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Nicholas Kitonyi
Nicholas Kitonyi
Articles  | Author's Website |

Is There a Good Side to Bankruptcy?

There are investment opportunities galore

December 14, 2017 | About:

Bankruptcy is a term that many people would rather not associate with. On a general view, there is nothing fancy about being bankrupt. Whenever a person or an entity is declared bankrupt, most friends and even family members will look the other way when they are approached. It is a very compromising position for anyone to find themselves in.

Yet, in the U.S. there are about 800,000 bankruptcies filed each year with about 97% of those being non-business, according to data filed by U.S. courts for the year ended June 30, 2017.

In Canada, the figure stood at about 122,000 bankruptcies for the 12-month period ended Sep. 30, 2017, as per information gathered from various sources including the Government of Canada’s Insolvency Canada platform and reports submitted by licensed insolvency trustees to third-party platforms like Bankruptcy Ontario, among others. In just a quick close-up, look at the situation in Canada: Ontario and Quebec account for most of the Bankruptcies filed with an annual figure of about 80,000 bankruptcies.

To sum things up, there are nearly one million bankruptcies filed in North America. And while figures have been declining significantly over the past few years, they are still quite high compared to historical and global averages.

Bankruptcy is a menace to any society. However, some people have found ways that can help capitalize on this unwanted tag-name. They go by many names, but the most popular term is "vulture investor." These investors are specialists on investing in entities that are under financial distress and many people have likened them to wolves that target ailing prey. But from an investment perspective, this is simply smart investing, as noted in this Forbes article.

There are two types of bankruptcies, namely, Chapter 7 and Chapter 11. The common one in the corporate world is Chapter 11 bankruptcy. This is ideally organized and executed by the entity in question and it creates multiple opportunities for vulture investors to pounce. With Chapter 7 bankruptcy, opportunities are fewer because the company filing for bankruptcy cedes the process to a third party to liquidate its assets and pay off creditors.

In 2015, one of Caesars Entertainment (NASDAQ:CZR)'s main operating units, Caesars Entertainment Operating Company (CEOC), filed for a Chapter 11 bankruptcy, and vulture investors have since paid attention to the activities of the company. They anticipate the parent company to follow suit after litigation by creditors claiming breach of fiduciary duty and fraudulent transfer of assets.

And recently, Toys R Us followed in the footsteps of many other corporations after it reportedly sensed a tough holiday season ahead. Initial reports indicated that Amazon (NASDAQ:AMZN)'s retail e-commerce dominance had been critical to Toys R Us' bankruptcy filing, but according to UBS analysts led by Arpine Kocharyan who wrote in a September note, a “Chapter 11 filing heading into Q4 may [have been] indicative of a subdued holiday outlook by Toys ‘R’ Us,” MarketWatch reported.

Now, when investing in distressed company stocks, there are two approaches. The first, which is also the most common with vulture investors, is shorting the stock. This is done when you anticipate that based on the company’s current financial situation, including a possibility of adverse outcome in a lawsuit, weakening management and leadership, or like is the case of Toys R Us a tough sales season, a bankruptcy filing is imminent.

Another potential real-life example that vulture investors can use to benefit in the same way is Caesars Entertainment. If investors expect an eventual bankruptcy filing by the main company, then there might be an opportunity for vulture investors to pounce.

The other approach is to act just after the filing of a Chapter 11 bankruptcy. This, unlike in the first scenario, involves taking a long position on shares of a company that might be greatly undervalued due to the negative sentiment brought by the bankruptcy. Incidentally, company shares tend to decline in value more than necessary in the case of a company that files for Chapter 11 bankruptcy to reorganize itself before resuming normal operations.

As the company prepares to launch itself back to the market after restructuring following a bankruptcy filing, most investors look to sell off their stock allocated as part of compensation during reorganization. This greatly affects the stock price, thereby creating an opportunity for optimistic investors to buy.

In Joel Greenblatt (Trades, Portfolio)’s 1997 book, “You Can Be A Stock Market Genius," he talks about individual investors seeking to get involved in bankruptcy investing and other uncommon scenarios. Buying long after a reorganization is one of the featured topics, and it clearly explains the risks and potential benefits of taking a chance on a company that is recovering from a Chapter 11 bankruptcy.

Therefore, while the term bankruptcy might be something that most people would rather stay away from, there are those who are constantly doing due diligence reports on potential candidates for vulture investing. So it appears there is a good side to bankruptcy after all.

Disclosure: I have no position in any stocks mentioned in this article.

About the author:

Nicholas Kitonyi
Nicholas the founder of CAGR Value. He is a financial analyst with extensive experience in investment research and stock market analysis. His analysis has been featured on research sites like Seeking Alpha and Benzinga.

Nicholas has solid knowledge of both U.S. and European markets. His investment style is focused on undervalued plays and growth stocks. As a trader, Nicholas classifies himself as a swing trader and likes to trade GBP/USD, gold and FTSE 100, among other liquid instruments.

Visit Nicholas Kitonyi's Website


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