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These companies that have filed bankruptcy will surprise you

 

Tuesday, April 12th, 2016

Many times in our posts on social media, when discussing the fundamentals of companies, we look at the balance sheet and focus on the debt.

We have pointed out many companies that are heavy in debt, and make note that the company will probably file bankruptcy in the future. This doesn't mean next week, or even the next month.

A company can hold on for many months, negotiating with creditors and keeping themselves afloat. However, the inevitable comes because sooner or later, their hole is just too deep to get out of. 

Over the past 12 months or so, we have talked about companies such as Verizon, Chesapeake Energy and most recently, the car rental company Hertz, whose debt-to-equity was nearly 8 times.

I know many people read or view our posts and think there is no way Verizon or a big company like Hertz would file bankruptcy. Many times it is not a voluntary filing of bankruptcy, rather the company is forced to file by the creditors because they aren’t meeting certain requirements established when the loan was validated. The creditor feels they need to get something now, before there is nothing left.

Let me also explain when a company files bankruptcy, it doesn't mean the company name goes away. It means all the stockholders lose their entire investment.

When the current shareholders lose their money and new stock is issued to the current creditors, it is called a re-capitalization. This can include the bondholders, and new stock can be issued to the public.

If you are still not convinced, let me go back to the history books and look at well-known companies that have filed bankruptcy, and where they are now.

I'm sure you know the major retailer Macy's; perhaps you even shop there. Currently Macy's is struggling with their sales, but not to the magnitude of back in the early 90’s that caused the company to file bankruptcy in 1992. As with almost all bankruptcies the major culprit was debt, which came from a leveraged buyout, along with high acquisition cost that the company could not pay for and borrowed.

Another well-known name is Borders, which succumbed to high debt and raised the bankruptcy flag in 2011. Borders had been in business for 40 years, but even a deal with Amazon couldn't save the company. 

You may think being in business for 86 years while selling a fun product such as toys would keep a company out of hot water. This was not the case for well-known toy company, KB Toys. Competition from companies like Walmart and Target, who were aggressively going after the toy market, caused KB Toys to throw in the towel.

The funny thing with debt that KB Toys discovered, is that the creditors always want to receive back the principal and interest on top of that. Common sense, yes of course; however when competition comes in and your profit margins get squeezed, it becomes harder to make those debt payments.

This is one reason why when we look at investing in companies, we make sure their debt is not out of hand. We want the company to be able to weather the storm and fight off competition if need be.

With KB Toys, eventually the trademarks and intellectual property rights were bought for pennies on the dollar.

If you are investing in a company and not looking at the debt, because your comfort comes from the fact the company has been around forever, you are asking for trouble.

After being in business for 60 years, Circuit City had to close their doors on 700 stores. This was a well-known company with well-known products that had too much debt, and couldn’t reduce prices enough to compete due to that debt load. Even with assets of $3.4 billion, it is the equity after you reduce the liabilities that keeps a company in business during the lean times. 

Do you currently drive a Chevy, Buick or Cadillac? General Motors filed for bankruptcy in June of 2009 because of the slowdown in the economy and the heavy debt load. As you can tell seven years later, you can still purchase a GM car, but shareholders lost all their investment and some who held this stock a lifetime.

As for the baby boomers, who could forget Woolworth, which was around for 117 years before closing their doors? While a sad time for this company, it is a good example for investors.

When you invest in a company, in addition to having a good product and being able to compete, a strong balance sheet is a must. This means good liquidity and low debt can keep your business in the game, even when the game becomes difficult.

I often say stocks aren’t risky if you don’t do risky things. If you are investing in stocks, and you (or your financial advisor) don’t understand the company’s balance sheet, then you are taking a substantial risk. 

Do you have a question or a company you would like us to take a look at?
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