market is very opaque and it’s sometimes preferable to cover the short position for few nickels and avoid the possibility of being stuck paying fees for months while the bankruptcy goes through.
There are a bunch of click bait “investment research” sites which are mostly computer-generated gibberish. I found the following “current analysis” to be most amusing:
I think somebody must have misspelled ‘bullshit’.