Bankruptcy Pays 18% Stock Return in Week-Long Trade as GM Files

By Eric Martin and Lynn Thomasson

June 2 (Bloomberg) -- General Motors Corp., the largest U.S. automaker, may prove a profitable bet for stock traders who sell their shares within a week of the company’s bankruptcy filing, if history is any guide.

Stocks of the 20 largest U.S. companies that declared bankruptcy since 1980 rose an average 18 percent one week after filing for court protection from creditors, according to data compiled by Bloomberg and BankruptcyData.com, a Boston-based research firm. The increase diminished to 3.1 percent over a month and turned into a 15 percent loss within three months as the shares began to be removed from exchanges, the data show.

The gains have little to do with expectations for a recovery. Instead, the shares rally as investors who had wagered on a decline buy the stock back to complete their trades, said John Carey, a fund manager at Pioneer Investment Management. Advances also reflect speculation a company will return money after paying creditors.

“Companies spiraling downward toward bankruptcy are often sold short as people realize the dire straits they are in,” said Carey, who helps oversee $200 billion in Boston. “The likelihood is the stock will become worthless and people want to cover their shorts.”

In a short sale, investors borrow shares with the intention of buying the stock back at a lower price and returning it to the lender. About 117 million GM shares were sold short as of May 15, according to New York Stock Exchange data compiled by Bloomberg.

GM’s Drop

GM, which has tumbled 77 percent in 2009, will be removed from the Dow Jones Industrial Average on June 8 and is being suspended on the NYSE. The Detroit-based automaker filed the fourth-largest bankruptcy in U.S. history after Lehman Brothers Holdings Inc. and Seattle-based Washington Mutual Inc. in September and WorldCom Inc. in 2002.

The U.S. plans to convert much of $50 billion in loans to the 100-year-old automaker into a 60 percent stake in a new entity. A worker health-care fund will get 17.5 percent, the Canadian government will receive 11.7 percent and bondholders and other unsecured creditors would be eligible for 10 percent plus warrants to buy another 15 percent.

A record 342 million GM shares changed hands yesterday, more than half the number available for trading. The stock, which rose as high as $93.63 in April 2000, closed at 75 cents yesterday, unchanged.

General Growth

General Growth Properties Inc., the Chicago-based mall owner that filed the biggest real-estate bankruptcy in U.S. history, has quadrupled since seeking protection from creditors on April 16. William Ackman of Pershing Square Capital Management LP, the New York-based hedge fund that holds about 25 percent, said the stock will rebound. General Growth’s business is “doing just fine” and the stock has “huge potential reward and generally limited risk,” Ackman said in a May 27 presentation in New York.

Lehman gained 2.4 percent in the four days after the New York-based securities firm filed the largest bankruptcy ever, with debt of $613 billion. The company sold its North American business to London-based Barclays Plc and its operations in Asia, the Middle East and Europe to Nomura Holdings Inc. in Tokyo.

WorldCom, once the second-largest U.S. long-distance phone provider, soared 75 percent in the week after its filing on July 21, 2002, on speculation the company would emerge stronger from its reorganization. WorldCom changed its name to MCI Inc. and moved from Clinton, Mississippi, to Ashburn, Virginia. New York- based Verizon Communications Inc. acquired MCI for $8.44 billion in January 2006.

Removed From Exchanges

Shares of bankrupt companies are usually removed from exchanges and canceled after the court proceedings are completed, according to Jerome Dodson, who oversees $2.2 billion at Parnassus Investments in San Francisco. Enron Corp. sank below $1 four days before entering Chapter 11 in December 2001, and kept trading for three more years, according to data compiled by Bloomberg. Stock of the Houston-based energy company eventually went to zero.

“I’m not saying you can’t make money, but it’s not investing,” said Dan Greenhaus, an equity analyst at Miller Tabak & Co. in New York. “It’s the hope of short-term gains. Nobody is buying this and holding.”

To contact the reporters on this story: Eric Martin in New York at emartin21@bloomberg.net; Lynn Thomasson in New York at lthomasson@bloomberg.net.