Bankruptcy ‘Bargains’ Are Risky Business
Bankrupt Enron Corp.’s shares scorched up the stock charts early last week, nearly quadrupling in three trading days, from 26 cents on Nov. 30 to a close of $1.01 on Wednesday. Trading volume was huge.
By week’s end the shares had pulled back to 75 cents, but that was 75 cents more than many analysts said the stock is likely to be worth if the company is reorganized.
The pattern in Enron’s stock is a familiar one: Speculators often rush into shares of big-name companies that file for bankruptcy protection, tempted by “cheap” prices.
But experts say buying the common stocks of companies in Chapter 11 is one of the riskiest games investors can play if the strategy is to find a bargain to hold on to. Short-term traders looking for a quick profit might or might not succeed, but experience shows that those who buy and keep bankrupt shares are wiped out far more often than not.
“The common stock of any distressed company is a dangerous animal--you’re the last guy on the food chain when it comes to being paid off,” said Jonathan Rosenthal, a partner at Saybrook Capital, a Santa Monica investment bank. Like many pros, he prefers investing in a distressed company’s bonds, although only after careful scrutiny.
In bankruptcies, common stock holders often end up with nothing, because they’re at the end of the line of those with claims on the company’s assets. The legal pecking order puts bondholders, banks and other creditors ahead of them; common stock holders, in fact, are dead last.
In the example of Enron, whatever value might be there for common holders, if any, is one of the biggest questions on Wall Street, and one for which no one yet has a good answer, given the company’s tangled finances and a morass of pending litigation.
“You might as well go to Las Vegas and play six the hard way” as bet on Enron common stock, said Scott Black, president of money manager Delphi Management Inc. in Boston. “Enron was always just a story, never a real business with any meaningful return on equity or return on capital, even at its peak last December,” he said.
Even in cases of bankrupt companies that seem less a financial puzzle than Enron, shareholders who hope for the best usually find their faith was misplaced, analysts say.
“It has been our experience that the common stock becomes absolutely worthless when a company reorganizes,” said Chris Stuttard, editor of BankruptcyData.com, a Boston firm that analyzes distressed companies. “That’s what happens 90% of the time, and in the cases where you do get something, it might be a token, like one share in the newly capitalized company for every 50 that you held in the old one.”
Like Enron, many other large companies that have filed for bankruptcy in the last year, including Bethlehem Steel Corp., Fruit of the Loom Ltd. and Polaroid Corp., now trade as penny stocks, available for speculation by the brave or foolhardy.
But the reorganization of funeral home and cemetery chain Loewen Group Inc., which filed for bankruptcy protection in June 1999, is typical of what can happen in a reorganization, analysts say: The company announced last week that bondholders and other creditors will be issued 40 million shares in the newly organized company, which will be renamed Alderwoods Group and start trading in January on Nasdaq. But the company’s current common stock holders will be shut out.
“Unfortunately, the company just has too much debt, and that’s the way the bankruptcy code is structured,” Loewen spokesman Mark Utting said.
Loewen stock soared from a low of 38 cents after its bankruptcy filing to a high of $1.50 by mid-July 1999. Last week, it still was trading in the over-the-counter market--for 6 cents a share.
Shares Keep Trading
Even when bankrupt companies specifically announce that their stock is worthless, as once-highflying sneaker maker L.A. Gear Inc. did in its January 1998 bankruptcy filing, speculators may continue to actively trade the shares for some time.
Of course, not all bankruptcies end up with total losses for common shareholders.
When Southland-based restaurant chain Sizzler International emerged from bankruptcy in June 1997, it paid off creditors in full and allowed shareholders to keep their equity in the company. The stock jumped from $2.25 that spring to $4.65 by mid-summer 1997. But the company, now called Worldwide Restaurant Concepts Inc., has faced new struggles in the last year, and the stock has fallen to $1.13 as of Friday on the New York Stock Exchange.
Utility giant PG&E; Corp.’s principal utility unit filed for bankruptcy protection in April, but the parent company’s shares have climbed from $7 then to $19.14 as of Friday on the NYSE. PG&E;’s case is a reminder that a bankruptcy filing doesn’t necessarily mean a company is insolvent, and many analysts think PG&E; will be financially viable going forward.
“It’s rare that a company maintains the shares all the way through the bankruptcy, but it can happen,” Stuttard said.
Regardless, many of Wall Street’s veteran “value” investors say they never buy common shares of bankrupt firms.
They’re more apt to buy the bonds of such companies, which provide far greater likelihood of some kind of payoff.
Mutual fund manager Marty Whitman, for example, said he would consider buying Enron bonds but not stock.
“We would look at the senior secured debt, but we would have to see more company filings first. We’re chickens around here and we want to make sure we will get paid,” he said. Enron’s web of financial partnerships makes its bankruptcy far more confusing than most, Whitman said.
“We don’t invest in things we don’t understand. All that energy trading business with swaps and derivatives is a mess,” said Whitman, who runs the highly rated Third Avenue Value stock fund.
Enron’s once-trendy shares traded for more than $83 a share at the start of this year, and for more than $30 as recently as two months ago--before the company’s finances quickly unraveled and the stock started free-falling.
Looking for a Fast Profit
People trading Enron common stock since the bankruptcy filing are just trying to make a fast profit, Rosenthal said. “It’s nothing more than gambling,” he said. “Those people couldn’t possibly have analyzed what the company’s intrinsic value really is.”
Even his firm is baffled by the complexity of Enron’s finances, Rosenthal said.
“We’re in the middle of the Enron storm, working the phones all day” to analyze the financials and review the pending litigation, he said, and “we’re nowhere near where we would need to be” to be able to buy the company’s stock.
Some financial advisors, such as George Putnam, editor of the investment newsletter the Turnaround Letter in Boston, say investors who are interested in bankrupt stocks should consider buying whatever new stock is issued after a company reorganizes--when its balance sheet may be cleaner but Wall Street may still hold a grudge against the stock, undervaluing it.
If you buy the new stock, you’ll be investing alongside the creditors who helped craft the company’s reorganization plan and who agreed to receive the new equity as compensation for debt or other obligations they were owed.
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Do Shareholders Get to Share?
When companies file for bankruptcy protection, common stock holders often get no shares in the reorganized company. Here are a few examples of how shareholders have fared in recent years, according to BankruptcyData.com:
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Bkrtcy. Assets What happened to Company date (mlns) common stockholders PennCorp Finl. 2/7/00 $6,031 No payment received Loewen Group 6/1/99 4,674 No payment received Harnischfeger Inds. 6/7/99 2,787 No payment received Contifinancial 5/17/00 2,355 No payment received Criimi Mae 10/5/98 1,873 Kept shares owned (current price: $3.73) Vencor 9/13/99 1,718 No payment received Levitz Furniture 9/5/97 934 No payment received Stage Stores 6/1/00 858 No payment received Tokheim 8/28/00 690 No payment received KCS Energy 1/18/00 309 Kept shares owned* (current price: $2.85)
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* subject to dilution for conversion of new preferred stock
Source: BankruptcyData.com Inc.
