Regarding NUZA we really don't know at this point, do we? Chapter 11 plays are generally bad bets period. From reading some of the posts on RB it is clear most are under the impression Chapter 11 is much more benefical to existing shareholders if the ongoing prospects of the company are good. I simply don't want some of the Bidders of the thread to be mislead and lose a bundle because some basic dd was missed, or not understood. I have a call into Dan Rouse and will report once I hear what he has to say. Here is all you ever wanted to know regarding bankrupcy.
Bankrupt stocks, reorganization plans and market efficiency: are
bankrupt stocks overpriced?
Jeff Hubbard Kevin Stephenson
06/22/1997
Quarterly Review of Economics and Business
Page 547
COPYRIGHT 1997 Board of Trustees of the University of Illinois
On Wednesday, January 20, 1993, the management of LTV Steel filed a
plan of reorganization to bring the firm out of its seven year bankruptcy.
To existing shareholders, the plan gave only warrants, which the firm
valued at a mere 3.22 cents per share. Surprisingly, the price of the
common stock actually rose steadily on Thursday and Friday, reaching a
high of $2 per share on Friday, before the company reminded investors
through a news release that their "common shares were worth less than a
nickel" (Mieher, 1993, p. A1). The stock still closed at $1.125 on
volume of over 15 million shares. Daily volume in the month prior to the
plan filing never exceeded 500,000 shares. The stock traded at a price of
$0.50 or higher the next several weeks on heavy volume, despite several
front page articles appearing in The New York Times and The Wall
Street Journal detailing the trading activity in LTV and restating the terms
of the reorganization plan. LTV 's stock was actively traded for four
more months before the plan was confirmed by the bankruptcy court and
actually closed at $0.25 per share (or eight times the stated value in the
plan) on the day before the confirmation hearing. The plan was confirmed
by the bankruptcy court yet LTV shares continued to be traded until the
company officially emerged from bankruptcy one month later. The market
value of the warrants was about four cents per old share.
Was this an isolated incident? In 1992, Ames Department Stores traded
for eight months after management filed a reorganization plan eliminating
the interests of its common and preferred shareholders, with the stock
trading as high as $0.75 on some days. News that nine insiders at Ames
sold their shares in the 24 days following the submission of the
reorganization plan apparently did not convince investors that their shares
would become worthless. Continental Airlines filed a plan eliminating their
shareholders. Wang Laboratories filed a reorganization plan which gave
the common shareholders warrants valued at only a few cents per share.
Both companies then publicly pleaded with the American Stock
Exchange to delist their shares. Both companies also issued statements
reminding shareholders of the plan provisions after the price reached
levels the firms apparently considered unrealistic. Continental's stock
reached a high of $1.50 in the 40 days it continued to trade. Wang's
stock traded for six months, reaching a high of $1.25, and was the most
heavily traded stock on the exchange on several occasions.
These four firms ultimately emerged from bankruptcy without changing
the provisions of their reorganization plans. If the stock market is
semi-strong form efficient, then publicly available information should be
incorporated into the stock price. Reorganization plans are filed with the
bankruptcy court and are available to the public. Were these four
companies trading at prices that did not incorporate information readily
available in their reorganization plans? This is impossible to answer
because a reorganization plan needs to be approved by the firm's
claimants, confirmed by the bankruptcy court and ultimately
consummated before the provisions of the plan are implemented. Hence
the firms discussed above could theoretically have emerged from
bankruptcy under a plan giving more to the shareholders than the original
plan called for. Yet, after the plans were filed, these companies reached a
combined high of about $5.75 per share, and emerged giving the
shareholders less than a dime. If this situation is "normal" for bankrupt
companies, then one can make a credible argument that stock prices of
bankrupt companies often do not incorporate publicly available
information. That is, investors overestimate what they will receive in a
reorganization.
Do the stock prices of bankrupt firms reflect the provisions of their
reorganization plans? If the market price is higher than the allocation
provided under the plan, is this price warranted? That is, are the plans
amended to give the shareholders more? The purpose of this paper is to
investigate a large sample of bankruptcies to answer these questions. Our
sample consists of all firms which filed for bankruptcy in 1988-1993 and
were still listed on a major exchange when they filed their first
reorganization plan.
