Stocks That Start When Chapter 11 Ends

With so many companies going into bankruptcy, some investment pros see new opportunities in the stocks of ones that are exiting it. If the companies use Chapter 11 to shape up their operations and restructure debt, they can be poised to do well once they emerge.

Just the idea that it might happen can drive up the stock, says George Putnam, of The Turnaround Letter. "And if the company cleans up its balance sheet by issuing large amounts of new stock to creditors, you can have an effect like an initial public offering, with almost a buying frenzy." When Southland came out of bankruptcy last March, its $2-a-share price jumped about 25% in the first weeks, on volume of 700,000 to 850,000 shares. And Maxicare Health Plans showed healthy gains in strong trading after it exited Chapter 11 last April.

But there's also a risk that once-stung creditors may unload their new stock and topple prices. So, even if you like a company's outlook, you might want to wait until the post-bankruptcy frenzy ends to get a fix on how it's really doing. A different approach is to invest before the company completes its reorganization. To do it, you buy a bond or preferred stock that will be exchanged for new common shares under the reorganization plan.

OPEN STORES. Some investors did that with Maxicare (chart). Now there's a similar opportunity in the wake of last year's collapse of Federated Department Stores and Allied Stores. Bankruptcy meant default on $700 million worth of 11.5% Allied bonds due in 1997. The reorganization plan says bondholders will get 12 shares of stock in the merged company. An analysis of the plan by BDS Securities suggests buying the bonds at the current asking price, 13~ on the dollar. So, a $130 investment secures 12 shares of new common, for a per-share price of $10.80. BDS expects the stock to trade at $14 to $15 in February when the company exits bankruptcy.

Among companies expected to emerge from Chapter 11, Putnam suggests looking at Revco, LTV, Tracor, and Lomas Financial. "But don't play the game unless you can diversify with five, six, or seven bonds in your portfolio," advises BDS' Carl Vaicek. That offsets some risks inherent in a complex reorganization scheme.

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