Wall Street Has Missed Before on Beat-Up Stocks
The deepening declines of WorldCom Inc.’s stock and bonds signal that many investors fear bankruptcy for the troubled telecom provider.
But could the market just be plain wrong?
Though investors appear to be bracing for the possibility of a Chapter 11 filing, the market “can and often does get it wrong,” said Robert Walberg, chief equity analyst at the investing Web site Briefing.com in Chicago. “With these telecom stocks, the market had it wrong on the other end a couple years ago, when they were riding so high,” he said.
George Putnam, editor of the Turnaround Letter, a “distressed-investing” newsletter based in Boston, pointed to packaging maker Crown Cork & Seal Co., whose stock dived to less than $1 in December on worries about its debt load and potential liability from asbestos-related lawsuits.
Since then the shares have soared to $11.47 Friday on the New York Stock Exchange, as the company has shed plants to trim costs.
The market often gets it right, of course: Plenty of dot-com stocks were marked down to penny levels ahead of the companies’ demise in the last two years.
Mutual fund manager Martin Whitman, who runs the Third Avenue Value Fund in New York and specializes in distressed securities, said that when he makes an investment he often has no clue whether the company is headed for bankruptcy.
“The California utilities are a perfect example,” amid last year’s energy crisis, he said. “We bought the bonds of both. [The utility arm of] PG&E; Corp. did file for Chapter 11, but Edison International didn’t.”
Whitman said he started buying bonds of housewares maker Home Products International Inc. in October 2000, thinking the company was headed for bankruptcy reorganization. “Instead, nothing happened except we’ve gotten our interest payments and done fine,” he said.
Whitman steers clear of the common stock of distressed companies, because those shareholders are at the bottom of the list when it comes to being paid in the event of a bankruptcy, meaning they often end up with nothing but a tax write-off.
When analyzing distressed debt, Whitman said, he prepares for any outcome: a bankruptcy liquidation, the worst case; a reorganization in which debt holders get stock in the new company; and avoidance of Chapter 11 altogether.
In the case of WorldCom, Whitman said he is still crunching numbers and reading company filings to determine whether to invest.
WorldCom’s 8.25% bonds maturing in 2031 fell to about 43 cents on the dollar last week. On Friday the price closed at $42.89 per $100 face value.
Credit-rating companies are reviewing the firm’s debt for possible downgrade to “junk,” or below-investment-grade status, an outcome that traders appear to be anticipating.
WorldCom’s stock has hit 10-year lows, closing at $1.79, down an additional 24 cents Friday on Nasdaq amid growing fear about the company’s cash crunch.
For a company like WorldCom, a spiraling market can become a “self-fulfilling prophesy,” said Blair Levin, a Legg Mason Inc. telecom and media-regulatory analyst based in Washington.
“There’s a dynamic at work when the stock is under this much pressure: Your access to capital gets cut off, and WorldCom is in a capital-intensive business,” Levin said. “So even if the market is ‘wrong,’ it’s right in that it shifts the momentum in that direction.”
For individuals, distressed investing can be a minefield.
“It’s as complex an area as you can get,” said Bruce Spector, a partner at Apollo Management, an investment firm with offices in Los Angeles and New York. “Determining whether a company can meet its obligations is a hard call even for professionals to make, and it’s only one factor in the equation.”
In WorldCom’s case, Putnam said one factor weighing on the securities could be the numerous acquisitions the company made over the years.
“There may be more problems hidden in WorldCom than anyone realizes,” he said, noting that nervous investors have punished other acquisitive companies recently as accounting fears have spread.
Once stocks get hammered to penny-stock status, they can languish for a long time. Networking giant Lucent Technologies Inc., for example, has traded in single digits for about a year as its business has continued to weaken, closing Friday at $4.40 on the NYSE.
Xerox Corp., which plunged to $6 in November, rallied to more than $11 in January, but since then the stock has flailed its way back to $8.03 Friday on the NYSE. The copier maker is far from out of the woods: Moody’s Investors Service downgraded its debt last week amid ongoing cash-flow concerns.
Despite the problems plaguing telecom, WorldCom and some of the other hard-hit stocks and bonds in the sector may represent a good risk-reward trade-off, say Putnam and other distressed-security analysts.
“People were overly optimistic about WorldCom in the past and they’re overly pessimistic now,” said Putnam, who has bought WorldCom bonds as a money manager for private clients. “The truth may be somewhere in between. My hunch is that they are a survivor.”
In his newsletter he recently recommended the stock of AT&T; Wireless Services Inc., which closed Friday at $8.94 on the NYSE. Based on his analysis of cash flow and debt load, Putnam believes it, too, is a likely survivor.
Curt Burns, an analyst at Metropolitan West Asset Management in Los Angeles, said his firm recently bought bonds of WorldCom and Qwest Communications International Inc. in its Metropolitan West Total Return Bond fund.
WorldCom’s bonds already “are trading at less than a liquidation scenario,” he contends.
Though a downgrade to junk status could force WorldCom to repay $2 billion within 90 days, essentially wiping out its cash on hand, Burns said the company is negotiating with lenders to deactivate those triggers.
“To believe WorldCom is going away, you almost have to believe that telecom services are going away, which isn’t likely,” he said, noting that a big chunk of the company’s revenue is from other large companies, which don’t change telecom providers often.
Only $60 million of WorldCom’s $30-billion debt load is due this year, Burns said. Although $1.7 billion is due in 2003, the company has $1.5 billion in cash and a $4.25-billion bank credit line (excluding about $3.75 billion the company is likely to allow to expire soon), and it is generating $1 billion in free cash flow per year, he said.
Still, some analysts who like WorldCom at these prices aren’t backing up that opinion with cash.
“My general feeling is that WorldCom will survive and the stock is undervalued,” Walberg said. “But I wouldn’t buy it. Too risky.”
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