When the company becomes insolvent and is no longer able to repay its debt, it can file for Chapter 11 protection and proceed with a bankruptcy process. Depending on a particular case, the outcome of the bankruptcy might vary, but the most important question remains – is there any value to be left for equity holders? The answer to this question might provide two types of play:
– Most of the time, when the bankruptcy is truly a result of a terrible financial position of the company you may find out that the equity is undoubtedly worth 0. However, for one reason or another, shares might be trading way above that. If borrow is available and the fees are adequate, such cases may provide an opportunity to short.
– However, sometimes companies file for bankruptcy not because of straight-up insolvency, but, for example, to get rid of certain legacy liabilities (e.g. post-spin) or to run a smoother asset sale process (in fact, there are cases when the company enters into bankruptcy with an already received offer for most its assets). Such situations are very interesting and often indicate high recovery potential for equity holders. If the recovery is high enough, it could provide an interesting entry point for a play on bankruptcy recovery.
However, it is very important to note that investing in any bankruptcy is highly risky and involves plenty of legal nuances and other potential caveats (bankruptcy filings, intricate conditions, uncertain timeline, unexpected appearance of claimants, etc.).