Will Your Company Quit and Go Home?

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

We usually think of bankrupt companies as being insolvent to the point where little cash remains and recovery prospects are dismal. Often times it is even the creditors of the company who force bankruptcy. But a new trend is emerging where bankruptcy is being used as a restructuring tool to deal with high structural costs and a difficult road ahead.

You've Been Warned

As a stockholder, you expect to have the most to gain and the most to lose in your investment when compared to other classes of corporate investment. But you also expect your company to fight to the end to preserve your stockholder value and the prospect of recovery.

There certainly are cases where a bankruptcy filing is in the best interest of the company and the company's other stakeholders including creditors, employees, and vendors. For example, the bankruptcy of General Motors was necessary since it was clear the automaker would continue losing money for the foreseeable future and a cash crisis was looming as the recession began. Today, the new General Motors (NYSE: GM) is producing better cars with a lower cost structure and is once again turning a profit.  

In other cases, bankruptcy is being used to reorganize cost structures, even when the company does not meet the typical definition of insolvency. An article in Time discussed the American Airlines bankruptcy and noted the airline had $4 billion in cash on hand with no immediate payments due. In addition to that, the airline claimed its operations could continue covering its costs to employees, vendors, and business partners. Because of this, the bankruptcy filing came as a surprise to many on Wall Street who saw American as trying to turn a corner and rebuild itself during an economic downturn.

Shareholders of American Airlines will likely see nothing and the airline itself displays a sobering outlook for stockholders on its investor relations webpage. The value in American shares lay in the potential for recovery and an eventual increase in earnings, both of which no longer exist for stockholders.

Protecting Your Portfolio

We like to think that the management at our companies would be trying to avoid bankruptcy until it is absolutely necessary but, unfortunately, this is not the case. Similar tactics were employed at Delphi to renegotiate labor contracts, and at the mall operator General Growth Properties ). However, General Growth was able to return value to its shareholders after many had undoubtedly sold their shares upon entering bankruptcy.

While I am not against all bankruptcy filings and see many as necessary to preserve the company's future for its stakeholders, there has been a trend towards bankruptcy without insolvency. Shareholders should be aware of the possibility of this taking place, particularly at labor intensive companies, and should balance their portfolios to reflect the possibility. Overall, this is not a reason to flee recovery opportunities and run to U.S. Treasury bonds and blue chips, rather it is a possibility to consider when investing in beaten down stocks. I, for one, continue to hold my shares of Air Canada, despite their previous bankruptcy, as a recovery play for the airline's growth and recovery prospects. But the possibility of a surprise bankruptcy is one of many reasons it remains a speculative part of my portfolio.


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