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Subject: RE: [CANSLIM] Off-CANSLIM: Common stock post-Chapter 11?
Date: Mon, 29 Jul 2002 10:36:22 -0400
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I think I speak for the rest of us when I say that I'm jealous,
Katherine, that you're sharing your knowledge with another board! Tell
us it's not true!
To your point on "residual ownership", during the go-go days I had a
chance to buy two "units" of a high tech "sure thing." After visiting
their offices and meeting with top management five years ago, I
convinced myself I was privileged to be in on the early action. I paid
$110,000 for the two units of Class C common stock, a total of 20,000
shares. Long story short, two months ago I got a letter about their
filing for bankruptcy, phoned my accountant, and here's her verbatim:
"You need to: a) Save the letter for the IRS; and b), between now and
December 31, capture whatever capital gains you can, 'cause they'll be
tax-free." Free?
Duke
- -----Original Message-----
From: owner-canslim@lists.xmission.com
[mailto:owner-canslim@lists.xmission.com] On Behalf Of Katherine Malm
Sent: Monday, July 29, 2002 12:37 AM
To: canslim@lists.xmission.com
Subject: Re: [CANSLIM] Off-CANSLIM: Common stock post-Chapter 11?
jans,
You've hit on a subject that is extraordinarily important to the
investor in individual equities. The key point to remember about a
common stock is that the shareholders have what is referred to as
"residual ownership." That is, if and only if there is anything left
over when everybody else has been paid off will they get a piece of the
pie. That's why you can own shares that have $0 value. On another
investing board, a member was telling everybody how he'd made the
"perfect low risk investment" in...tadah...WCOM. Said his downside risk
was only the $125 he had in the stock, as he'd picked it up at a bargain
price of $.11. Said his upside potential was a return of $18,000. He
added that "WCOM wasn't going away" and went on for 3 paragraphs about
all their assets. I mentioned the issue of residual ownership and tried
to explain what that meant to a bankrupt company and to the existing
common shareholders, and he *still* didn't get that the likelihood of
losing 100% of his $125 was nearly 100%. Unbelievable. Anyway, as
always, Briefing.com has written some excellent articles on the subject
and this one gives a great overview of the pecking order of payoff under
bankruptcy. As you can see, common stockholders fall to the bottom of
the heap.
- -Katherine
======
(apologies to those who don't have HTML capable email programs, but this
is just much easier to cut & paste from the site)
Bankruptcy and The Risk of Common Stock
27-Nov-01 09:37 ET
[BRIEFING.COM - Robert V. Green] For those investors holding stocks of
companies headed into or already in bankruptcy, an understanding of how
bankruptcy works is essential. For all holders of common stock, it is
important to know that you are the "last in line" when it comes to
bankruptcy proceedings. Here's how it works.
Declaring Bankruptcy
Bankruptcy becomes an option when a company realizes that it cannot pay
all of its obligations from a combination of cash flow and cash
reserves. The bankruptcy option allows a company to suspend and
restructure existing obligations to allow the company to either continue
operations or dissolve.
Bankruptcy proceedings are defined by federal law for publicly traded
companies. Management of the company declares bankruptcy by filing a
petition in Federal court.
Generally, the time sequence to enter bankruptcy follows these basic
steps:
* Company realizes it has financial problems that cannot be
addressed through normal business operations.
* Company files Chapter 11 or Chapter 7 bankruptcy petition
* Chapter 7 is giving up: The company ceases operations, sometimes
immediately, liquidates (sells) everything and distribute proceeds to
the claimants.
* Chapter 11 is reorganization: The company continues operations,
but stops paying all debt interest and dividends, and restructures the
debt and equity of the company to an "equitable" new level.
* The court approves the bankruptcy petition and the company
officially is in bankruptcy.
During the entire time of bankruptcy, between the approval of the filing
of the initial petition and the approval of reorganization or
liquidation plan, every step of operation of the company, and payment of
company funds, must be approved by the court. In essence, the court has
complete control of the company during the bankruptcy period, although
plans for management and operational decision making are submitted to
the court, and generally do not originate there.
Purpose of Bankruptcy
Chapter 11 bankruptcy exists to allow a company to reorganize claims
against it, in order to allow the company to continue operations.
Bankruptcy is not designed to fully relieve a company from its
obligations, but instead allows restructuring in order to permit the
company to make good on its obligations under new payment schedules.
The common perception that debts are simply "forgiven" in bankruptcy
stems from personal bankruptcy concepts, not corporate bankruptcy
proceedings.
