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The Globe and Mail

Buying after bankruptcy: Not always a dumb move

In a past journalistic life, I wrote an article not long after the bankruptcy of United Airlines' parent company that began, "There are no books called The Idiot's Guide to Buying Stock in Bankrupt Companies. That should be self-evident."

Rude, yes, but prompted by the fact that shares of UAL Corp. doubled in price in the days after the company's December, 2002, Chapter 11 filing – and some readers were asking if the shares were still a good investment.

Well, the phenomenon still occurs. Since the close of the markets Nov. 29, the day that AMR Corp., parent of American Airlines, declared bankruptcy, the best-performing North American airline stock is … AMR Corp., which is up more than 40 per cent. (The stock fell 84 per cent the day the company announced the bankruptcy.)

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My advice, however, is now somewhat tempered. Trying to make a bet on a bankrupt company's common stock is almost always a losing proposition. There are a couple of situations, however, where there are intriguing possibilities.

First, let's turn to Paulo Santos, a contributor to the financial blog site Seeking Alpha, who wrote an article called " prepare to buy Kodak" on the news that the iconic film company was considering bankruptcy. (Kodak shares rose 36 per cent to 81 cents on Wednesday and have doubled since the start of the week.)

Mr. Santos suggests buying the shares of a company in the 30 to 60 minutes after the first post-bankruptcy share trading occurs. He says "well-known, well-anticipated, large bankrupt [companies]that had large volume and short interest" before the filing frequently show strong gains "after taking the initial bankruptcy hit."

Mr. Santos theorizes that a significant factor in the increases could be demand from short sellers buying shares to close their short positions. Sometimes, it's speculation on news: Shares in AMR Corp. went from 26 cents, their Nov. 29 close, to $1.12 on Dec. 7 when a report emerged that the company's assets could be valuable enough to provide some recovery for equity holders.

But in any bankruptcy, common shares get in line behind all secured and unsecured creditors, meaning in most cases, stockholders get zero and the company cancels the shares. "Do not overstay your welcome," Mr. Santos writes. "The post-bankruptcy pop is very common, but the stock will most likely be worth zero over the long term."

The Vox column prefers holding periods of two years, rather than two hours or two days, so we pass along Mr. Santos' advice with less than a full recommendation.

At the same time, we bring to your attention an exception to the bankruptcy rule of common shares rendered worthless: Lee Enterprises Inc., a publisher of mostly small daily and weekly U.S. newspapers. (The St. Louis Post-Dispatch is its best-known property.)

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Like many North American newspaper publishers, Lee was burdened by debt as the industry suffered both a secular and cyclical decline over the past several years. The company spent much of 2011 negotiating with its lenders for a restructuring, but was hampered by debt agreements that required 100 per cent agreement of the holders before the maturities could be extended.

So, in December, Lee Enterprises filed for bankruptcy, allowing it to force the restructuring plan on the small minority of lenders who hadn't consented. Importantly, Lee stockholders would preserve their holdings with just 13 per cent dilution. Rather than falling immediately, shares jumped 34 per cent, to 71 cents, where they remain today.

If things go as planned, Lee's stock won't be worth zero, but what's the upside? If you wish to engage in the deeply contrarian practice of buying shares in a newspaper company, Lee may offer some gains.

Its per-share price is ripe for speculative swings as it emerges from bankruptcy, perhaps in a few weeks. Longer term, Lee offers above-average margins, growth in its digital revenue, and a portfolio of smaller papers that face fewer challenges than major metro U.S. newspapers.

But it also has one of the higher valuations in the industry on the basis of enterprise value (market capitalization plus debt) to EBITDA (earnings before interest, taxes, depreciation and amortization). Lee's choice to preserve its equity value means the company is also preserving, rather than wiping away, its debt.

So that makes a purchase of Lee stock merely risky – not as dumb as it could be.

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