When I think about bankruptcy investing, I often compare it to dealing with kids who get bad grades. Not all kids who struggle in school are destined for failure. Some kids are inherently talented but have challenges—maybe they’ve got a tough family situation or they learn in a different way. With the right support and patience, these kids can grow into some of the most successful people, like Albert Einstein, who was thought to be a problem child but went on to change the world. The same goes for companies facing bankruptcy. Not all bankruptcies are created equal. Some companies are simply struggling due to a temporary issue or a fixable problem, while others are fundamentally flawed. The key to successful bankruptcy investing is knowing how to discern between these situations—understanding which companies have the potential to turn things around and which are just bad bets.
One of the first things I learned when getting into bankruptcy investing was the importance of picking your spots carefully. It’s not about taking on any distressed company—it’s about identifying those with the right mix of underlying value and potential for recovery. Think of it as finding the diamond in the rough—a company that, despite its current troubles, has something tangible that makes it worth saving.
A great example of this is Chesapeake Energy, which filed for bankruptcy in 2020. The company was buried under a mountain of debt, largely due to overexpansion and the collapse of oil prices. On the surface, it might have looked like a complete disaster. But for those willing to dig deeper, there were some promising signs. Chesapeake had significant oil and gas reserves, valuable infrastructure, and a proven ability to generate cash flow in better market conditions. The company’s bankruptcy wasn’t because it lacked a solid business model—it was simply overleveraged and got caught in a perfect storm of external pressures.
Here’s how I approached Chesapeake as an opportunity:
1. Identifying Valuable Assets
The first step was to evaluate Chesapeake’s underlying assets. In asset-heavy industries like energy, transportation, or utilities, the company’s value often lies in its tangible assets. Chesapeake had vast oil and gas reserves, which are physical, valuable commodities. This alone made it a more attractive candidate compared to a tech company with intangible assets. I looked at the value of these reserves relative to the debt, and I saw that there was enough there to justify the company’s survival if it could reorganize its finances.
2. Analyzing the Capital Structure
Understanding the capital structure is crucial. Not all debt is created equal, and being in the right part of the capital stack can mean the difference between a total loss and a profitable investment. In the case of Chesapeake, I focused on senior secured bonds, which had collateral backing them. These bonds had a claim on the company’s physical assets, putting them at the front of the line if the assets were to be sold. This level of security provided a cushion that gave me confidence in the investment, even if things didn’t go perfectly during the restructuring.
3. Evaluating Industry Dynamics
Next, I looked at the industry dynamics. The energy sector is inherently cyclical, and at the time, oil prices were at historic lows. But history has shown that energy prices tend to rebound after major downturns. The industry’s cyclical nature suggested that Chesapeake could recover as conditions improved. This is where the importance of patience comes in—bankruptcy investing isn’t about instant gratification. It’s about having the conviction to wait for the right conditions to play out.
4. Assessing Management and the Restructuring Plan
Lastly, I reviewed the management team and their restructuring plan. The best restructuring plans involve reducing debt to a manageable level, cutting costs, and focusing on the core business. Chesapeake’s management was committed to making the company leaner and more focused. They laid out a clear plan to emerge from bankruptcy with a stronger balance sheet and a better chance of profitability moving forward. The restructuring plan gave me confidence that this wasn’t just a desperate attempt to stay afloat—it was a well-thought-out strategy to return to stability.
Another example that illustrates the value of careful bankruptcy investing is Intelsat, the satellite communications company. Intelsat filed for bankruptcy in 2020 due to an overwhelming debt load. But what caught my attention was the strategic value of its assets—satellites that were crucial for broadcasting and telecommunications. Satellites are expensive, high-value assets that don’t lose their value overnight. The company also had the potential to secure government contracts, which could provide a steady stream of income once it restructured.
Investors who took the time to understand Intelsat’s strategic assets and industry position were able to identify a compelling opportunity. By investing in Intelsat’s debt, which was trading at a steep discount, they positioned themselves to benefit from the company’s eventual restructuring and emergence from bankruptcy. The lesson here is that bankruptcy isn’t always a dead end—sometimes it’s a chance for a company to shed excess baggage and refocus on what makes it valuable.
Key Guidelines for Bankruptcy Investing
If you’re considering dipping your toes into bankruptcy investing, here are a few key takeaways that I’ve found helpful:
Look for Asset-Heavy Companies: Focus on companies with tangible, valuable assets. These provide a level of security that can protect you even if the restructuring doesn’t go exactly as planned.
Understand the Capital Structure: Know where you stand in line. Secured bonds and senior debt are generally safer bets than common stock, which is often wiped out in a bankruptcy.
Evaluate the Industry: Some industries, like energy or transportation, tend to recover after downturns, while others may face ongoing challenges. Understanding the broader industry dynamics can help you gauge whether the company is likely to bounce back.
Assess the Restructuring Plan: Look for a clear, realistic restructuring plan. The best opportunities are in companies that have a solid plan to cut debt, reduce costs, and focus on core operations.
Bankruptcy investing isn’t about rolling the dice—it’s about doing the work, understanding the situation, and picking your spots carefully. Just like with those troubled kids, it’s about recognizing potential where others see failure, and being willing to step in with the support—or in this case, the capital—that’s needed to help them turn things around. When you pick the right spots, bankruptcy investing can be incredibly rewarding, both financially and intellectually.