Stock Often Has a Hangover After Company's Bankruptcy
By MITCHELL PACELLE, Staff Reporter of THE WALL STREET JOURNAL, Wall Street Journal, Feb. 26, 2003

Finova Group, Loewen Group, NTL, McLeodUSA. All onetime failures, they are now living proof that second acts exist in American business.

After a record surge in bankruptcy filings, more companies are emerging from Chapter 11 bankruptcy-law protection with their balance sheets tidied up and executives ranks purged, eager for a second audience with the investing public. But what many of them don't have are healthy stocks. Wall Street analysts ignore them and potential investors steer clear. They drift down on light trading.

"Most people have the illusion that when you emerge from bankruptcy, you're all done" with the turnaround, says John Lacey, chairman of Alderwoods Group, the freshly named successor to Loewen, the Cincinnati funeral-home chain that sought bankruptcy protection in 1999. "That's not true."

Like many such companies, when Alderwoods exited from bankruptcy court in January 2002, its pre-bankruptcy shareholders were wiped out. The reorganization replaced them with a whole new group of shareholders: former holders of the company's bank debt and bonds. Some were reluctant stockholders, says Mr. Lacey, which produced selling pressure on its stock.

Call it a bankruptcy hangover, or overhang. Over the past 14 months, Alderwoods shares dropped in value from about $15 a share to $4.07 in 4 p.m. Nasdaq Stock Market trading Tuesday. Poor market conditions in the funeral industry were only partly to blame.

"There is overhang on the stock," says Mr. Lacey. "We viewed it as out of our control. Our focus was on getting the company to survive." Besides growing the business, he has concentrated on improving morale.

Many of the companies to emerge from bankruptcy-court protection in the past year have faced similar trading woes. Finova Group, McLeodUSA, NTL, Covad Communications Group, Mpower Holding and Washington Group International all have seen their shares fall since emerging from bankruptcy court. Although the reasons are varied, a selling overhang is often a factor.

In the coming year, a host of large companies is expected to emerge from court protection, including Conseco, Kmart, US Airways Group and WorldCom. "Most of these companies are going to have sell-side pressure for the first couple of years," says Randall E. Curran, chairman and chief executive of ICG Communications, a Denver telecommunications concern that emerged from bankruptcy last October. "It's just there, and there's nothing to do about it. It creates an atmosphere where no one really cares about the stock price for a while."

The lackluster stock performance underscores the short-term risk for investors hoping to get in on the ground floor of a turnaround. To be sure, such investments are inherently risky. There is a long list of post-bankruptcy mediocrities, including a few companies that fell back into Chapter 11, an ignoble trajectory known informally as Chapter 22.

Even in the case of companies whose stocks eventually perform well, there's that immediate rockiness. It is often sparked by banks that have received stock in exchange for what they were owed. These banks often have little appetite to hold on to the shares. Banks are barred by regulators from holding such stock for more than three years, although they can apply for two years of extensions. They often try to trickle it into the market, or sell it in blocks. (Stock distributions to various creditor groups are detailed in corporate reorganization plans, filed in bankruptcy court.)

In the case of Washington Group, an engineering, construction and management firm that emerged in January 2002, bank lenders got 80% of the stock in the reorganization, according to Joseph von Meister, who follows post-bankruptcy debt and equities for Jefferies & Co.

For several months, the shares held fairly steady. "Then it sold off hard," he says. "The largest constituents were not natural holders."

In other cases, the largest holders are unlikely to quickly dump stock onto the market. ICG emerged from bankruptcy with its debt load slashed to $200 million from $2.5 billion and huge blocks of its stock in the hands of W.R. Huff Asset Management and Cerberus Capital Management. Both are sophisticated hedge-fund investors known for buying distressed debt to take control of companies in bankruptcy. Now they hold four of ICG's five board seats. Such "vulture" investors rarely look to cash out before the stock is on the upswing.

"You need the conviction and patience to hold," says Paul S. Levy of Joseph Littlejohn & Levy, a private-equity firm that has invested in several companies in the midst of bankruptcy reorganizations. "That's why, for the right kind of person, they can be great" investments.

One clue to a company's prospects is whether it has the support of such major institutional investors. While it isn't easy for potential investors to ascertain the intentions of such investors, or their time horizons, they seldom have the opportunity to bail out of large positions quickly.

McLeod is a case in point. The telecommunications firm emerged from Chapter 11 last April with its debt pruned to $715 million from $4 billion and a scaled-back business plan that generated revenue of $992 million last year, down from $1.8 billion in 2001. Buyout kingpin Theodore Forstmann's investment fund holds 58% of the stock.

Mr. Forstmann hasn't disclosed how long he plans to hold, or what his exit strategy is. Since emerging, McLeod's stock has drifted down from $1.53 a share to 71 cents in Nasdaq trading.

"I don't look at the stock price every day," says McLeod Chief Executive Chris A. Davis, a turnaround specialist brought in by Mr. Forstmann. The price decline and the light trading, she says, are "not a surprise." Her goal, she says, is to build a strong company.

If a company emerging from bankruptcy succeeds in finding a way to generate new growth, its stock has the potential to stabilize and begin rising. For post-bankruptcy investors, such a U-shaped stock movement represents the best of outcomes.

ICG's Mr. Curran says he watched such a pattern develop when he took welding-equipment maker Thermadyne through Chapter 11 in the mid-1990s. Its stock slid from $13 a share to $9, then began rising, he says. The company was eventually sold for $35 a share, he says. In 2001, Thermadyne sought bankruptcy protection once again.