What are the company's obligations? Claimants file petitions to the
court to make their claims. Generally, all claimants in a single class
are organized together.
The Priority of Claims
Federal law establishes the hierarchy of claims against the company.
Claims of a higher priority must be paid or settled before claims of the
lower priority.
The basic principle behind all bankruptcy claim payments is simple:
The higher the level of risk assumed in a transaction with the company,
the lower the level of claim in bankruptcy
This principle makes the assumption that the claimant, when he/she first
made their deal with the company, negotiated a price which accounted for
the level of risk they were assuming in the transaction.
The following table lists the priority of claims, by class of claimant.
Claim Priority Level Group Claim Comment
1. IRS 100% of unpaid taxes of all kinds. No surprise;
the government wrote the laws.
2. Employees Any outstanding claims related to payroll,
accrued vacation, pension contributions. 100% is generally paid. Affects
only payments for existing work already performed. In Chapter 11,
payroll and benefits continue to be paid unaffected. Jobs are not
guaranteed, however. Employees are rarely paid less than 100% of
outstanding balance. Also, while the cash value of contributions to a
401(k) plan are secured, the value of the investment after purchase, for
example, in company stock, is not. Management bonuses are frequently
excluded. Option value is not included nor considered. Options are on
common stock, (see which).
3. Debtors-in-Possession Creditors 100% regardless of whether
secured or not. Includes persons lending money to a company during
bankruptcy. They get first priority over all other claimants other than
employees, since risk is highest.
4. Secured lenders Full outstanding balance, up to day of
filing. Leases for real estate and equipment. Often current amounts
continue to be paid through bankruptcy, and full amount owed is carried
over, with security, into post-chapter 11 operation. (This means secured
lenders effectively lose nothing if company exits Chapter 11
successfully.)
5. Vendors Outstanding balance up to day of filing.
Frequently settled for less than the full amount, in exchange for a cash
payment at time of approval, any excess amount owed is wiped off the
books of the company.
6. Bondholders and Unsecured Lendors Principal, plus unpaid
interest Frequently bondholders will accept partial cash payment
with equity in the company issued in exchange for the unpaid principal
amount.
7. Preferred Stock Liquidation preference, as stated in
stock agreement, plus accrued dividends, if any. In many cases
where debt payment is the cause of bankruptcy, there is little left
after the above claimants have been settled, so the preferred stock has
little bargaining position. Often restructured into common stock, with
dividends wiped out upon exit on bankruptcy. For these reasons,
preferred stockholder in public companies often have veto rights over
debt issuance.
8. Common Stock Level of claim is on whatever is left over,
after all of the above classes of claims have been settled. Rarely
is anything left. In Chapter 11, if bondholders accept equity in
exchange for debt, any amount left over can be assigned to common stock.
Often, there is no value remaining.
Priority of Claim
In the table above, it is important to realize, each level of claimant
is entitled by law to 100% of their claim, before anyone below them gets
anything. It may be in their interest to accept less than 100% of their
outstanding claim, but the starting point for all claims is 100% of any
outstanding balance.
It is also important to note:
Common stock is at the very bottom of the list.
Most claimants settle for less than the full amount of their claim, at
the time of bankruptcy. The reason is that few companies can pay off
100% of any claim below the vendor level. Any claimant who insists on
100% of their claim risks throwing the company into liquidation.
Therefore most bondholders and claimants subordinate to bondholders
settle for something less than the full amount owed to them, with some
mechanism designed for them to possibly recover the unpaid balance over
time, either through equity, or restructured debt or dividends.
The Process - Chapter 11
When a company enters bankruptcy, the future ownership structure is
eventually determined by a court.
A "Plan of Reorganization" is submitted by management of the company to
the court. Management generally tries to come up with a plan which will
be acceptable to vendors and bondholders, prior to submission. A plan
which is submitted to the court with the support of the major claim
holders will generally be accepted by the judge.
The timeline for the court's process follows this basic outline:
* Plan of reorganization submitted
* Claimant parties either file statements of agreement to the plan
or objections, and submit an alternate plan.
* Judge reviews and either accepts, requests new plan, or writes
own plan (rare).
* The judge's decision is generally final, although an appeals
process exists.
* The approved reorganization plan is put in place, the company is
recapitalized, new securities are issued, old securities are cancelled.
* Company emerges from bankruptcy and continues operations.
Chapter 7, the alternative, is simply to sell everything and divide up
the proceeds according to claimant's claim levels. In some cases, if the
parties cannot agree on a Chapter 11 plan of reorganization, the
bankruptcy court will order a Chapter 7 liquidation and the company is
dissolved.
