Most investors think of bankruptcy as bad. As a result, they tend to avoid the stocks of companies that have been through Chapter 11 bankruptcy. But Chapter 11 can be very beneficial to a company. The bankruptcy process provides the company with an opportunity to solve most of its financial problems and aggressively address its operational issues. The emerging company will most certainly be stronger than it was going into bankruptcy. It may also be stronger than many of its competitors.
However, because investors have such a negative view of bankruptcy, the stocks of these newly emerged companies are often under-followed and likely undervalued. Wall Street analysts and commentators who recommend a stock before it went into Chapter 11 will have painful memories and won’t likely recommend it again. Similarly, the views of most investors will be tainted by their memories of the troubled company before it was transformed through the Chapter 11 process. As a result, they overlook the improvement in the company’s prospects and avoid the stock.
Post-bankruptcy stock can be undervalued for another reason. Often when a company comes out of Chapter 11 it will give creditors new stock to pay off some or all of their old debts. While the creditors are grateful to get paid something, most would rather have cash than stock, and will sell their shares as soon as they can. This short-term selling pressure may depress the price of the stock for some time after the company emerges from Chapter 11.
Eventually, the selling by creditors will stop and investors will begin to realize that the company is much stronger than before. When that happened, the stock can appreciate dramatically.
For example, US Concrete (Nasdaq: USCR) a maker of concrete and related building products, was forced into bankruptcy in early 2010 following the 2008 financial crisis. It emerged from Chapter 11 later in 2010 at around 9, then traded to below 3 the following year as investors unloaded their positions. The shares then began a rebound that took the price to above 60 by early 2016.
Similarly, AMR Corp. (Nasdaq: AAL) the parent of American Airlines, was pushed into bankruptcy in late 2011 by high operating costs and a heavy debt load. While in Chapter 11, the company restructured its labor contacts, reduced other operating costs, and exchanged its old debt for new equity. AMR emerged from Chapter 11 in late 2013 through a merger with US Airways. The stock of the new company began trading at around 24 in December 2013, and by early 2015 it had risen to 55.
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