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This chapter is from the book

Distress Investing

Distress investing is another side of panic buying. Some people say that distress investing is similar to the strategy of vulture investors. The approach is the same and the results similarly gratifying. Investors take advantage of a precipitous drop in a stock’s price, or a sizable decline in the business and growth of a company.

In other words, the distress-investing player scouts for companies whose businesses have practically collapsed, driving their stocks way down. Usually the companies that distress investors look for are in greater trouble than those that panic investors, like Maloney, invest in.

It is worth repeating here that individual investors aren’t expected to do what institutional investors do because they don’t have the resources that the professional investors have to pursue strategies like distress investing. But individual investors do have recourse to cutting into these kinds of deals by paying attention to what the distress investors do and go after. Usually, you can find out what these distress players are up to from their filings with the SEC, which categorically state their intentions. For instance, if you know that a person like Martin D. Sass focuses on distress investing, you could simply screen filings by M. D. Sass to determine what kinds of stocks he has been buying. Investor service companies in Washington, D.C. specialize in finding out what these investors have filed. Invariably, newspapers and magazines get hold of them, too, and publish the information. Barron’s, Bloomberg News, and Reuters usually report these types of stock holdings. Newspapers like the Wall Street Journal and The New York Times also publish such filings when they involve well-known investors, such as Carl Icahn, Nelson Peltz, George Soros, or Martin D. Sass.

It is a good idea for individual investors to track what these distress investors are buying, but you have to be nimble and quick because distress investors are like race-car drivers: They move fast and act decisively almost at whim. Because their deals end up publicized in the media, it is easy to keep track of them. But again, you have to do some research into what these investors are buying to make sure you are in step with their thinking.

Sass in particular has become an expert at investing in distressed companies. In 1972, he founded MD Sass, a multipronged investment outfit that manages several hedge funds and various investment portfolios. The company’s hedge funds invest mainly in financial equities, real estate securities, and risk arbitrage deals. With assets under management of $10 billion, Sass is able to invest where most investors fear to tread. He finds value in companies that others have given up for dead or are on the brink of financial collapse.

One of Sass’s prized deals involved Leaseway Transportation Corp., which provides trucking and related services in the U.S. and Canada. Sass invested a total of $20.8 million, on which he made a handsome 60 percent profit in two years. A colorful cast of characters became involved in trying to take control of Leaseway. Among the participants: activist/corporate raider Carl Icahn, Michael Milken’s now-defunct but once influential Wall Street bank Drexel Burnham Lambert, Citigroup, and transportation mogul Roger Penske. The genesis of this deal got some publicity, so it is an example of how individual investors could have gone along for the ride, which turned out to be a profitable one.

The story began in June 1987 when buyout firm Citicorp Venture Capital launched a leveraged buyout (LBO) bid for Leaseway for $650 million. Leaseway’s two primary businesses were auto hauling—mainly for General Motors, Chrysler, and Toyota—and logistics services, which managed third-party transportation systems. The leveraged buyout deal, LBO, funded by Drexel and Bankers Trust Company, involved $380 million of bank debt, $192.5 million of 13 percent senior subordinated debentures, and $5 million of equity from Citicorp (which is now Citigroup) and Drexel. Drexel Burnham was then flying high from the mighty clout and influence of financier Michael Milken, who was known as the “junk-bond king” in the 1970s. He was indicted on 98 counts of racketeering and securities fraud in 1989. Pleading guilty to six securities law violations, he was sentenced to ten years in prison, but was released after less than two years.

Things turned sour in 1988, a year after the LBO. Leaseway’s sales for its auto-related business started to skid because of a severe economic slowdown. Fierce competition from other haulers helped push Leaseway into a financial squeeze. The huge debt that the company incurred because of the 1987 LBO exacerbated its financial woes. The result: Leaseway failed to make interest payments on its 13 senior subordinate debentures.

That failure drove Leaseway into bankruptcy. When it filed for Chapter 11 protection in December 1992, it had 12-month revenues of $753 million and earnings before interest taxes, depreciation, and amortization (EBITDA) of $130 million. Enter the company’s creditors—Credit Agricole, the biggest holder of the debentures, and corporate raider Carl Icahn. Before long, the two started battling for more secure positions. But for more than three years, they could not agree on a reorganization plan or an out-of-court settlement to divide the spoils.

That was when the wrangling caught the eye of Marty Sass, having followed the series of unsuccessful negotiations between the banks and bondholders. Sass started accumulating a substantial stake in Leaseway’s bonds. At about that time, in late 1992, an exasperated Icahn was trying to get out of the situation and looking for someone to unload his entire bond stake for about $60 million. By then Sass had become the second largest bond holder. By the fall of 1992, Credit Agricole and Icahn were still at loggerheads—and remained at a standstill.

Sass became actively involved. He raised his stake to assume control. Then he made sure that, as the second largest bondholder, his own trusted lieutenant, James B. Rubin, a senior managing director at MD Sass Investor Services, was appointed chairman of the Official Creditors Committee. In that position, Rubin had the responsibility of coordinating efforts in devising a prepackaged Chapter 11 Plan of Reorganization. The next thing Rubin did was negotiate and get on behalf of bondholders substantially all of the company’s common stock in return for the bonds.

When Leaseway emerged from bankruptcy in late 1993, it listed its stock on the NASDAQ. That is when the individual investor could have cut into the deal and purchased shares of the reorganized Leaseway. Sass filed papers with the SEC reporting his purchase of shares of Leaseway. The stock traded then at $8. For the panic or distressed players, buying Leaseway after the bankruptcy would have been the ideal buying point because normally investors don’t want to touch a company that just came out of bankruptcy. That puts a lid on the price of the stock, so invariably, the shares of once-bankrupt companies remain undervalued. Despite the unpleasant taint associated with bankruptcy, companies that emerge from it are free of old troubles and are more lean and efficient. That is what reorganization does. The debts are paid off and new management steps in.

Rubin joined Leaseway’s new board on January 1995. “We wanted to make sure that we acted as a catalyst to maximize the value of Leaseway’s common shares,” says Sass, in explaining Rubin’s getting a board seat. Sass started accumulating shares of Leaseway when it got on NASDAQ, raising his stake to 24 percent. And, as in the case of other companies that had come out of a Chapter 11 reorganization, Leaseway emerged from bankruptcy as an underpriced stock.

Leaseway’s intrinsic private-market value was more than the price of the stock. With Leaseway out of the woods, Sass sought to maximize the value of the company by selling it. Leaseway entered into talks with Roger Penske, chairman of Penske Truck Leasing Co. After tedious negotiations, Leaseway’s board of directors, on March 15, 1995, approved the sale to Penske Truck Leasing at $20 a share—a 52 percent premium over the previous day’s closing stock price. Marty Sass’s hard work paid off handsomely.

Here’s the lesson that Marty Sass learned from this deal: You can be a latecomer at a party and still leave with the grand prize. Sass realized that patience and determination paid off, but planning and strategy helped seal the deal.

Investors who are able to discipline themselves into buying shares when the market is in a panic, learn to understand value—from tracking how the market prices fluctuate under varying circumstances. Buying a stock when fear is prompting others to sell and selling when greed energizes them to buy is a great learning experience in valuing stocks.

Buying stocks when everybody else is in a panic leads to another principle: concentrated investing. The pros that use the panic-buying strategy have to concentrate their capital in just a few stocks. Diversifying is out of the question.

The book’s next commandment, “Concentrate. Diversify Not,” explains the merit of concentration versus diversification. Portfolio diversification is a universally popular strategy whose appeal is misguided. The next chapter explains why.

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