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  • Writer's pictureIshfaaq Peerally

How to Invest in Bankrupt Stocks

Many companies have been filing for bankruptcy recently and usually, the stocks would crash but this is not happening this time. Hertz $HTZ gained 1400% in days after filing for bankruptcy and the company is even considering issuing new shares. Whiting Petroleum $WLL is another bankrupt stock doing great.

Investing in bankrupt companies can be a great opportunity. For example, if you had invested $10 000 in American Airlines $AAL when it filed for bankruptcy in 2012, you would have made $1.6 million in 5 years. This is an investment for a lifetime. But you would not have known that this would have happened and this is only an exception. Most bankruptcies don't end well for shareholders. Anybody remembers Enron or Lehman Brothers?

If a company files a Chapter 7 bankruptcy it is liquidated and most of the time, the shareholders won't get anything. But if it files a Chapter 11 Bankruptcy, there are two possible scenarios: debt restructuring or merging with another company.

I prefer debt restructuring as this is when most of the time, you can find good deals. Let's take for example, Whiting Petroleum. This is an $OIL company which filed for bankruptcy and already negotiated with their creditors that they are going to give them 97% of the equity. I made the calculations about the future tangible book value and took a big margin of safety, and found out that it could be a good investment at the right price. Another important factor, is that the stock is correlated with oil prices. Higher oil prices will be a good catalyst for this stock. Unfortunately, the stock was not cheap enough for me to invest.

Let's talk about Hertz. The company filed for bankruptcy and Carl Icahn sold all his shares at a massive lost. It would not make sense holding the stock as he would need to wait decades before making any profits. Should we take the opportunity to invest in Hertz? The problem is that Hertz doesn't have a plan yet of how they are going to get out of bankruptcy. Without this plan, investing in Hertz will be just speculation. Now Hertz took the decision to issue $1 billion in shares. The SEC is investigating but this doesn't make sense. The shares will be eventually diluted.

Another stock about to file for bankruptcy is Chesapeake Energy $CHK . The stock price is going up but the company doesn't have any plan yet how they are going to get out of bankruptcy if they file. It doesn't make sense investing in a company when the management says that they are preparing for bankruptcy.

Companies file for bankruptcy because of poor performance. Very rarely, a bankruptcy is just technical, for example, when Carl Icahn invested in Texaco in 1988. It was something in his circle of competence, something that he understood. This is the same strategy that we need to employ.

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