Revlon Bonds Are in the Tank. It’s a Sign the Surging Stock is Overvalued.

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A disconnect has emerged between

Revlon
‘s

surging stock and the depressed bonds of the bankrupt cosmetics company.

Some Revlon debt trades at distressed levels of around 10 cents on the dollar, indicating pessimism among fixed-income investors about the recovery value for its debt in the bankruptcy process. Since the cosmetic company’s debt is senior to its equity, it suggests that investors ought to be cautious about buying Revlon stock. Shareholders in bankrupt companies often get little or nothing in court-authorized reorganization plans.

Yet shares of Revlon (ticker: REV), which filed for bankruptcy protection on June 16 under the weight of heavy debt, continued their recent surge Wednesday amid apparent buying by retail investors. The stock rose 34% to $8.14 on huge volume of 175 million shares after touching a high of nearly $10. The company now has a market value of almost $450 million.

The stock, which had finished at $1.17 as recently as June 13, rose 62% to $6.06 on Tuesday, also on heavy volume. Before the bankruptcy filing, volume averaged a few hundred thousand shares daily.

The rising stock price reflects enthusiasm among retail investors for Revlon and the fact that relatively little stock is available for trading. Chairman Ron Perelman owns 46.2 million shares, or 85% of the 54.5 million outstanding. This leaves a public float of about nine million shares, and of that amount, nearly three million shares have been sold short, according to Bloomberg data.

The hope among retail buyers is that a buyer for Revlon could emerge and that the shares might mimic the spectacular gains Hertz achieved last year. That stock rose in bankruptcy from under $1 to about $9 as conditions improved dramatically in the rental-car market, allowing bondholders to be paid off in full and providing significant recovery value for equity holders.

Revlon bonds, however, don’t suggest that kind of optimism. They traded Wednesday at distressed levels: The company’s $450 million of 6.25% debt due in 2024 was changing hands around 10 cents on the dollar, according to TRACE, which collects data on trading of corporate bonds in the over-the-counter market.

There is no ticker symbol for the Revlon bonds, but their Cusip, or identifying number, is 761519BF3. TRACE stands for Trade Reporting and Compliance Engine and was established by financial regulators to provide a window into the opaque corporate bond market.

For those bullish on Revlon’s prospects, the debt looks like a better bet than the stock. If the debt is paid off in full, investors could reap a tenfold gain, although the current price indicates pessimism that could happen. Investors could score even if the debt doesn’t get paid off in full, as long as the recovery value is above the current price.

Some pros may be buying Revlon debt and shorting the stock as a hedge, so that gains from betting against the shares would offset losses if the bonds’ price falls further.

Revlon has struggled in recent years, burdened by about $3.4 billion of debt and interest expense of more than $240 million annually. During the first quarterit had sales of $480 million, which were up 7.8% from the year-earlier period, but it lost $67 million due in part to heavy interest expense.

Its debt on March 31 was more than 10 times its 2021 earnings before interest, taxes, depreciation and amortization of $293 million. Most companies like to keep their debt/Ebitda ratio under three, while more aggressive companies will go to around five.

In announcing its bankruptcy filing last week, Revlon alluded to its debt problem. “The Chapter 11 filing will allow Revlon to strategically reorganize its legacy capital structure and improve its long-term outlook, especially amid liquidity constraints brought on by continued global challenges, including supply chain disruption and rising inflation, as well as obligations to its lenders, ” it said.

Revlon’s goal is to reduce its debt, which suggests the company is seeking to inflict losses on its bondholders. “By addressing these complex legacy debt constraints, we expect to be able to simplify our capital structure and significantly reduce our debt, enabling us to unlock the full potential of our globally recognized brands,” it said in its press release announcing the bankruptcy filing.

Revlon has secured debt, which is senior to the 6.25% issue due in 2024, that trades around 33 cents on the dollar, according to Bloomberg. This is another indication of caution among bond investors about recovery prospects.

Write to Andrew Bary at andrew.bary@barrons.com