Make the riskiest wager on Troubled Stocks

Betting on distressed companies -- whether they are nearly bankrupt or just enduring a long financial decline -- can be lucrative.

It's the riskiest wager an investor can make. In bankruptcies, equity shareholders can lose everything. Companies that don't file Chapter 11 can see their shares bump along at low prices for a long period of time. But recently investors who dared to snap up shares of troubled firms at single-digit prices have seen some handsome returns.

Shares of outfits in the troubled casino, airline, and auto sectors, banks, and other cash-strapped companies have surged in recent weeks on hopes that an economic recovery this year could save the stock market from a wave of bankruptcies.

The danger is real. According to BankruptcyData.com, 64 public companies have filed for bankruptcy in the first three months of 2009, including Lyondell Chemical, Nortel Networks, and casino firm Trump Entertainment Resorts. The total assets of these 2009 bankruptcies was $100.1 billion. By contrast, in the first quarter of 2007, the market had seen just 16 public company bankruptcies valued at $1.1 billion.

Airline Sell-Off Overdone?
A share price below 5 is a commonly recognized sign of bankruptcy danger to equity investors. In many hard-hit industries, it's now a common sight.

With a stock so close to zero, it's fair to say stocks are moving based on their chances of survival, not other fundamental measures of value. "You see stocks trading not on expected earnings, but on whether they're going to live or die," says independent market strategist Doug Peta.

As a result, the rewards for escaping bankruptcy can be substantial.

Among the recent buyers of these risky stocks has been Robert Bacarella, portfolio manager of the Monetta Mutual Funds (MONTX). He is investing a small portion of his portfolio in casinos, airlines, and banks despite the risk embedded in their single-digit stock prices.

In many cases, "[Wall] Street is telling you this company is going bankrupt," he says. But Bacarella expects an economic recovery this year, which could save many of those troubled firms. The sell-off in airline stocks, for example, was "way overdone," he says.

Some apparently agree. Airlines like Delta (DAL), United parent UAL Corp. (UAUA), American parent AMR Corp. (AMR), and U.S. Airways (LCC) are up 12% to 22% since the start of April, though all four still trade below 7 per share. Delta, UAL, and U.S. Airways have each endured bankruptcy proceedings in the past decade.

MGM's Roller-Coaster
The recent rally has been even stronger in industries harder hit by the recession.

In just two trading sessions, the battered shares of casino operator MGM Mirage (MGM) surged 76% as investors hoped that bankruptcy could be avoided through some asset sales.

MGM Mirage traded above 100 per share 18 months ago, but these days Morningstar (MORN) analyst Jeremy Glaser gives the casino operators' shares a fair value estimate of zero. "We think [bankruptcy] is the most likely outcome," he says, citing MGM's heavy debt load and overly ambitious expansion plans.

"There are certainly scenarios in which MGM is worth quite a bit more than [zero]," Glaser says. But, "with credit markets so seized up, it seems unlikely the common shareholders are going to come out with anything."

MGM shares rallied until Apr. 7, when Janney Montgomery Scott analyst Brian McGill downgraded the stock to "sell," warning asset sales would be difficult. MGM shares fell 20% on Apr. 7 to 4.45 per share.

Another large casino operator suffering from a high debt load is Las Vegas Sands (LVS). Its shares were up 74% in the five days before Apr. 7, when the stock dropped 19% to close at 4.03.

Still another prominent casino operator already went under. Trump Entertainment Resorts filed for bankruptcy reorganization on Feb. 17.

Varied Views
The prospects that a company can avoid bankruptcy vary wildly depending on the state of its industry and its balance sheet. And analysts and investors can strongly disagree.

Vaughn Cordle, chief analyst at Airline Forecasts Investment Strategy & Research, believes the economy will recover and save major airlines from bankruptcy.

First-quarter results will be "ugly -- no doubt about it," he says. But airlines have cut costs -- domestic capacity was down 11.5% last quarter -- and they could save almost $20 billion in fuel costs this year, Plus, he says, "We're going to have a recovery. The recovery will be mild and weak, but it's a recovery nonetheless."

Jesup & Lamont (JLI) transportation analyst Helane Becker says airlines, though heavily in debt, have enough cash to make it through 2009. However, she says, bankruptcy "is a 2010 risk if nothing improves in the economy and credit markets."

For automakers, the worry is far more short-term. General Motors (GM) shareholders face two prospects, neither attractive, says Standard & Poor's equity analyst Efraim Levy: GM could file for bankruptcy, thus making shares "essentially worthless." Or, the automaker could issue billions of dollars in new shares, which would dilute current shareholders' stakes.

For Ford (F), which has more cash, the risk of bankruptcy is lower, Levy says. "If they can make it through this downturn, then the risk of bankruptcy is mitigated," Levy says. "The key is getting through the next 12 months or so, until demand starts to come back" and cost-cutting pays off. [Levy, as an equity analyst, has no involvement with credit ratings at S&P, which like BusinessWeek is a unit of The McGraw-Hill Cos. (MHP).]

This month, Ford shares are up 33%, closing Apr. 7 at 3.49. GM shares are essentially flat, closing at 2 on Apr. 7.

"Free-Enterprise Darwinism"
Troubled firms essentially face two problems. In the short term, they must try to meet debt payments, raise cash, and negotiate with creditors. But their long-term challenges are no easier: They must adapt to an economic climate that could be quite different from just a couple years ago.

For casinos, for example, "investors have to think about, 'What's the future of the Las Vegas market?'" Glaser says. "Are people still going to be willing to take very discretionary trips out to Las Vegas?"

Airlines have slashed fares, which seems to be luring leisure travelers into the airport, Becker says. But business travel spending remains depressed.

Gary Wolfer, chief economist at Univest Wealth Management (UVSP), expects a wave of bankruptcies in the next year or two. Even if firms survive the recession, the recovery will be too subdued to keep weak companies afloat, particularly in the consumer discretionary sector. "Sooner or later, the walking dead start to fall," Wolfer says.

If bankruptcies accelerate, shareholders could lose big. But some could benefit.

It's "free-enterprise Darwinism," Wolfer says, in which the strong survive and benefit from their rivals' collapse.

"The problem here is you have to decide which companies will be able to survive the downcycle to benefit from the upcycle," Levy says.

Given massive levels of uncertainty about the economy and credit markets, that's a difficult decision to make. Especially when a bankruptcy can render shares worthless.

Source from: msn.com

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