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- In nearly every case, the shares of a company in bankruptcy become worthless. In very rare cases, however, they can become great investments. W.R. Grace (NYSE:GRA) shares produced a 75-fold return, as an example.
- With California utility PG&E (NYSE:PCG) now in bankruptcy, the range of possible outcomes for its equity is wide.
A straightforward approach would put the range at a total loss (-100%) to +400% gain.
- A back-of-the-envelope estimate might put the upside at $25-40 for a 79% to 185% potential return – generous but risky given the real possibility of a 100% loss.
- Buying PCG shares may make sense for sophisticated investors able to tolerate a total loss, but not for nearly anyone else.
In nearly every case, the shares of a company in bankruptcy become worthless. The company’s liabilities exceed its ability to pay them, and typically its assets don’t have enough value to cover the obligations, either. Once the remaining value gets carved up among various creditors, there is usually nothing remaining for shareholders. Sears Holdings, now in bankruptcy, will likely go this route.
However, in very rare cases, the shares of companies in bankruptcy can make great investments. One of the most notable examples was chemical company W.R. Grace (NYSE: GRA). When faced with overwhelming liabilities from asbestos claims, the company chose to protect its business by filing for bankruptcy in 2001. But unlike most bankrupt companies, Grace’s underlying business and financial condition were strong. Through a complicated 13-year Chapter 11 process, the asbestos liabilities were carved out into two separate trusts, leaving the otherwise healthy business, and shareholders, to prosper. From its 2001 bankruptcy price of around $1.30/share, GRA stock rebounded to over $100/share, for a 75-fold return.
Is PG&E’s equity worth a look?
In late January, California utility giant PG&E (NYSE:PCG) filed for Chapter 11 bankruptcy, in the largest public company filing in the past decade and the sixth largest corporate bankruptcy ever in the United States. The company cited potentially $30 billion in liabilities related to the deadly wildfires. Among many other costs, the company is also facing a criminal proceeding that may result in the company implementing safety measures costing upwards of $150 billion. PCG shares plummeted from their peak of $70 in late 2017 to about $14 today.
With its filing, PG&E is entering into a legal battle over the value of its assets and liabilities and how those will be allocated through complex negotiations. The long list of negotiating parties includes the company, fire victims, politicians, insurance companies, regulators, judges, lenders, shareholders, independent power providers, suppliers, pensions and other claimholders and stakeholders.
The company’s structure may change considerably, as well. PG&E may be broken up into different entities, perhaps based on power type (natural gas-fired, hydro-fired, other) or by region (some cities want to run their own utilities in PG&E territory).
While these issues are being sorted out, the company has the daunting task of focusing on its operations, staying competitive even as its traditional electric power monopoly is being eroded, addressing the renewable energy and carbon reduction goals of California, maintaining its safety and quality standards (difficult enough before the stultifying constraints of bankruptcy) and retaining jittery employees.
The range of possible outcomes is very wide, and the resolution could take years, rendering the post-Chapter 11 equity value as essentially unpredictable.
What does this mean for PG&E’s equity?
Here is a straightforward way to frame the possibilities:
If the shares adhere to a typical bankruptcy outcome, they would become worthless, handing investors a 100% loss. Given the complexity of the negotiations ahead, and the powerful constituents on all sides, the odds of this outcome are high. Potential investors should be fully prepared for a total loss.
In a perfectly optimistic outcome, the company would revert to its pre-downfall condition, with its shares returning to their prior high of just over $70. With PCG shares currently trading at about $14, this would produce a 400% gain. We estimate that the odds of this outcome are extremely low, if not zero.
Inside of this +400% to -100% spread are many unknowns. The company currently has a market capitalization of about $6.8 billion, so investors believe there is a chance that some equity value will remain. One likely source of value: the estimated $30 billion in wildfire liabilities don’t actually exist yet… they are potential future liabilities, not actual judgements that the company is obligated to pay. It is possible that PG&E’s wildfire liabilities will be significantly less than $30 billion. Recall that it was found not liable for the 2017 Tubbs fire, eliminating an estimated $7 billion to $11 billion in potential liabilities.
Another source of value would come from any settlement that PG&E reaches with the state that would cap its liabilities for all past and future wildfires. This would address the risk from the “inverse condemnation” laws that can put the liability for fire damage onto the electric utility regardless of fault. PG&E also has liability insurance that would cover some costs, and it is likely that the utility could take a tax deduction for its settlements, further reducing the after-tax cost. At least some of these would accrue to equity holders.
Another possibility is that a separate trust is created to house the wildfire liabilities much like the trusts that were created for W.R. Grace’s asbestos liabilities. Perhaps PG&E can renegotiate some of its costly contracts to buy wind and solar power from independent suppliers. A wide range of other shareholder value enhancing outcomes may also be negotiated.
Using back-of-the-envelope calculations, given all of the uncertainties and interim legal and other expenses, an optimistic investor may consider an upside scenario of perhaps $25-40. This would provide a possible 79% to 185% return – generous but risky given the real possibility of a 100% loss.
For highly sophisticated, risk-accepting investors or casino gamblers only
Buying shares of PG&E may make sense for sophisticated investors who have expertise in the legal, financial and other aspects of Chapter 11 bankruptcies and public utility companies, who can reasonably estimate the underlying value of the company’s assets and liabilities, who can engage with all the uncertainties that come with a negotiated transaction, and can accept the risk of a complete loss. For everyone else, PCG shares would not be worth buying for any reason other than a casino-like gamble.
Head of Equity Research, The Turnaround Letter
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