Tuesday, May 27, 2008

Bankruptcy Pays for Michael Price

Most of the value investors you hear about are super old. This is mainly because, to have proven yourself successful as a value investor, you've had to put in years of patience and shown that you can beat the market over long periods of time. Michael Price was fortunate enough to be recognized as a great value investor by the time he was 40.

After graduating from college, Price worked for 13 years for Heine Securities. When Max Heine died in 1988, Price assumed direction. A few years later, he sold the company to Franklin Resources, and soon started his own smaller company. He has kept his fund private, so as not to succumb to the quarterly pressures inherent in public companies.

One area where price has made a killing is on bankruptcies. For those diligent enough to study a company in or entering bankruptcy, an investment does not correspond to a random spin of a wheel.

As outlined by Bruce Greenwald, there are four main stages to most bankruptcies:

  1. Before filing for bankruptcy: Here, the company may be desperate for cash to keep afloat, and thus may be willing to grant equity or debt at attractive prices. If an investor is confident the company will eventually return to normal, there are large gains to be made here.
  2. The filing itself: Many funds are forbidden to own securities in companies that involved in such reorganization, and thus many of these securities can be acquired at fire-sale prices
  3. A reorganization plan: Two-thirds of each class of security holders must approve the plan for it to go through, so controlling one-third of the votes of any class garners some control, which can result in payoffs if used well.
  4. Liquidation or re-emergence of the firm: Either liquidation, whereby stakeholders are paid with senior debt holders first in line, or re-emergence, where debt is substantially reduced, and the company is now in a position to be more profitable than it was before.

A lot of people invest in bankruptcies looking for dead-cat bounces or other random movements in prices. But there is value to be found for those willing to put the effort into doing the work!

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