Investors piling into Kmart's ( KMRT) newly minted shares sense an opportunity to reap big gains from a company just out of Chapter 11. Who can blame them, with memories of the 1,700% rise in Carl Icahn's restructured XO Communications ( XOCM) fresh in mind? With the therapeutic aspects of bankruptcy behind them, the argument goes, other of Chapter 11's fallen angels could also be ready to reascend. But is it really a good idea to invest in these companies? The answer is a qualified yes, as long as certain conditions are met.
Take U.S. Airways ( USALA), which many feel is poised for success because of the $1 billion in private financing it received in its restructuring. The money became available via a federal loan guarantee program instituted in the wake of Sept. 11. "They are much more healthy financially," said Jim Corridore, airline equity analyst at Standard & Poor's. "They have lower debt, lower ongoing liabilities, which enabled them to revamp their cost structure." It's also crucial that a business be sized to its new reality. Often this means closing stores or offices, reducing manufacturing capacity or leaving unprofitable markets. "Telecom companies which had overcapacity and excessive debt, for instance, used bankruptcy protection to reject leases for more equipment and are now emerging debt-free," said Stephen Marotta, a principal of Marotta Gund Budd & Dzera, a financial advisory firm. Randall Eisenberg, chairman of the International Committee for the Turnaround Management Association, says airlines are also doing a good job shedding noncore assets. "They are using Chapter 11 to fix their capital structure and their business to be competitive."
With one way pointing skyward and the other to oblivion, investors would be wise to think carefully before plunging into their own turnaround plays. "There's great opportunity in buying companies emerging from Chapter 11, but you have to do the same amount of homework as for other companies," said Dominic DiNapoli, senior managing director and co-head of restructuring at FTI Consulting. "If the issues were dealt with effectively, these survivors get a new lease on life."