BONFIRE OF THE VANITIES (EXCELLENT READ ON BANKRUPTCY)

Forbes ^ | 20 November 2003 | Richard Lehmann

[MeneMeneTekelUpharsin]

If you think the current mutual fund scandal or tainted research by Wall Street firms is bad, you should see what happens in a bankruptcy. When a company files for bankruptcy, disclosure suddenly comes to a dead halt. Few financial reports come out, even though they are now more critical than ever. The legal process throws a blanket over all information that becomes privileged to committee members and company insiders--never mind that there is an ongoing company whose securities still trade.

This information vacuum causes larger creditors to scramble and try to get on the creditor committee, where they frequently stay only long enough to get the inside information needed to determine whether to ride it out or bail out. The information the creditor committee gets is denied to the rest of the investing public. This dearth of information leads to a serious game of "Guess How Much I'm Worth?" Except for the select insiders and a few savvy distressed debt players, this is a game of craps. Even as information begins to come out, it seems to be interpreted more by emotion than common sense.

Smart bond and preferred stock selection is one reason Forbes bond guru Richard Lehmann is up 40% year to date in his highest-yielding portfolio. To get access to his nine current recommendations, click here. The recent bankruptcies of Mirant (otc: MIRKQ - news - people ) and NorthWestern (otc: NTHWQ - news - people ) stand as good examples of how markets can misread events. The Mirant bankruptcy came about over a dispute with the banks as to how much of the company's bond debt would be collateralized. Mirant stated in its bankruptcy filing that it could meet its debt load obligations, but it just couldn't meet the maturity schedule of debt coming due. After its first asset writeoff, Mirant reported a loss of $2.2 billion, leaving it still with some $744 million of equity.

This is a far different situation from that of NorthWestern, whose balance sheet showed $400 million in negative net worth before the inevitable writedowns. This bankruptcy was truly a case of last resort. Mirant's was not. So how does the junior debt of these two companies trade today? Mirant's trust preferreds trade at about 18% of their claim amount. NorthWestern's preferreds trade at 32% of claim value. Go figure. Another truism of the bankruptcy process is that the past accounting of the company is truly put to the test. When a company files, it almost always takes a massive asset writedown. This is motivated as much by a desire to make a fresh start with undervalued assets as reaching accounting nirvana. Want to make an airline competitive? I can't think of an easier way than bankruptcy. In fact, TWA used it three times but found you can't fool the same people that often.

Thanks to little-known wireless plays like Warwick Valley Telephone, the portfolio of Forbes Wireless Stock Watch is up more than 70% since its inception. The most frequent development in bankruptcy is a disclosure that the books have been cooked for a long time. Today, some people are likely to go to jail for this, but a few years back, this was not the case. Take Boston Chicken, a former Arthur Andersen client. A $2 billion balance sheet melted down to a liquidation value of $170 million. There was not even an investigation. Junior creditors and shareholders have the most to fear when new management enters the fray. They want to make life as easy for themselves as possible, and they can do this easily through massive writeoffs and bleak business forecasts designed to cram down all but the most senior creditors. As a creditor junior to all bank claims, you want bankruptcies where management continuity still exists because they may still be burdened with enough guilt not to dump on their existing junior creditors and shareholders. The best situation, of course, is one where management has a significant equity ownership stake. Count on those people to play hardball with senior creditors. However, make sure the company is not in bankruptcy because they were stealing it blind!

Excerpted from the November 2003 issue of Distressed Debt Securities

Richard Lehmann is also the editor of the Forbes/Lehmann Income Securities Investor.

[MeneMeneTekelUpharsin]

Very interesting read on Mirant in particular. He who laughs last, laughs best of all. FYI everyone...

[MeneMeneTekelUpharsin]

You might want to read this...it is VERY interesting. It is of particular note that it comes from a reputable distressed securities researcher by the name of Lehmann. This one is in the "For What It is Worth" category.

