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Debtors' Vision: Betting on Chapter 11 Turnarounds


For a brief moment, it looked as if Enron Corp. might make daring investors rich again. On July 11, the once-high-flying energy trader filed its bankruptcy reorganization plan. In the next four days, the stock shot up 70%, to 8.2 cents, as volume spiked to 13.8 million shares a day, eight times its average. Go-go postings popped up on Internet message boards, urging everyone to hurry and buy shares.

Offering the opposite view, though, were other messages warning would-be purchasers to steer clear. They noted that, under Enron's plan, its equity would disappear, as company executives all along have said. In a posting on Lycos Inc.'s Raging Bull Web site, buzzbee20 cautioned: "I got out today. Lost a bundle but not all. My advice, my friend -- get out and stay out." Sure enough, Enron stock began slipping a week later and now sells once again for 5 cents a share.

These days, investors are spoiled for choice when it comes to bankrupt companies. After a three-year explosion of corporate failures, more than 400 public companies are now in Chapter 11, figures PricewaterhouseCoopers LLC -- an all-time record. Included are many big, familiar names such as insurer Conseco Inc. (CNCEQ) and airline UAL Corp. (UAL) Indeed, eight of the 12 largest bankruptcy filings in U.S. history, measured by assets, are now being sorted out in court -- as the companies continue to trade in the so-called pink-sheet and bulletin-board markets. What's more, the shares often go for pocket change, so even a penny-a-share price rise can bring a market-beating return.

Very occasionally, stocks in tottering outfits do maintain at least some value when the companies exit bankruptcy. But the harsh reality is that, in almost every reorganization, what money companies can scrape together goes to creditors first, often in the form of new equity, leaving old shareholders empty- handed. "If you purchase stock in a bankrupt company, it is highly likely that your investment not only will not rise in value, but that you'll be holding worthless shares," says Susan F. Wyderko, director of investor education and assistance at the Securities & Exchange Commission.

So why do people still buy? One reason is the temptation of a quick buck held out on Internet message boards and in spam. Some companies in Chapter 11 even push their own stock, such as U-Haul International Inc. parent Amerco. And because these stocks often are volatile, investors can score with well-timed buys. For example, shares in Mirant Corp., an electric-power wholesaler, rocketed 31% in two days of trading, to close at 42 cents on Aug. 19.

Besides, many investors believe that the companies can turn themselves around, so they figure the stocks must be a good investment. Even when brokers or the companies warn that today's shares will be voided, many investors simply choose to ignore them. "These investors are so rebellious by nature that when the company says you get nothing, they think the company is lying to them," says Michael Weinstock of Quadrangle Group, which manages $600 million in distressed securities.

The SEC is seeing a sharp rise in complaints from shareholders who got wiped out in bankruptcy reorganizations. That's due in part to Kmart Corp. (KMRT). After filing for Chapter 11 protection in January, 2002, the discount retailer announced on Apr. 22, 2003, that the bankruptcy court had approved its reorganization. The next day, 133 million shares were traded, up from a daily average of 21 million, and in a week the stock price doubled, to 12 cents. On Raging Bull's Kmart message board, some posters urged investors to hold on to their shares. "This could be a great opportunity!!" cheered dadgummit. "I may just be a buyer here." But only two weeks later, the shares lost all their value as the Troy (Mich.) company emerged from Chapter 11 and ownership of the company was transferred to its creditors.

Now, as other big names prepare to leave Chapter 11 behind, SEC officials say many more investors undoubtedly will find that they, too, have been left holding the bag. Conseco plans to emerge in September, and Enron, UAL, and WorldCom (now known as MCI) are all planning to come out in the next few months. Each has warned that its stock will be worthless, yet shares in UAL, for one, still fetch 47 cents.

In rare cases, shareholders do get something. For instance, when Peregrine Systems Inc., a San Diego software company, emerged from bankruptcy on Aug. 7, its equity holders received a third of its new shares. Amerco's chairman, Edward J. Shoen, has been telling shareholders they'll be rewarded when the Reno (Nev.) company reorganizes and pays off creditors in full. His assurances have helped Amerco shares nearly triple, to $11.85 from $4.08, when it filed for bankruptcy protection on June 20, after defaulting on a $100 million bond repayment.

Stockholders in USG Corp. (USG) may fare even better. The wallboard manufacturer, pushed into Chapter 11 two years ago by a surge of asbestos-liability claims, has said its equity owners could come out whole if Congress approves a trust fund that limits its hit. Indeed, stock in the Chicago company is still listed on the New York Stock Exchange and closed at $15.48 on Aug. 19, up 300% from $3.88 when USG filed for bankruptcy in June, 2001. Already, DC Capital Partners LP has made a bundle on USG. Douglas L. Dethy, a managing director of the New York contrarian investment firm, bought 2 million shares in 2002, at around $6.10 apiece, and sold 1.5 million shares between Apr. 1 and June 30 as the share price topped $20.

Still, Dethy says most investors should avoid companies in bankruptcy court. "To make money, things have to get substantially better, and that doesn't usually happen," he says. "The vast majority of these do not work out." That's something to remember the next time some spam shows up pushing a Chapter 11 stock. By Michael Arndt in Chicago, with Mara Der Hovanesian in New York


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