Common Stock Comes Last
As a common stock holder, you must realize that Chapter 11 bankruptcy
law places your claim on the company assets after all other claims.
This is a fundamental principle of bankruptcy law. Your ownership of the
company can be drastically reduced and even removed entirely.
In many cases, existing common stock holders do not lose their entire
value, but are simply diluted to such an extent as to render the shares
worthless. For example, common stock holders may hold 100% of equity in
a company prior to bankruptcy, but only 1% afterwards, as equity is
transferred to bondholders. The smallest shareholders don't even show up
in the eighth decimal point of percentage ownerships. Those shares can
be unilaterally cancelled by the bankruptcy court in exchange for a
modest payment or even nothing at all. If this happens, you have no
recourse as a common shareholder.
However, in some cases, common stock ownership is wiped out entirely. If
the total valuation of the company is far less than the total debt owed,
the equity value of the company may be transferred to the bondholders.
With no existing value left for common holders, their ownership can be
cancelled entirely.
Exodus Communications As Example
Exodus Communications filed bankruptcy on September 26, 2001. At that
point, all bond payments and bill payments stopped, and the company
filed a bankruptcy petition with the court. The company will now submit
requests to make payments on bills and other expenses while in
bankruptcy, and every payment must be approved by the court. Eventually
a plan of reorganization will be submitted to the court.
The total debt owed by Exodus exceeds $3 billion. The total value of the
company is probably in the $1 to $1.5 billion range, given a price/sales
ratio of about 1.0. If the company were liquidated, bondholders would
receive, at best, one-third of the amount owed to them. It is likely
that bondholders, as a class, will approve a plan that gives them
continuing debt of approximately $1 to $1.5 billion outstanding. This
leaves them with another $1 to $1.5 billion still owed to them. In
exchange for that amount, the bondholders may accept equity in the
company instead.
Since the entire company is only worth about $1 to $1.5 billion, the
bondholders will likely wind up owning the entire company. Common
stockholders will be able to make a claim on whatever is left over,
which is likely to be nothing. The company issued a statement to this
effect on November 12, possibly concerned that the stock was still
trading at a price that assumes there will be at least $100 million in
value left over for existing common stockholders. The only possible
explanation for this statement is that the company is perplexed that the
stock still trades at $0.10 per share, and wants to avoid future
liability by making it clear to holders of EXDSQ that their equity is
almost certain to be wiped out, as bondholders claims are settled.
Is It Fair?
The investing world is a risk/reward proposition.
Common stock always gets the reward of all the upside. When a company
grows in value, the newly created wealth is reflected only in the value
of the common stock (and in preferred stock). None of the new value is
reflected in the bonds. Although the credit rating may go up, the
interest payments do not.
The flip side of this is that the common stock has no downside
protection. When the company fails, common stock has no risk protection.
From the email we have received it is clear that many common
shareholders holding stock in bankrupt companies do not feel it is fair
to pay bondholders in equity and recapitalizing a company.
Is it fair? Definitely. When you capture all of the upside, it is only
fair that you also capture all of the downside.
Investors often ask, "How low can the price go?" The answer, for common
stock holders of bankrupt companies, is "Zero."
Comments may be emailed to the author, Robert V. Green, at
rvgreen@briefing.com
- ----- Original Message -----
From: Spencer48@aol.com
To: canslim@lists.xmission.com
Sent: Sunday, July 28, 2002 9:18 PM
Subject: Re: [CANSLIM] Off-CANSLIM: Common stock post-Chapter 11?
Tom:
Does this mean that any bankrupt company that forms itself into a
new
entity (perhaps by changing its name) can avoid its obligation to its
common
shareholders because now the old shareholders are owners of a bankrupt
company?
So the newly formed company can once again sell shares in the new
company (while legally ignoring its fiduciary obligations (for instance,
paying the old shareholders from any company assets left over after the
secured creditors and preferred shareholders are paid) the shareholders
of
its old company?
Isn't this (don't you think) like a legally sanctioned Ponzi
scheme-ie,
the corporation big-boys are legally benefitting from running the
company
into the ground?
jans
In a message dated 7/28/2002 9:24:55 PM Eastern Daylight Time,
stkguru@bellsouth.net writes:
<< The typical scenario is that a new corp is created, in which
ownership is
by the secured creditors of the old corp, and possibly a partial
ownership by
the unsecured creditors. Rarely do the common stock shareholders get
any
ownership in the new corp. The assets are transferred to the new corp,
remaining debts are left with the old. The secured creditors swap their
claim
on assets of the old corp for ownership in the new corp. Net result,
shareholders are left with shares in a shell corp, owning only debt and
no
assets>>
- -
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- -In the email body, write "subscribe canslim" or
- -"unsubscribe canslim". Do not use quotes in your email.
