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.
Zero to 60
First, it's necessary to define terms. The question is not how owners of shares prior to bankruptcy fare: Their stock almost always ends up worthless. And it's not about how professional turnaround specialists or so-called vulture investors fare by entering the proceeding after it begins. This story focuses on the new shares of newly reorganized companies, the ones whose whittled-down debt load and cheaper financing make them a tempting bet to some. "This is certainly the best time. At least better than the reverse, when they are going into bankruptcy," said Randye Soref, chairman of insolvency at Buchalter, Nemer, Fields & Younger, a law firm. "These companies have typically secured exit financing coupled with the extinction of a great deal of debt. They can come out as better competitors, much ahead of the game." They can also fail just as miserably and return to bankruptcy, what experts refer to as "going Chapter 22." Discount retailer Bradlees ( BRADQ), for instance, got a temporary boost when it started trading, only to be liquidated less than two years later.
Hallmarks of Durability
While no analysis is foolproof, experts say viable turnaround candidates do share some habits. Perhaps most important is the amount of financing the company secures, and how it's spent. Is the company burning money to operate, or using it to pay down existing debt?