Stocks and Bankruptcy

Question

Trying to understand what happens when a company goes in and out of bankruptcy. I'll use American Airlines as an example because it's what I've been following for some years.

In November 2011, AA announced its bankruptcy; its stock, which was sliding, dropped to 0.38. It stayed flat during 2012, and now that a merger deal has been approved, it climbed up to almost 12.

During 2012 I thought of buying some AA stock because it was so damn cheap. If I had, I could be selling it today for a nice 32x profit. But at the time I was adviced not to - I was told because the company was bankrupt, its stock was just for speculators, pump and dump schemes, and so on, and it would become worthless when the company merged (it would be delisted and a new one added).

So when I read that the merger was approved, I expected it to drop to near zero. Instead, it climbed sharply.

Can anyone explain what's going on? If I had bought in 2012, what would have been the risk to offset this fantastic 32x reward? What will actually happen to AA stock once it exits bankruptcy? It sounds too good to be true, so it probably is, but I can't see why. What am I missing? Why didn't everyone buy AA during 2012?

Answer 1

As Mhoran said, the risks of buying a bankrupt company are huge, and even successful bankruptcy turnarounds don't involve keeping the same stock. For instance, the GM bankruptcy was resolved by the company more or less selling all its valuable assets (brands, factories, inventory) to a new version of itself, using that money to pay off what liabilities it could, and then dissolving. The new company then issued new stock, and you had to buy the new stock to see it rise; the old stock became worthless.

AA could have gone the same way; Delta could have bought it out of bankruptcy and consumed it outright, with any remaining shareholders being paid off at market value. That's probably the best the market was hoping for. Instead, the deal is a much more equal merger; AMR brings a very large airport network and aircraft fleet to the table, and Delta brings its cash, an also-considerable fleet and network, and a management team that's kept that airline solvent. The stockholders, therefore, expect to be paid off at a much higher per-share price, either in a new combined stock, in Delta stock, or in cash.

Answer 2

When they entered Bankruptcy they changed their stock symbol from AAMR to AAMRQ. The Q tells investors that the company i in Bankruptcy. This i what the SEC says about the Q:

"Q" Added To Stock Ticker Symbol

When a company is involved in bankruptcy proceedings, the letter "Q" is added to the end of the company's stock ticker symbol. In most cases, when a company emerges from bankruptcy, the reorganization plan will cancel the existing equity stock and the old shares will be worthless. Given that risk, before purchasing stock in a bankrupt company, investors should read the company's proposed plan of reorganization. For more information about the impact of bankruptcy proceedings on securities, please read our online publication, Corporate Bankruptcy.

The risks are they never recover, or that the old shares have nothing to do with new company. Many investors don't understand this. Recently some uninformed investors(?) tried to get a jump on the Twitter IPO by purchasing share of what they thought was Twitter but was instead the bankrupt company Tweeter Home Entertainment.

Shares of Tweeter Home Entertainment, a Boston-based consumer electronics chain that filed for bankruptcy in 2007, soared Friday in a case of mistaken identity on Wall Street.

Apparently, some investors confused Tweeter, which trades under the symbol TWTRQ, with Twitter and piled into the penny stock.

Tweeter, which trades over the counter, opened at 2 cents a share and jumped as much as 15 cents — or 1,800 percent — before regulators halted trading.

Almost 15 million shares had changed hands at that point, while the average daily volume is closer to 150,000.

Sometimes it does happen that the new company does give some value to the old investors, but more often then not the old investors are completely wiped out.