Should you make an investment in bankruptcy? A growing number of securities salesmen are telling their customers that there might be a lot of money in companies rising from the dead. And as the casualties list increases among public companies, so do your potential buying opportunities.
Bankruptcy specialists agree, however, that it's usually a mistake to speculate in the stocks of bankrupt companies. In a liquidation, when the company's assets are taken apart and sold, stockholders usually lose everything.
Even in a reorganization, when the luckless company restructures itself and re-enters the world of the living, stockholders usually come out on the short end of the stick.
But the bonds of bankrupt companies can be something else again. Many bonds are secured by specific assets, like real estate or airplanes, or stand first in line as a claim against the company's assets. In either a sale or a reorganization, senior bondholders are very likely to get a good settlement.
Bonds are often at their cheapest right after the company files for bankruptcy. Braniff's 9 1/8 percent $1,000 debentures due in 1997, for example, sold for $400 just one month before the airline went into Chapter 11, May 13, and $300 the day after. Last week, those same bonds were up to $450. Had you bought in the post-filing panic, you'd show a 50 percent profit in five months.
But buying on bankruptcy is always a big risk. One good example is Saxon Industries, which gave up the ghost on April 15. Its 5 1/4 junior convertible debentures, due in 1990, dropped to $220 right after the filing, from $350 a month earlier. A good buy? Absolutely not. "After the Saxon bankruptcy, additional fraud was uncovered," bankruptcy specialist Henry Wilf, of the Los Angeles office of Drexel Burnham Lambert, told my associate, Virginia Wilson. Those same bonds recently sold for $140.
Two mistakes that novice investors often make is to buy a bankrupt's junior or subordinated debt, or bonds with an early maturity date. "People think that the early maturity date means they'll pay off first," Wilf says. But all the creditors are paid at the same time and in a strict rank order, under the bankruptcy act. Secured bank creditors, senior trade creditors and senior bondholders come first, often leaving little money for unsecured or junior creditors.
If you can't resist cheap stocks, bankrupt issues often sell for less than $1 in over-the-counter trading or on the regional exchanges. The Pacific Stock Exchange has made itself a haven for moribund companies. But professionals say that these stocks are an enormous gamble. You can't guess what they'll be worth until the company's reorganization plan is announced--and even then, the market can cross you up.
Specialists in these issues agree that amateurs ought to stay away from individual bankruptcy issues and invest instead in one of the mutual funds that make a business of finding gold amid the dross.
This game's most experienced player is 72-year-old Max Heine, head of the highly successful Mutual Shares Corp. His fund has about 10 to 15 percent of its assets in bankruptcy situations; 20 to 25 percent in issues resulting from mergers and reorganizations; 60 percent in low-debt, deep-discount stocks that are currently out of fashion in the marketplace; and the rest in cash.
In 10-year profit performance, Mutual Shares ranks fourth among the 552 mutual funds now followed by Lipper Analytical Services. Mutual Shares carries no sales charge. For more information, write to the fund at 26 Broadway, New York, N.Y. 10004.
First Investors Bond Appreciation Fund, which emphasizes high-yielding, low-rated corporate and convertible bonds, puts 15 percent of its assets into bankrupt securities. Portfolio manager David Solomon sees such a future in bankruptcy that he's asking his shareholders for permission to invest more. This fund had a slow start four years ago and now ranks 208 on the Lipper list. It's available through stockbrokers for a 7.25 percent sales charge.
The brokerage firm Merrill Lynch just brought out a new fund called Phoenix, to invest in bankruptcy issues (mostly bonds) and in distressed industries like forestry, steel, airlines and autos that might prosper in a cyclical upswing. This fund is aimed at higher income speculators. Maximum sales charge, 6.5 percent.
Some of the dead, of course, are really dead. There can be big profits in some bankruptcies, but as investments a majority are a lost cause.