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Mid-Year Bankruptcy Review and outlook
Bankruptcy activity has slowed somewhat in the first half of 2018. Through June 24, we have seen 29 publicly traded companies with a total of $32.6 billion in assets file for Chapter 11, compared to 42 companies with $43 billion assets over the first half of last year.
While there are still three oil & gas companies on the list of the twelve largest bankruptcies so far this year (see the table on the next page), bankruptcy activity in the energy sector continues to wind down from its 2016 peak. Not surprisingly, given the pressure from internet retailers, four of the top twelve Chapter 11 filers operate brick and mortar stores (including grocery stores). This sector is likely to continue to generate a substantial number of bankruptcies for the foreseeable future.
The largest bankruptcy of 2018 so far is iHeartMedia which is in the radio broadcasting and outdoor advertising business. Interestingly, iHeart, which was formerly known as Clear Channel Communications, was one of the largest leveraged buyouts of all time when it agreed to be acquired in November 2006. Investors were wary of the deal even then, and the transaction was not completed until June 2008. The company has struggled to handle its heavy debt load ever since, and it finally succumbed and filed for Chapter 11 in March.
As long as the debt markets remain robust (some might say “frothy”), the number of large public bankruptcies may stay low. However, we expect to see bankruptcy activity pick up significantly in the not-too-distant future. There is an estimated $1.7 trillion of lower quality debt coming due over the next five years, and if the debt markets cool off, some not-insignificant fraction of that debt will fail to be refinanced forcing the issuers to file for Chapter 11.
In the meantime, we believe the most interesting bankruptcy-related investment opportunities are in post-reorganization equities, particularly in the energy sector. The stocks of companies coming out of Chapter 11 are often weak for a period as former creditors who received stock in the reorganization sell, and mainstream buyers have not yet recognized the positive changes that the company made during its stay in Chapter 11. There have been so many energy companies emerging out of Chapter 11 over the last year and a half that the downward pressure on their stocks has been magnified and the period of undervaluation has been lengthened.
The coal stocks generally came out of bankruptcy first, and their stocks are finally beginning to reach reasonable valuations. (For example, see one of this month’s “Sale Recommendations.”) However, many of the post-reorganization oil & gas stocks continue to experience downward pressure even as the price of oil rises. Our February recommendation, Midstates Petroleum, is an example of this. We expect that the technical imbalance between the sellers and buyers of these oil & gas stocks will eventually correct itself, leading to considerably higher stock prices.