Bankrupt Stock Usually Loses

For investors, UAL Corp. shares now may look like a cheap ticket. But experts warn that taking this ride probably would prove costly.

The stock rallied initially Monday as the airline giant filed for bankruptcy protection. The shares opened at 64 cents, soared as high as $1.19, then closed unchanged at 93 cents on the New York Stock Exchange.

Stocks of companies in bankruptcy protection often are extremely volatile, and big rallies -- at least in percentage terms -- are common.

But market veterans warn investors that it’s usually a mistake to buy such stocks on an expectation of a long-term payoff. That’s because shareholders go to the end of the line of creditors when a company is reorganized or liquidated in bankruptcy, and there is usually nothing left for them.

What looks like a “cheap” stock is more than likely to be a virtually worthless stock in the long run.

“The common stock almost always fares badly in a bankruptcy, and with UAL that will almost certainly be the case,” said George Putnam, head of Web site Bankruptcy Data.com in Boston, noting the company’s massive debt.

So, why did UAL stock nearly double Monday from its intraday low to its high?

Short-term speculators often pour into bankrupt stocks, looking for a quick buck.

There also can be another factor boosting such shares, at least early on: Short sellers may have been buying UAL to close out their bets on the stock’s decline.

It’s a version of the classic “buy on the rumor, sell on the news” trading strategy, said Russ Koesterich of State Street Global Markets in Boston. In a short sale, a trader borrows stock and sells it, anticipating a price drop and expecting to buy the shares back later at a lower value. If the bet is correct, the trader pockets the difference between the sale price and the repurchase price.

In UAL’s case, some short sellers sold the stock in recent weeks or months, anticipating a bankruptcy filing. The number of shorted UAL shares rose from 9.1 million at the start of the year to 25.5 million as of mid-November, according to the NYSE.

On Monday, some of those short sellers were buying back the shares to repay the loans, after the bankruptcy became reality. The buying helped push up the price for much of the session, analysts said.

In general, however, experts say traditional buy-and-hold investors should steer clear of bankrupt stocks. If the shares’ value isn’t wiped out completely as a company’s assets are distributed to creditors, at common stockholders’ expense, the stock may wind up valued at just pennies a share.

Meanwhile, the stocks can bounce around dramatically while awaiting their ultimate fate.

After infamous energy trader Enron Corp. filed for Chapter 11 a year ago, the stock soared from 26 cents on Nov. 30 to $1.01 by Dec. 5. It now trades for less than 10 cents as the company continues to work through its bankruptcy case.

After Kmart Corp. filed for bankruptcy protection in late January, the stock swung as high as $1.55 within two weeks, and reached $1.78 in two months. But the discount retailer’s shares have since been marked down to 54 cents, as of Monday.

Like Enron, WorldCom Inc., Global Crossing Ltd. and Adelphia Communications, among others, Kmart still is working through its reorganization plan, and it isn’t clear what, if anything, common shareholders will receive.

“A lot of people think, ‘Gee, this used to be a $30 stock and now it’s at $1 -- how much lower can it go?’ ” Putnam said. “Well, it can go to zero, meaning you can lose 100%” of whatever you pay.

Indeed, in a statement Monday, Kmart warned that “holders of Kmart common stock should assume that they could receive little or no value as part of a plan of reorganization.”

In UAL’s case, even many “value”-oriented money managers see no value in the stock.

“We look to take on risk in our Focused Value fund, but even we wouldn’t touch” UAL, said Nicholas Gerber, manager of the Alameda, Calif.-based Ameristock funds.

Gerber added that his Focused Value fund owns shares of regional carrier Midwest Express Holdings Inc. and Dutch airline KLM, which have relatively clean balance sheets.

Said Shelly J. Meyers, head of Beverly Hills-based Meyers Capital Management, “The only airline I would ever consider owning is Southwest Airlines Co. They’re making money when others can’t -- that’s the bottom line.”

Experts say buying the common stocks of companies in Chapter 11 is among the riskiest games investors can play if the strategy is to find a bargain to keep. But even as a short-term trade the stocks can be tricky to read.

One potential handicap is that bankrupt shares often are delisted from the New York Stock Exchange or Nasdaq, and end up trading in the over-the-counter market, where price swings can be particularly wild and market regulation is limited at best.

“If traders are extremely nimble and lucky they might make money,” Putnam said. “Maybe there is a secret, but I haven’t figured out what it is.”

Still, UAL is likely to appeal to rapid traders, just as stocks such as Enron, WorldCom and US Airways Group have in the recent past.

“These stocks can move 20% or 30% in one day. There are some traders who live for that kind of volatility,” Gerber said.

Putnam suggests that with UAL -- or any bankruptcy, for that matter -- individuals looking for a bargain wait and consider buying the newly issued stock only if or when the company emerges from Chapter 11 protection.

That way, they would be investing alongside the creditors who help craft the company’s reorganization plan and who typically agree to receive the new equity as compensation for debt or other obligations they had been owed.

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The year’s big bankruptcies: a sampling

Among major companies that have filed for bankruptcy protection this year, their common share prices mostly are lower now than on the date the firms filed for court protection. Assets Stock price on: Company Filing date (billions)* Filing date** Mon. WorldCom 7/21 $103.9 $0.14 $0.21 Global Crossing 1/28 30.2 0.13 0.02 Adelphia Commun. 6/25 21.5 0.14 0.10 Kmart 1/22 14.6 0.70 0.54 NTL 5/8 13.0 0.12 0.02 US Airways Group 8/11 7.9 0.65 0.54 XO Communications 6/17 7.9 0.03 0.06 Williams Commun. 4/22 6.0 0.17 -- Budget Group 7/29 4.5 0.14 0.04 National Steel 3/6 2.6 0.45 0.10 * As of latest 10-K filing ** Or closing price on first trading day after filing Sources: BankruptcyData.com, Bloomberg News