Buying Stock of Companies in Bankruptcy
Unless you are a very daring short-term trader, The Turnaround Letter rarely recommends that you buy the stock of a company operating under protection of the U.S. Bankruptcy Court. Under bankruptcy law, any blood that can be squeezed out of a distressed corporation’s stone is first allocated to senior creditors, like bank lenders and bondholders.
Stockholders are the lowest priority when it comes to payback; and—even if a company can successfully emerge from Chapter 11 protection—there is rarely enough value in that reorganized entity to give the old stock any value. To the contrary, often the old stock is cancelled altogether, rendering it completely worthless.
Other money-losing scenarios include the old stock remaining intact—but hugely diluted by newly-issued stock; or the issuance (to old stockholders) of out-of-the money warrants in the reorganized entity. These are almost worthless, as well. We address this very topic in “Should You Buy Kodak Stock Now?”
It is important to recognize the difference between the old stock in a company in Chapter 11 and the new stock issued by the company upon its emergence from bankruptcy (post-reorganization stock). The new, post-reorganization stock often has significant value, particularly if the company has used bankruptcy as an effective turnaround tool. These post-bankruptcy stocks are often over-looked and under-valued and present significant investment opportunities. Read “Busy Month for Bankruptcies: Interesting Investment Opportunities” and “Reorganized but not Respected” for more post-reorganization investment tips.
Remember, not every post-bankruptcy stock does well. Over the years we’ve learned about Chapter 22 and Chapter 33, colloquial designations for habitual bankruptcy filers. Sometimes, a company doesn’t reduce its debt enough while in Chapter 11, or perhaps its business just wasn’t viable for some other reason. Read “Turnaround Investing: Lessons Learned Over 25 Years” to benefit from our 25 years of distressed debt investment experience.
Turnaround Tips
TLCorner
Where Are the Customers' Yachts?
This headline could easily apply to Goldman Sachs today, as recently described by former employee Greg Smith. Actually, it is the title of a book written in 1940 by a former Wall Street employee named Fred Schwed, Jr. The title refers to a story about person admiring the yachts owned by bankers and brokers who asks where the customers' yachts were. Of course, the customers, who had dutifully followed the advice of the bankers and brokers, couldn’t afford yachts. This just goes to show that there is nothing new about the attitude that Goldman Sachs employees were purported (probably accurately) to have about their clients. It was just as true in 1940--and likely has been forever--as it is now.
Read More.Beware of Trendy Turnaround Candidates - Even Green Ones
Don't Chase the Headlines
The recent unfortunate accident involving the Costa Concordia cruise ship, which is owned by a subsidiary of Carnival Corp., raises an important investing question: Should you bail out of a stock if the company is affected by a serious negative event? Unless the event could be part of a series or trend, the answer is usually “no,” for two reasons.
Read More.What did The Turnaround Letter see that others did not?
Questions & Tips
AskGeorge
Now that Greece's latest bailout is complete, is it safe to buy European stocks again?
We’re not at all sure that either Greece’s or Europe’s troubles are truly behind them. But that said, we also believe that it makes sense to have some European exposure in your portfolio. The advice we gave in the November 2011 issue still holds...
Read More.With so much turmoil and uncertainty in the U.S. economy, and even more fear of collapse overseas, do you ever recommend just getting out of the stock market all together and hunkering down with something safer like bonds?
I never recommend getting out of the stock market entirely--or even making major changes to your allocation to stocks. The stock market is so unpredictable that if you bail out, the risk is very high that you will miss a significant upturn. Moreover, even if you make the right call to get out of the market, you then have to muster the courage to get back in.
Read More.What is your opinion on investing in foreign turnaround companies?
There are certainly good opportunities in foreign turnarounds, but also very significant risks as well. The market inefficiencies that provide unusually high return potential for turnarounds here in the U.S. are probably even greater in foreign markets. However, there may be special, local features that affect foreign companies that we may not understand when we view them from afar.
Read More.Bankruptcy Investing
George reflects on bankruptcy investing activity & trends seen in 2010. Read more.