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<HTML><HEAD>
<META HTTP-EQUIV=3D"Content-Type" CONTENT=3D"text/html; =
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<BODY bgColor=3D#ffffff>
<DIV><SPAN class=3D328150514-29072002><FONT face=3DArial>I think I speak =
for the=20
rest of us when I say that I'm jealous, Katherine, that you're sharing =
your=20
knowledge with another board! Tell us it's not =
true!</FONT></SPAN></DIV>
<DIV><SPAN class=3D328150514-29072002><FONT =
face=3DArial></FONT></SPAN> </DIV>
<DIV><SPAN class=3D328150514-29072002><FONT face=3DArial>To your point =
on "residual=20
ownership", during the go-go days I had a chance to buy two "units" of a =
high=20
tech "sure thing." After visiting their offices and meeting =
with top=20
management five years ago, I convinced myself I was privileged to be in =
on the=20
early action. I paid $110,000 for the two units of Class C =
common=20
stock, a total of 20,000 shares. Long story short, two months ago =
I got a=20
letter about their filing for bankruptcy, phoned my accountant, and =
here's her=20
verbatim: "You need to: a) Save the letter for the IRS; and b), between =
now and=20
December 31, capture whatever capital gains you can, 'cause they'll be=20
tax-free." Free?</FONT></SPAN></DIV>
<DIV><SPAN class=3D328150514-29072002></SPAN> </DIV>
<DIV><SPAN class=3D328150514-29072002><FONT =
face=3DArial>Duke</FONT></SPAN></DIV>
<BLOCKQUOTE dir=3Dltr style=3D"MARGIN-RIGHT: 0px">
<DIV></DIV>
<DIV class=3DOutlookMessageHeader lang=3Den-us dir=3Dltr =
align=3Dleft><FONT=20
face=3DTahoma size=3D2>-----Original Message-----<BR><B>From:</B>=20
owner-canslim@lists.xmission.com =
[mailto:owner-canslim@lists.xmission.com]=20
<B>On Behalf Of </B>Katherine Malm<BR><B>Sent:</B> Monday, July 29, =
2002 12:37=20
AM<BR><B>To:</B> canslim@lists.xmission.com<BR><B>Subject:</B> Re: =
[CANSLIM]=20
Off-CANSLIM: Common stock post-Chapter 11?<BR><BR></FONT></DIV>
<DIV>jans,</DIV>
<DIV> </DIV>
<DIV>You've hit on a subject that is extraordinarily important to the =
investor=20
in individual equities. The key point to remember about a common stock =
is that=20
the shareholders have what is referred to as "residual ownership." =
That is, if=20
and only if there is anything left over when everybody else has been =
paid off=20
will they get a piece of the pie. That's why you can own shares that =
have $0=20
value. On another investing board, a member was telling everybody how =
he'd=20
made the "perfect low risk investment" in...tadah...WCOM. Said his =
downside=20
risk was only the $125 he had in the stock, as he'd picked it up at a =
bargain=20
price of $.11. Said his upside potential was a return of $18,000. He =
added=20
that "WCOM wasn't going away" and went on for 3 paragraphs about all =
their=20
assets. I mentioned the issue of residual ownership and tried to =
explain what=20
that meant to a bankrupt company and to the existing common =
shareholders, and=20
he *still* didn't get that the likelihood of losing 100% of his $125 =
was=20
nearly 100%. Unbelievable. Anyway, as always, Briefing.com has written =
some=20
excellent articles on the subject and this one gives a great overview =
of the=20
pecking order of payoff under bankruptcy. As you can see, common =
stockholders=20
fall to the bottom of the heap.</DIV>
<DIV> </DIV>
<DIV>-Katherine</DIV>
<DIV> </DIV>
<DIV>=3D=3D=3D=3D=3D=3D</DIV>
<DIV>(apologies to those who don't have HTML capable email programs, =
but this=20
is just much easier to cut & paste from the site)</DIV>
<DIV> </DIV>
<DIV>
<TABLE cellSpacing=3D0 cellPadding=3D4 width=3D"100%">
<TBODY>
<TR>
<TD class=3Dheader><STRONG><FONT size=3D4>Bankruptcy and The Risk =
of Common=20
Stock</FONT></STRONG></TD></TR>
<TR>
<TD><FONT class=3Ddate face=3DVerdana =
size=3D1><STRONG>27-Nov-01 09:37=20
ET</STRONG></FONT></TD></TR>
<TR>
<TD height=3D8><STRONG><FONT face=3DVerdana =
size=3D1></FONT></STRONG></TD></TR>
<TR>
<TD>
<P>[BRIEFING.COM - Robert V. Green] For those investors holding =
stocks=20
of companies headed into or already in bankruptcy, an =
understanding of=20
how bankruptcy works is essential. For all holders of common =
stock, it=20
is important to know that you are the "last in line" when it =
