Market Watch : Gambling on the Bankrupt-Bound

Carter Hawley Hale Inc. seems destined to join the growing ranks of bankrupt corporate giants. To traders of distressed securities, this is just another opportunity--but it’s also a very dangerous one, many experts say.

The Los Angeles-based department store chain’s common stock bounced wildly in trading last week as rumors of an expected Chapter 11 filing spread. The shares jumped 62.5 cents to $2.50 on Thursday, then sank by the same amount Friday, to $1.875.

To buy the stock now, you have to believe that the company will end up being sold to a rich competitor or that Carter Hawley will eventually reorganize and remain a going concern. In either case, current shareholders must be convinced that they’ll end up with much more than $1.875 a share.

But veteran players of troubled securities say traders in Carter Hawley shares are making the same mistake of countless others who have tried this game over the years. The result is almost always the same, the vets say: There is little or nothing left for the common stockholders.

“Generally, buying the equity of a company going into bankruptcy is a sucker’s play by definition,” says Chriss Street, managing director of the Reorganized Securities Group, an arm of Seidler Amdec Securities in Los Angeles.

What attracts amateur traders to a bankrupt stock is that the shares often trade in a wide--but cheap--range while the company is in Chapter 11. That can give the impression of easy profits or that there is some bona fide value in the shares.

Stock in Ames Department Stores, for example, has traded as high as $7 and as low as 47 cents during the past year. Ames filed for Chapter 11 protection last April. The stock closed Friday at $1.38 a share. So in theory, at least, a buyer who picked up the stock at the low of 47 cents could have tripled his money by now, while waiting for Ames to emerge from bankruptcy.

But trading these issues often is much more difficult than it looks because of their penny-stock status. Many brokers won’t even deal with such securities.

Indeed, many veteran traders say bankrupt stocks exist in a Never-Never Land where logic is ignored. “Oftentimes these stocks trade at irrationally high levels,” says T. K. Duggan, a trader at New York-based Delaware Bay Co., a broker of troubled firms’ shares.

Prices of the stocks are constantly buffeted by trading games. For example, traders who know that other traders have shorted a bankrupt stock--betting that it will become worthless--sometimes engineer “short squeezes” that attempt to panic the shorts into covering their positions. That can cause a bankrupt stock to rocket for no reason.

True, such games may allow nimble traders to make a fast buck. But the big moves in these stocks also can pull in investors who become convinced that the bankruptcy reorganization will mean a windfall for common shareholders. That is rarely the case:

* Wheeling Pittsburgh Steel, which filed Chapter 11 in 1985, saw its stock trade as high as $27.50 in 1988 on optimism about what shareholders might receive. But in the reorganization plan approved late last year, shareholders will end up with just 8.7% of the company. The original shares end up being worth $2.50 each--less than half the lowest price of the stock in 1985, after the bankruptcy filing.

* When Manville Corp. emerged from a six-year bankruptcy reorganization late in 1988, shareholders got just one share for every eight they had owned. The new stock now trades for $6.125 a share. Some traders paid the equivalent of $28 for the stock early in 1988, betting on a much more favorable outcome.

Of course, some bankruptcies have worked out better for shareholders. But overall, experts say, speculators would be far smarter to buy a bankrupt company’s bonds than its stock. The bonds are what the pros play, because they know that a bankrupt company’s debt is what will become the new equity in the reorganized business. The bondholders are near the front of the line, generally, in terms of payback.

Yet bankrupt bonds, too, are only for people who can afford to lose their entire investment. In 1990, a First Boston Corp. index of bonds in default showed a negative total return of more than 30% for the year. So a lot of investors who thought they bought bargains found that their trash bonds became even bigger bargains by year-end, at their expense.

Carter Hawley’s two bond issues, paying 12.25% to 12.5% annual interest, were trading around $200 per $1,000 face value Friday. If the company were to find a buyer willing to pay bondholders even 50 cents on the dollar, speculators could make a killing.

But analyst Street calls Carter Hawley’s bonds “still overpriced. . . . I think this will probably be a very difficult reorganization,” he said. “There are problems much larger in this bankruptcy than most,” he said, including potential litigation because of the 45% of Carter Hawley stock that is owned by the company’s employee retirement plan.

Edward Weller, retail analyst at Montgomery Securities in San Francisco, warns that despite Carter Hawley’s important store franchise in California, “it is not clear in my mind that there’s a natural buyer for the company.” If not, a reorganization could take many years--and shareholders could very well end up with nothing.

THE BANKRUPTCY CLUB

Carter Hawley Hale is expected to file for Chapter 11 bankruptcy reorganization shortly. Some of the other big names in that club:

Filed 52-week Fri. Stock Chap. 11 high/low close Carter Hawley expected 8.25-1.38 1.88 Pan Am Jan., 1991 4.00-0.25 0.34 Interco Jan., 1991 0.81-0.06 0.16 Continental Air Dec., 1990 9.25-1.00 2.13 Lone Star Dec., 1990 17.13-1.88 4.00 Circle K May, 1990 3.00-0.25 0.63 Ames Dept. Store April, 1990 7.00-0.47 1.38 Public Serv. N.H. Jan., 1988 4.00-1.75 3.13 LTV July, 1986 1.63-0.44 1.00