Turnaround Investing Blog

George Putnam, one of the country's leading turnaround and distressed investing professionals, shares his timely insight on the economy and turnaround investing opportunities.

Bankruptcy/Chapter 11 / Bonds / Post-Bankruptcy Stocks

Distressed Investing: What Happens in a Bankruptcy?

While investing in distressed companies can produce enormous gains, not all distressed companies fully recover. Some slip into bankruptcy, yet this might still produce a positive return for some bondholders. However, in some cases the company has little value at all, and is best sold piecemeal, for scrap, in essence. What happens to your investment then? In The Turnaround Letter’s continuing series on investing in distressed securities, we explore this worst-case scenario to help frame the risks.


Highlights

  • As the company’s outlook is nearly hopeless and there is little value remaining, the company will file for Chapter 7, which is for liquidation of the company.
  • The assets of the company are sold piecemeal.
  • In our example, there is only a partial recovery for the secured bank loans and no recovery for the bondholders and shareholders.

Discussion

Many of your distressed investments turned out well. But this one just didn’t work and now it’s slipping into the abyss. The industry has turned downward and the company’s turnaround strategy didn’t make any progress. In fact, it is nearly hopeless. This is the worst-case scenario. What does it look like?

Management and the creditors couldn’t find a buyer or agree on pre-bankruptcy debt restructuring. The business is producing a loss at the Ebitda level, and it has few if any products that look promising. Filing for a Chapter 11 bankruptcy doesn’t make much sense because the cash costs are high, banks are unwilling to provide any DIP financing, and there isn’t much value to fight over anyways. The only realistic path is filing for Chapter 7—liquidation.

Like Chapter 11 bankruptcy, a Chapter 7 filing puts the company under the Bankruptcy Court’s formal jurisdiction. The court’s primary focus is to ensure a fair process for allocating value to the claims holders. In this case, the company is sold piecemeal rather than having its operations and debt restructured to emerge as a healthier, low-debt company. After discussions with investment bankers and other liquidation specialists, the value available to creditors will come from these sources:

Example: Proceeds from liquidation ($millions)



Selling the company piecemeal will produce only $100 million in cash proceeds, hardly enough to satisfy the $400 million in debt, along with $50 million in accounts payable. Similar to a Chapter 11 bankruptcy, value is distributed based on creditors’ absolute priority:


If you held the unsecured bonds, your recovery rate is zero. You received one of the 9% interest payments last year, but this year’s payment was missed. As you purchased the bond for 30, and you received 9 cents per bond in total proceeds, you will have a 70% loss. It could have been worse—you could have lost your entire investment.
 
As we are approaching the end of this distressed investing blog series, we will next explore some other considerations when looking at a distressed security investment.

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Amazon = US GDP 1970

Amazon joined Apple in reaching a $1 trillion market capitalization. $1 trillion is about the same as the total value of New York City property and the total value of loans at JP Morgan, the nation’s largest bank in terms of assets. Jeff Bezos’ $160 billion stake would place him (personally) as the #33 largest company in the S&P 500 in terms of market cap, next to Coca-Cola, Disney and Netflix. We aren’t bold enough to predict whether the shares will continue upwards or if they are in a bubble reaching maximum inflation. Setting aside for a moment their investment prospects, let’s admire the truly remarkable milestone that these two companies have reached. Read More.

EV/EBITDA: What Is It & Why Are We Using It More?

In reading recent editions of The Turnaround Letter, you have probably noticed that we are increasingly using EV/EBITDA as a valuation measure, rather than the better-known price/earnings multiple.  We thought it might be useful to describe this measure and why we like it.

Read More.

Turnaround Letter Stock Pick Named Top Performer of 2017

 

stock market advicex

 

What Last Year's Top Stock Pickers Are Buying in 2018

 

This Forbes write-up follows up on the recent Top Stock Tips report--naming The Turnaround Letter's Crocs recommendation the top performer of 2017: With 90% gains, CROX beat out 100 other investment ideas included in the report; and the stock continues to have value investing appeal, according to Putnam.

 

George notes, "We see additional upside for the stock in 2018 as management's efforts continue to bear fruit, though the gains will likely be more muted than we saw in 2017."