Some Funds Pursue Bankrupt Firms
Institutional investors are pouring hundreds of millions of dollars into bankrupt companies, convinced that profits lurk in waters shunned by mainstream Wall Street.
In the last year, money management firms have raised $250 million to $500 million for new funds designed to invest in companies in bankruptcy or teetering on its brink, fund managers estimate.
Baltimore-based T. Rowe Price Associates last month closed a $107.2-million fund that seeks to exploit the traditional bias against these companies by buying their debt and securities at a discount and, after bankruptcy proceedings are completed, selling at a profit.
“People are averse to even consider investing in bankrupt companies for emotional, non-rational reasons,” said David Breazzano, a fund manager at T. Rowe Price. “Many think the assets have no value. After a company goes bankrupt, they just dump it . . . . That’s why there are opportunities.”
Boston-based Fidelity Investments, the nation’s largest mutual fund group, has amassed $200 million for its Special Situations Fund.
Special situations, explained fund manager Dan Frank, are “Companies that are bankrupt, near bankrupt, or in the land of the living dead.”
Such firms are not in short supply. Several high-profile companies have filed for federal bankruptcy protection within the last month or so, including Texas Air Corp.’s Eastern Airlines and MCorp, the second-largest bank in Texas.
As investments, securities of bankrupt companies are no different from others: the point is to buy low and sell high.
The trick, fund managers said, is to ensure that the value of a company’s assets, if they are stripped off and sold, exceeds that of the securities and debt the company holds.
“The key is price. Everything has a price that is attractive,” Breazzano said. “If you can acquire a claim at a value below that of the assets, then it’s a good investment.”
When a company files for bankruptcy, the price of its stock, bonds and other debt claims generally nose-dives as mainstream investors flee what they view as a sinking ship.
“You get a distress sale at the bottom (of the market) by a forced seller,” said Fidelity’s Frank.
Under Chapter 11 of the U.S. Bankruptcy Code, defaulted companies are granted protection from creditors while they draft a plausible reorganization. During this uncertain period, before the firm either emerges restructured or is liquidated outright, the bankruptcy funds strike.
The idea is not entirely new: Individual investors with an appetite for risk have bought into bankrupt companies for years. Their brashness has often paid off handsomely, as with Interstate Stores Inc., the predecessor to Toys “R” Us Inc., whose common stock sank below $1 after it filed for bankruptcy in 1974. The company emerged from bankruptcy in 1978 and its stock now trades near $40 a share.