We show that the stock price following the submission of a reorganization
plan was, on average, much higher than the shareholder ultimately
received. For example, in the six years of data examined, in not a single
case where a firm which initially proposed to give its shareholders nothing
was its plan altered to give the shareholders more. Yet, the announcement
that shareholders would receive nothing did not cause the stock to be
delisted. Instead, the shares continued to be actively traded and, in a few
cases, actually rose above the value that prevailed before the
announcement that shareholders would receive nothing.
The evidence suggests that shareholders overestimate the value of what
they will ultimately receive. Shareholders who continued to hold these
stocks through the remainder of the bankruptcy process would have done
much better had they sold them immediately: Investors purchasing the
stock after the first plan was filed lost an average of about 38% by the
end of the bankruptcy, with a median loss of about 83%.
The remainder of this article is organized as follows: The bankruptcy
process is outlined in the next section. The literature is reviewed in
Section II. In Section III, characteristics of the sample are discussed. We
analyze the stock price relative to the provisions of the reorganization plan
in Section IV. Section V concludes the paper.
I. THE BANKRUPTCY PROCESS
Before examining the bankrupt companies, the bankruptcy process needs
to be understood. A company in financial distress may file for bankruptcy
under Chapter 7 or Chapter 11 of the 1978 Bankruptcy Reform Act. If a
company files under Chapter 7, a trustee is appointed to oversee the
orderly liquidation of the firm's assets. Claimants are then paid according
to an absolute priority rule. This rule provides that no lower claimants
shall receive any value until all higher claimants are paid in full. At the very
bottom of the pecking order are the equity interests, in the order of
preferred stockholders, common stockholders and warrant holders.
Unsecured creditors in a Chapter 7 filing typically receive only a fraction
of their claim while shareholders almost always receive nothing.(1) Most
large companies attempt to reorganize by filing under Chapter 11. The
management of the firm remains in control and has 120 days of exclusivity
to submit a reorganization plan and another 60 days to solicit approval for
this plan. This period of exclusivity can be, and usually is, extended by the
courts. If the period of exclusivity ends before a plan has been approved,
any interested party may submit a reorganization plan.
The plan of reorganization classifies the types of claims filed and proposes
a plan of payment according to these classifications. A disclosure
statement provides claimants with sufficient information to enable them to
make an informed judgment about the plan. Once a reorganization plan is
filed with the bankruptcy court, it is sent with the disclosure statement to
members of all classes entitled to vote. The bankruptcy court cannot
confirm a plan of reorganization unless it is in accordance with the
following rules:
1. All classes of creditors and security holders must either accept the
plan, be unimpaired under the plan, or be subject to the "cram down"
provisions discussed below.
2. With respect to each impaired class of creditors and equity holders,
each class will, pursuant to the plan, receive at least as much as such
holder would receive in a liquidation.
Plans not initially approved may be amended and resubmitted. If an
impaired class does not accept the plan, the proponents of the plan may
invoke the "cram down" provisions of the Bankruptcy Reform Act. This
allows the court to confirm the plan as long as it is "fair and equitable" to
the class that rejected it. The fair and equitable standard is similar to the
absolute priority rule applied in a liquidation. This means that unless all
higher ranking classes receive full payment of their claims or consent to
partial payment, lower ranking classes must receive nothing. A firm
typically emerges from bankruptcy two to six weeks after the plan is
confirmed (the "effective date").
Research has shown that: (1) management typically plays a major role in
the submission of a reorganization plan (that is, plans submitted by other
parties are rare), with the typical plan being co-sponsored by creditor
groups and management; and (2) deviations from an absolute priority rule
are common, with shareholders often receiving some value, albeit small,
typically at the expense of unsecured creditors.(2) Shareholders of
seemingly insolvent firms received something for several reasons.
Management, in an attempt to appease all parties, will often include
shareholders in initial plans. The period of exclusivity and potential
extensions, combined with management's private knowledge about the
firm, discourage creditors from submitting their own plan eliminating
shareholders. Another reason is that the proponents of any plan
eliminating shareholders must convince the court that the value of the
reorganized firm will not exceed the claims against it. This requires costly
valuations and, more importantly, will lengthen the time in bankruptcy and
therefore increase the direct and indirect costs of bankruptcy. Hence,
unsecured creditors will often try to shorten the bankruptcy process by
giving a little to the shareholders at their own expense. The shares might
also maintain value because of prior net operating losses. Firms are
allowed to carry these losses forward for fifteen years to offset income,
thereby reducing their tax obligations in profitable periods.