comes to=20
bankruptcy proceedings. Here's how it works. </P>
<H3>Declaring Bankruptcy</H3>
<P>Bankruptcy becomes an option when a company realizes that it =
cannot=20
pay all of its obligations from a combination of cash flow and =
cash=20
reserves. The bankruptcy option allows a company to suspend and=20
restructure existing obligations to allow the company to either =
continue=20
operations or dissolve. </P>
<P>Bankruptcy proceedings are defined by federal law for =
publicly traded=20
companies. Management of the company declares bankruptcy by =
filing a=20
petition in Federal court. </P>
<P>Generally, the time sequence to enter bankruptcy follows =
these basic=20
steps:</P>
<UL>
<LI>Company realizes it has financial problems that cannot be=20
addressed through normal business operations.=20
<LI>Company files Chapter 11 or Chapter 7 bankruptcy petition=20
<LI>Chapter 7 is giving up: The company ceases operations, =
sometimes=20
immediately, liquidates (sells) everything and distribute =
proceeds to=20
the claimants.=20
<LI>Chapter 11 is reorganization: The company continues =
operations,=20
but stops paying all debt interest and dividends, and =
restructures the=20
debt and equity of the company to an "equitable" new level.=20
<LI>The court approves the bankruptcy petition and the company =
officially is in bankruptcy. </LI></UL>
<P>During the entire time of bankruptcy, between the approval of =
the=20
filing of the initial petition and the approval of =
reorganization or=20
liquidation plan, every step of operation of the company, and =
payment of=20
company funds, must be approved by the court. In essence, the =
court has=20
complete control of the company during the bankruptcy period, =
although=20
plans for management and operational decision making are =
submitted to=20
the court, and generally do not originate there. </P>
<H3>Purpose of Bankruptcy</H3>
<P>Chapter 11 bankruptcy exists to allow a company to reorganize =
claims=20
against it, in order to allow the company to continue =
operations.=20
Bankruptcy is not designed to fully relieve a company from its=20
obligations, but instead allows restructuring in order to permit =
the=20
company to make good on its obligations under new payment =
schedules.=20
</P>
<P>The common perception that debts are simply "forgiven" in =
bankruptcy=20
stems from personal bankruptcy concepts, not corporate =
bankruptcy=20
proceedings. </P>
<P>What are the company's obligations? Claimants file petitions =
to the=20
court to make their claims. Generally, all claimants in a single =
class=20
are organized together. </P>
<H3>The Priority of Claims</H3>
<P>Federal law establishes the hierarchy of claims against the =
company.=20
Claims of a higher priority must be paid or settled before =
claims of the=20
lower priority. </P>
<P>The basic principle behind all bankruptcy claim payments is=20
simple:</P>
<BLOCKQUOTE>
<P>The higher the level of risk assumed in a transaction with =
the=20
company, the lower the level of claim in =
bankruptcy</P></BLOCKQUOTE>
<P>This principle makes the assumption that the claimant, when =
he/she=20
first made their deal with the company, negotiated a price which =
accounted for the level of risk they were assuming in the =
transaction.=20
</P>
<P>The following table lists the priority of claims, by class of =
claimant. </P>
<TABLE cellSpacing=3D2 cellPadding=3D2 width=3D"100%" =
border=3DBORDER>
<TBODY>
<TR vAlign=3Dcenter align=3Dmiddle bgColor=3D#cfcfcf>
<TH width=3D"10%">Claim Priority Level</TH>
<TH width=3D"10%">Group</TH>
<TH width=3D"40%">Claim</TH>
<TH width=3D"40%">Comment</TH></TR>
<TR vAlign=3Dcenter align=3Dmiddle>
<TD>1.</TD>
<TD>IRS</TD>
<TD>100% of unpaid taxes of all kinds.</TD>
<TD>No surprise; the government wrote the laws. </TD></TR>
<TR vAlign=3Dcenter align=3Dmiddle>
<TD>2.</TD>
<TD>Employees</TD>
<TD>Any outstanding claims related to payroll, accrued =
vacation,=20
pension contributions. 100% is generally paid. Affects =
only=20
payments for existing work already performed. In Chapter =
11,=20
payroll and benefits continue to be paid unaffected. Jobs =
are not=20
guaranteed, however. </TD>
<TD>Employees are rarely paid less than 100% of outstanding=20