[MeneMeneTekelUpharsin]

FYI

[MeneMeneTekelUpharsin]

This nice thing about this forum is we can easily remind each other of important things. You might want to read this one. I would appreciate your comments. Are you a bond trader, out of curiousity? The bondholders like to get the companies for pennies on the dollar. They'll have to fight to get this one. Sorry.

[Dialup Llama]

Is Mirant one of those credit card companies that lobbied congress to pass a law to make their debt a higher priority than even child support or back taxes, making it impossible for their customers to get a clean bankruptcy under the guise of a wholesome sounding anti-scofflaw law?

[MeneMeneTekelUpharsin]

Richard,

Your perspective on this...please.

[MeneMeneTekelUpharsin]

I don't think so. Here's the link, by the way, to the message board for those who want it:

Click here for Mirant message board (hard to find).

[Doodle]

Mirant was an energy company - spun off from the regulated utility, Southern Company. It went down along with NRG and others when they all over-built gas-fired electricity generating facilities over the past few years. They were also an energy commodity trading firm (a la Enron).

[TopQuark]

Thanks for your ping. I very much appreciate it but will be away (or at least unable to post) for a while. I am letting you know so that you would not misunderstand the absence of my reply.

No, I am not a bond trader (and have no other personal stake in the outcome of the trial).

Best, TQ.

[MeneMeneTekelUpharsin]

No problem. Thought you might want to read the item from Forbes. At the least, this is an interesting case and will probably end up in the textbooks. History in the making...

[MeneMeneTekelUpharsin]

Well, somebody knows something. Very interesting jump in Mirant TODAY -- Wednesday, December 3, 2003. Now, why would Mirant jump up 23%+ on a very big increase in volume? Apparently, the Forbes guy was pretty much on target. Worth watching...

Here's today's chart:

[MeneMeneTekelUpharsin]

You're awfully quiet now. Hmmm....

[arete]

You're awfully quiet now. Hmmm....

I've been talking too much lately and now it is time to be quiet . . . and many other agree with that. As far as the article, really nothing new. Once a company goes into backruptcy, the vultures are going to pick the bones clean -- almost always leaving shareholder standing there holding nothing but an empty bag. It is happening quite regularly and I expect more of it in the not too distant future.

Richard W.

[MeneMeneTekelUpharsin]

In the case of Mirant, I beg to differ.

[MeneMeneTekelUpharsin]

Well Richard, Mirant shows in the recently released MOR and net profit of 88 million +. Very interesting. It's looking better every day. Patiently waiting...

[MeneMeneTekelUpharsin]

And, after the news of the 88 million gain in this past month, here's TODAY'S chart:

Notice the big jump right after the news came out.

[arete]

Your patience may as yet payoff.

Richard W.

[MeneMeneTekelUpharsin]

I don't know if it's patience or insanity. Mirant did some VERY interesting things the last few days. On one day, some 17 million shares traded hands and very big blocks traded (200k and 300k+). The price shot up to around .63 and then the last couple of days has subsided somewhat. Now, why would some big investor (it wasn't little guys buying blocks THAT big) buy this stock?

Mirant Philippines said something about an IPO of the Philippine subsidiary and then later said they probably won't do it this year. I don't know. However, here is the chart for the last five days...heavy volume on January 12 and 13 (yesterday).

[MeneMeneTekelUpharsin]

I don't know if it's patience or insanity. Mirant did some VERY interesting things the last few days. On one day, some 17 million shares traded hands and very big blocks traded (200k and 300k+). The price shot up to around .63 and then the last couple of days has subsided somewhat. Now, why would some big investor (it wasn't little guys buying blocks THAT big) buy this stock?

Mirant Philippines said something about an IPO of the Philippine subsidiary and then later said they probably won't do it this year. I don't know. However, here is the chart for the last five days...heavy volume on January 12 and 13 (yesterday).