This discussion illustrates that shareholders of clearly insolvent firms have
no bargaining power other than the ability to delay the bankruptcy. Once
management submits a plan eliminating shareholders, shareholders have
no recourse and will be eliminated. The plan might need to be further
amended to placate certain creditors, but unless the financial condition of
the firm rapidly and dramatically improves, shareholders interests will still
be eliminated.
II. THE LITERATURE
To our knowledge no published literature compares the stock price with
the value estimated in the reorganization plan. However, several papers
have investigated the stock performance during bankruptcy. Clark and
Weinstein (1983) examined ten firms for the six months following a
bankruptcy filing and reported returns not significantly different from zero
during this period. All ten firms filed for bankruptcy before the 1978
Bankruptcy Reform Act, and the small sample size precludes inferences.
Morse and Shaw (1988) used a sample of 55 firms that filed for
bankruptcy in 1973-1982 and remained on an exchange for at least one
month after the filing. The three year residual return for firms filing after
the 1978 Bankruptcy Reform Act was not statistically different from zero,
with approximately half of the securities having price increases and half of
the securities having price decreases.
Hubbard and Stephenson (1997) examined all firms that filed for
bankruptcy from 1984-1993 and remained on an exchange for at least
one month after the filing. Eliminating firms still in bankruptcy left a final
sample of 273 firms. Their results differed significantly from earlier
studies. They reported residual returns of -12% during the bankruptcy for
the New York Stock Exchange and American Stock Exchange firms and
residual returns of -91% for the Nasdaq firms.
Hotchkiss (1995) examined the post-bankruptcy performance of firms
that survived the Chapter 11 process. She found that 40% of the
emerging firms continued to experience operating losses for the three
years following their reorganizations, and that nearly a third of the
companies required a second bankruptcy filing or distressed restructuring.
Furthermore, she showed that management's cash flow projections at the
time of the reorganization tend to be overly optimistic, particularly when
the pre-bankruptcy managers remain in control of the company. These
findings have implications for our study: If investors are aware of them,
then we should expect the market valuation of the equity of the
reorganizing firms to be below the estimated values found in the
reorganization plans.
III. THE SAMPLE
A. Sample selection
Firms are sometimes delisted upon filing for Chapter 11 protection. This
is especially true of smaller firms. A delisting often reflects the exchange's
perception that the shares will ultimately be worthless. For the purposes
of this paper, we desired a sample of firms that had a "reasonable"
chance of giving something to the shareholders. We therefore restrict the
sample to New York Stock Exchange (NYSE) and American Stock
Exchange (ASE) firms whose shares remained trading on the exchange
for at least one month past the bankruptcy filing. Hence these firms
"survived" the bankruptcy filing itself. Ninety-eight NYSE and ASE firms
which fried for bankruptcy between January 1, 1988 and December 31,
1993 met this criterion.(3) Fifteen pre-packaged bankruptcies,(4) three
limited partnerships, three Real Estate Investment Trusts and nine firms
still in bankruptcy as of June 1995 were removed leaving a final sample of
68 firms.
The reorganization plans were obtained from the Bankruptcy Database
within Lexis/Nexis or, if still in existence, from the company itself.(5) A
multitude of sources were used to gather plan filing dates, court
confirmation dates and plan effective dates. Within Lexis/Nexis, we
searched the Bankruptcy Database, the news and magazine files, the
company "all news" file, the mergers and acquisition file, and SEC filings
including annual reports, form 10-Ks and form 8-Ks. Some details were
also gathered from Predicast's Capital Changes Reporter and the
1991-1995 issues of The Bankruptcy Yearbook &Almanac.
B. Volume
Price and return data are not useful if the volume is so small that one
could not buy or sell at the prices given. To determine if this is the case
with our sample, we compared the average daily turnover during the
bankruptcy with the "normal" pre-bankruptcy turnover for the company.
Normal turnover is defined as the average daily turnover in the one year
period ending three months before the bankruptcy. The post-bankruptcy
filing daily turnover was calculated as a percentage of the normal
pre-bankruptcy turnover for each firm using volume and share data
available on the CRSP tape. For example, if 1.0% of a firm's shares
traded on average each day before the bankruptcy and 0.6% traded each
day on average during the bankruptcy, the average turnover during
bankruptcy was 60% of the average turnover before the bankruptcy. The
firms were then separated based on this percentage with the results
shown in Figure 1.
As Figure 1 indicates, volume was relatively high during the bankruptcy
for most of the firms in the sample. |
