Chapter 11 June 11, 2009, 5:00PM EST

Betting on the Equity in Bankrupt Companies

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That's one issue equity holders may raise at TXCO Resources, which listed assets of $432 million and debts of $323 million in its bankruptcy filing. Analyst Chris Pikul at investment bank Morgan Keegan says shareholders could emerge with a valuable stake in the reorganized company. The shares have been trading for less than 25 cents since the filing; he thinks they could be worth $1.50 to $5.

Pros say to stay away from situations where a company's entire industry is suffering, as is the case with airlines, homebuilders, publishers, and financials. For example, shares of Yellow Pages publisher R.H. Donnelley sank to about 5 cents after it filed for Chapter 11 protection in May. The company, which lost $2.3 billion in 2008, has proposed a plan wiping out shareholders and giving bondholders total ownership.

Investors who shunned R.H. Donnelley might have been recalling the experience of Delphi shareholders. The auto supplier filed for bankruptcy in 2005 and an initial reorganization plan would have given shareholders stock in the new entity and warrants to buy more shares. But with sales at the Big Three automakers plunging, Delphi's outlook has dimmed. A revised plan announced on June 1 wipes out shareholders. That outcome worries investors considering shares of General Motors or auto parts maker Visteon (VC). The U.S. and Canadian governments' involvement further complicates the issue. "The governments are very big players here, and it's very difficult to determine what is going to be valued and what will not," says Recovery Partners' Jurshevski.

Where does all of this leave General Growth? Unlike some rivals, it hasn't been hurt much yet by the demise of dozens of retail chains. In April the company said it had a vacancy rate of less than 10% and net operating income in 2009's first quarter of $555 million. The declared value of its 200 malls and other property carried on its books of $29 billion already exceeds its debts of $27 billion.

Hedge fund manager Ackman and others argue that the assets are worth much more than $29 billion. In a 68-page presentation Ackman sent to some institutional investors in late May, he figured that based on cash flows and assets, shares could be worth $9.11 to $21.50 after a reorganization. Tilson, who shorted General Growth before the bankruptcy, bought a small position for his funds at under $1 a share. At $3, the potential payoff is large enough to outweigh the real possibility that it won't survive, he says.

Pressman is a correspondent in BusinessWeek's Boston bureau.