Performance of Companies Post-Chapter 11

Last week I finished reading Corporate Financial Distress and Bankruptcy by Edward Altman, the man who created the z-score. The book was published in 2005 and is pretty much a compilation of a lot of data and studies on pretty much every aspect of the distressed debt investing world. It was interesting, but it’s definitely not a good “how-to” book.  The following are notes I took on the various aspects of post-Chapter 11 performance which you might find interesting.

Outcomes of Chapter 11 Cases

Some facts:

• estimated confirmation rates for cases do not exceed 45 percent in any year since 1990
• many confirmed plans are liquidating plans
• there is a strong correlation between the amount of assets listed by the debtor and the confirmation rate

Additionally, there are some large companies that have many related filings. An extreme example is Footstar in 2004 whose case had about 2,510 separate filings—about 20 percent of all Chapter 11 cases expected to be filed that year. This problem can lead to an overstatement of confirmation rates.

A large proportion of companies do emerge from Chapter 11, though not all remain publicly registered. The most important firm characteristic related to whether firms successfully reorganized rather than liquidated was firm size, measured by the prepetition assets of the company. Availability of debtor-in-possession financing to large companies is also an important determinant of the reorganization versus liquidation outcome.

Postbankruptcy Operating Performance

Some key data from studies:

• over 40% of firms emerging from bankruptcy (“BK”) continued to experience operating losses in the three years following BK
• larger firms have somewhat better performance based on accounting measures (e.g., ROA and profit margins)
• industry conditions are an important determinant of the frequency of BK and economic decisions like asset redeployment in BK
• based on cash flow returns, emerging firms at best perform as well as the market overall
• involvement of “vulture investors” is strongly related to post-BK success
  • percentage of firms experiencing negative operating income in the year following BK is 31.9% for firms with no evidence of vulture involvement, versus 11.7% when a vulture has been involved in the restructuring
  • when the vulture remains active in the governance of the firm post-Chapter 11, the % of firms experiencing operating problems drops to 8.1% (just look at Eddie Lampert with Kmart and Wilbur Ross with International Steel)

Cash Flow Projections of the Reorganization Plan

Not surprisingly, firms on average fail to meet their projections, which are often too optimistic. There is an important distinction here: pre-BK managers projections have a larger negative forecast error while mangers that come in post-BK tend to have a smaller forecast error.

Incidence of Subsequent Distressed Restructurings

• In a 1995 study, it was found that 32% of firms restructure again either through private workout, a second BK, or an out-of-court liquidation. Subsequent studies have confirmed a similar rate.
• Continued involvement of original management is strongly associated with the likelihood of post-BK failure.

Interesting fact: there has only been one “Chapter 44″ case (i.e., a firm that has gone through Chapter 11 four times) and that is TransTexas Gas Corporation.

Post-BK Stock Performance

• only one published academic study on this topic
  • there are large positive excess returns in the 200 days following emergence
  • average cumulative abnormal return over the first 200 days is 24.6% (median is 6.3%)