As the US economy begins to lift itself up out of the Great Recession, there will be many public equity offerings that will accompany the rise in GDP. Public equity offerings are the easiest (and cheapest) way for companies to raise capital for expansion, acquisitions or sponsor/debt pay down. Some of these equity issuances will be first time participants and some will be making secondary offerings and some will be returning as reorganized companies emerging from bankruptcy.
According to JP Morgan, “since 2007, 426 public companies filed for bankruptcy, representing $1.2 trillion in assets.” Not all reorganizations will successfully emerge from bankruptcy as healthy companies and return to the public equity markets, in fact, many will not and there business units or assets will be sold off in order for senior secured lenders to recover value. However, expect that companies such as General Motors will tap into the public equity markets once again over the course of this year and the next.
Determining whether to invest in the offering of a company that has emerged out of bankruptcy has to be on the basis of prudent analysis. There are essential factors that assist investors in forming an investment thesis on whether a reorganized company will perform well. The investor should be analyzing a “combination of cyclical and secular factors”, debt reduction, asset structure shifts and management changes.
A successful reorganized company has the following characteristics:
- Debt reduction of at least 50%
- Management changes
- EV/EBITDA is less than 5.0x – which is a discount to the S&P average
- Company is in one of the top 5 sectors based on performance following reorganizations (Telecom, Materials, Consumer Staples, Utilities and Consumer Discretionary).
- Cyclical factors that sent the company into reorganization are no longer present.
The first few months following an emergence from bankruptcy and public offering is the narrow timetable for when the investor should decide to invest in a reorganized company in order to maximize return. During this short time period the company will typically experience specifics items that depress their stock price – information access will be limited because of the lack of regular updates; investor skepticism is often observed within the first few months of going public as mainstream investors typically view reorganized companies poorly; lack of research will further limit the information out there as coverage tends not resume for at least one year; and there is expected to be an initial drive down in prices as lenders are quick to sell their holdings to realize a nominal return. A prudent approach could lead to successful returns, which history has shown us to be true during the last recession and rebound of the early 2000s, where the first 12 month gains of publicly traded reorganizations averaged 84% in returns (relative to the S&P).
