Approach Distressed Companies With Care

Speculating on troubled stock is a dangerous game.  Recently I have read a lot of comments about ITT Educational Services, Inc. (NYSE: ESI) and they bring back bad memories.

Many public companies go bankrupt and ESI seems to be following the script: government scrutiny, management shakeups, delayed financials, huge drops in the stock interspersed with lulls of slight hope, disintegration of primary business activities, multiple law suits, numerous consumer complaints.

Any new investor needs to realize that common stockholders are dead last in the bankruptcy process.  The Government, creditors, bondholders and preferred stockholders are all in line ahead of common stockholders.  Generally being last in line means they get nothing.

Back around the year 2000 I bought some distressed companies at bargain prices: Webvan, Loews Cineplex Entertainment and United States Gypsum Corporation (NYSE: USG).  All three were already in or very near reorganization.  But I figured they had viable businesses.  They would come out the back end with their debts charged off.  The shares would rise and I would profit.

Then the simplicity of my thinking became clear.  Webvan decided to completely liquidate.  Shortly after Loews Cineplex, as they were getting ready to exit bankruptcy, cancelled all their common shares.  I had not known this was allowed.

United States Gypsum did work out.  They emerged from bankruptcy without cancelling their common shares.  Then the building boom geared up and shares soared.  I made good money on that one, actually enough to cover losses on the other two and still profit.  So it isn’t always a sad story.

But the point still stands: buying common shares of distressed companies is dicey.  Treat any money you invest like you would money in Vegas: kiss it goodbye and be really happy if it actually pays off.  People I see today talking about ESI at $15 could stand to keep that lesson squarely in mind.

 

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Articles presented here are general opinions for your own consideration.  They are not specific advice for any one investor.

 

Cancelled Common Shares, Reorganization

Investment Strategy