balance. Also, while the cash value of contributions to a =
401(k)=20
plan are secured, the value of the investment after =
purchase, for=20
example, in company stock, is not. Management bonuses are=20
frequently excluded. Option value is not included nor =
considered.=20
Options are on common stock, (see which). </TD></TR>
<TR vAlign=3Dcenter align=3Dmiddle>
<TD>3. </TD>
<TD>Debtors-in-Possession Creditors</TD>
<TD>100% regardless of whether secured or not.</TD>
<TD>Includes persons lending money to a company during =
bankruptcy.=20
They get first priority over all other claimants other =
than=20
employees, since risk is highest. </TD></TR>
<TR vAlign=3Dcenter align=3Dmiddle>
<TD>4.</TD>
<TD>Secured lenders</TD>
<TD>Full outstanding balance, up to day of filing.</TD>
<TD>Leases for real estate and equipment. Often current =
amounts=20
continue to be paid through bankruptcy, and full amount =
owed is=20
carried over, with security, into post-chapter 11 =
operation. (This=20
means secured lenders effectively lose nothing if company =
exits=20
Chapter 11 successfully.)</TD></TR>
<TR vAlign=3Dcenter align=3Dmiddle>
<TD>5.</TD>
<TD>Vendors</TD>
<TD>Outstanding balance up to day of filing. </TD>
<TD>Frequently settled for less than the full amount, in =
exchange=20
for a cash payment at time of approval, any excess amount =
owed is=20
wiped off the books of the company. </TD></TR>
<TR vAlign=3Dcenter align=3Dmiddle>
<TD>6.</TD>
<TD>Bondholders and Unsecured Lendors</TD>
<TD>Principal, plus unpaid interest </TD>
<TD>Frequently bondholders will accept partial cash payment =
with=20
equity in the company issued in exchange for the unpaid =
principal=20
amount. </TD></TR>
<TR vAlign=3Dcenter align=3Dmiddle>
<TD>7.</TD>
<TD>Preferred Stock</TD>
<TD>Liquidation preference, as stated in stock agreement, =
plus=20
accrued dividends, if any. </TD>
<TD>In many cases where debt payment is the cause of =
bankruptcy,=20
there is little left after the above claimants have been =
settled,=20
so the preferred stock has little bargaining position. =
Often=20
restructured into common stock, with dividends wiped out =
upon exit=20
on bankruptcy. For these reasons, preferred stockholder in =
public=20
companies often have veto rights over debt issuance. =
</TD></TR>
<TR vAlign=3Dcenter align=3Dmiddle>
<TD>8.</TD>
<TD>Common Stock</TD>
<TD>Level of claim is on whatever is left over, after all of =
the=20
above classes of claims have been settled. </TD>
<TD>Rarely is anything left. In Chapter 11, if bondholders =
accept=20
equity in exchange for debt, any amount left over can be =
assigned=20
to common stock. Often, there is no value remaining.=20
</TD></TR></TBODY></TABLE>
<H3>Priority of Claim</H3>
<P>In the table above, it is important to realize, each level of =
claimant is entitled by law to 100% of their claim, before =
anyone below=20
them gets anything. It may be in their interest to accept less =
than 100%=20
of their outstanding claim, but the starting point for all =
claims is=20
100% of any outstanding balance. </P>
<P>It is also important to note: </P>
<BLOCKQUOTE>
<P><I>Common stock is at the very bottom of the list.=20
</I></P></BLOCKQUOTE>
<P>Most claimants settle for less than the full amount of their =
claim,=20
at the time of bankruptcy. The reason is that few companies can =
pay off=20
100% of any claim below the vendor level. Any claimant who =
insists on=20
100% of their claim risks throwing the company into liquidation. =
</P>
<P>Therefore most bondholders and claimants subordinate to =
bondholders=20
settle for something less than the full amount owed to them, =
with some=20
mechanism designed for them to possibly recover the unpaid =
balance over=20
time, either through equity, or restructured debt or dividends. =
</P>
<H3>The Process - Chapter 11</H3>
<P>When a company enters bankruptcy, the future ownership =
structure is=20
eventually determined by a court. </P>
<P>A "Plan of Reorganization" is submitted by management of the =
company=20
to the court. Management generally tries to come up with a plan =
which=20
will be acceptable to vendors and bondholders, prior to =
submission. A=20
plan which is submitted to the court with the support of the =
