How Activist Managers Buy Debt and Provoke Companies
A company that may be on the verge of bankruptcy or one that has already collapsed into chapter 11 doesn't sound like the kind of business any investor would want to go near with a 10-foot pole.
But all sorts of investment professionals buy securities — bonds or stock—at these kinds of distressed companies every day. Some corporations are either about to enter or exit bankruptcy, while others are in financial distress and are willing to complete a debt restructuring to avoid bankruptcy. In a restructuring, the company, which can no longer make all its debt payments, must negotiate with banks, creditors, and suppliers, often by altering the debt-to-equity ratio on the balance sheet.
Often, creditors of a company that has become distressed are apprehensive about the securities they own. They are willing to sell rather than hold on and wait to see what kind of value their deflated stake may ultimately produce as the distressed company struggles to improve its bottom line and bring itself back to profitability. Many institutional investors of bonds in companies that have become distressed are required by the risk parameters of their internal bylaws and charters to sell their investments when things start looking bad. Institutions, such as insurance companies and mutual funds, that find they own a hefty amount of low level D-rated bonds, may need to divest; otherwise, their total debt rating may drop ...