major claim=20
holders will generally be accepted by the judge. </P>
<P>The timeline for the court's process follows this basic =
outline: </P>
<UL>
<LI>Plan of reorganization submitted=20
<LI>Claimant parties either file statements of agreement to =
the plan=20
or objections, and submit an alternate plan.=20
<LI>Judge reviews and either accepts, requests new plan, or =
writes own=20
plan (rare).=20
<LI>The judge's decision is generally final, although an =
appeals=20
process exists.=20
<LI>The approved reorganization plan is put in place, the =
company is=20
recapitalized, new securities are issued, old securities are=20
cancelled.=20
<LI>Company emerges from bankruptcy and continues operations. =
</LI></UL>
<P>Chapter 7, the alternative, is simply to sell everything and =
divide=20
up the proceeds according to claimant's claim levels. In some =
cases, if=20
the parties cannot agree on a Chapter 11 plan of reorganization, =
the=20
bankruptcy court will order a Chapter 7 liquidation and the =
company is=20
dissolved. </P>
<H3>Common Stock Comes Last</H3>
<P>As a common stock holder, you must realize that Chapter 11 =
bankruptcy=20
law places your claim on the company assets after all other =
claims. </P>
<P>This is a fundamental principle of bankruptcy law. Your =
ownership of=20
the company can be drastically reduced and even removed =
entirely. </P>
<P>In many cases, existing common stock holders do not lose =
their entire=20
value, but are simply diluted to such an extent as to render the =
shares=20
worthless. For example, common stock holders may hold 100% of =
equity in=20
a company prior to bankruptcy, but only 1% afterwards, as equity =
is=20
transferred to bondholders. The smallest shareholders don't even =
show up=20
in the eighth decimal point of percentage ownerships. Those =
shares can=20
be unilaterally cancelled by the bankruptcy court in exchange =
for a=20
modest payment or even nothing at all. If this happens, you have =
no=20
recourse as a common shareholder. </P>
<P>However, in some cases, common stock ownership is wiped out =
entirely.=20
If the total valuation of the company is far less than the total =
debt=20
owed, the equity value of the company may be transferred to the=20
bondholders. With no existing value left for common holders, =
their=20
ownership can be cancelled entirely. </P>
<H3>Exodus Communications As Example</H3>
<P>Exodus Communications filed bankruptcy on September 26, 2001. =
At that=20
point, all bond payments and bill payments stopped, and the =
company=20
filed a bankruptcy petition with the court. The company will now =
submit=20
requests to make payments on bills and other expenses while in=20
bankruptcy, and every payment must be approved by the court. =
Eventually=20
a plan of reorganization will be submitted to the court. </P>
<P>The total debt owed by Exodus exceeds $3 billion. The total =
value of=20
the company is probably in the $1 to $1.5 billion range, given a =
price/sales ratio of about 1.0. If the company were liquidated,=20
bondholders would receive, at best, one-third of the amount owed =
to=20
them. It is likely that bondholders, as a class, will approve a =
plan=20
that gives them continuing debt of approximately $1 to $1.5 =
billion=20
outstanding. This leaves them with another $1 to $1.5 billion =
still owed=20
to them. In exchange for that amount, the bondholders may accept =
equity=20
in the company instead. </P>
<P>Since <I>the entire company</I> is only worth about $1 to =
$1.5=20
billion, the bondholders will likely wind up owning <I>the =
entire=20
company.</I> Common stockholders will be able to make a claim on =
whatever is left over, which is likely to be nothing. The =
company issued=20
a statement to this effect on November 12, possibly concerned =
that the=20
stock was still trading at a price that assumes there will be at =
least=20
$100 million in value left over for existing common =
stockholders. The=20
only possible explanation for this statement is that the company =
is=20
perplexed that the stock still trades at $0.10 per share, and =
wants to=20
avoid future liability by making it clear to holders of EXDSQ =
that their=20
equity is almost certain to be wiped out, as bondholders claims =
are=20
settled. </P>
<H3>Is It Fair?</H3>
<P>The investing world is a risk/reward proposition. </P>
<P>Common stock always gets the reward of <I>all the upside.</I> =
When a=20
company grows in value, the newly created wealth is reflected =
only in=20
the value of the common stock (and in preferred stock). None of =
the new=20
value is reflected in the bonds. Although the credit rating may =
go up,=20
the interest payments do not. </P>
<P>The flip side of this is that the common stock has no =
downside=20
protection. When the company fails, common stock has no risk =
protection.=20
</P>
<P>From the email we have received it is clear that many common=20
shareholders holding stock in bankrupt companies do not feel it =
is fair=20
to pay bondholders in equity and recapitalizing a company. </P>
<P>Is it fair? Definitely. When you capture all of the upside, =
it is=20
only fair that you also capture all of the downside. </P>
<P>Investors often ask, "How low can the price go?" The answer, =
for=20
common stock holders of bankrupt companies, is "Zero." </P>
<P>Comments may be emailed to the author, Robert V. Green, at <A =
href=3D"mailto:rvgreen@briefing.com">rvgreen@briefing.com</A> =
<!--(V) (RVG)--></P></TD></TR></TBODY></TABLE></DIV>
<BLOCKQUOTE=20
style=3D"PADDING-RIGHT: 0px; PADDING-LEFT: 5px; MARGIN-LEFT: 5px; =
BORDER-LEFT: #000000 2px solid; MARGIN-RIGHT: 0px">
<DIV style=3D"FONT: 10pt arial">----- Original Message ----- </DIV>
<DIV=20
style=3D"BACKGROUND: #e4e4e4; FONT: 10pt arial; font-color: =
black"><B>From:</B>=20
<A title=3DSpencer48@aol.com=20
href=3D"mailto:Spencer48@aol.com">Spencer48@aol.com</A> </DIV>
<DIV style=3D"FONT: 10pt arial"><B>To:</B> <A =
title=3Dcanslim@lists.xmission.com=20
=
href=3D"mailto:canslim@lists.xmission.com">canslim@lists.xmission.com</A>=
=20
</DIV>
<DIV style=3D"FONT: 10pt arial"><B>Sent:</B> Sunday, July 28, 2002 =
9:18=20
PM</DIV>
<DIV style=3D"FONT: 10pt arial"><B>Subject:</B> Re: [CANSLIM] =
Off-CANSLIM:=20
Common stock post-Chapter 11?</DIV>
<DIV><BR></DIV>Tom:<BR><BR> Does this mean =
that any=20
bankrupt company that forms itself into a new <BR>entity (perhaps by =
changing its name) can avoid its obligation to its common =
<BR>shareholders=20
because now the old shareholders are owners of a bankrupt =
<BR>company? =20
<BR><BR> So the newly formed company can =
once again=20
sell shares in the new <BR>company (while legally ignoring its =
fiduciary=20
obligations (for instance, <BR>paying the old shareholders from any =
company=20
assets left over after the <BR>secured creditors and preferred =
shareholders=20
are paid) the shareholders of <BR>its old=20
company?<BR><BR> Isn't this (don't you =
think) like a=20
legally sanctioned Ponzi scheme-ie, <BR>the corporation big-boys are =
legally=20
benefitting from running the company <BR>into the=20
ground?<BR><BR>jans<BR><BR><BR>In a message dated 7/28/2002 9:24:55 =
PM=20
Eastern Daylight Time, <BR><A=20
href=3D"mailto:stkguru@bellsouth.net">stkguru@bellsouth.net</A>=20
writes:<BR><BR><< The typical scenario is that a new corp is =
created,=20
in which ownership is <BR>by the secured creditors of the old corp, =
and=20
possibly a partial ownership by <BR>the unsecured creditors. =
Rarely do=20
the common stock shareholders get any <BR>ownership in the new corp. =
The=20
assets are transferred to the new corp, <BR>remaining debts are left =
with=20
the old. The secured creditors swap their claim <BR>on assets of the =
old=20
corp for ownership in the new corp. Net result, <BR>shareholders are =
left=20
with shares in a shell corp, owning only debt and no=20
<BR>assets>><BR><BR>-<BR>-To subscribe/unsubscribe, email "<A=20
=
href=3D"mailto:majordomo@xmission.com">majordomo@xmission.com</A>"<BR>-In=
the=20
email body, write "subscribe canslim" or<BR>-"unsubscribe =
canslim". Do=20
not use quotes in your =
email.</BLOCKQUOTE></BLOCKQUOTE></BODY></HTML>
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- -To subscribe/unsubscribe, email "majordomo@xmission.com"
- -In the email body, write "subscribe canslim" or
- -"unsubscribe canslim". Do not use quotes in your email.
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