Markets
Can Tainted Stocks Make Good Investments?
In the post-Enron era, scandal doesn't always tarnish a company for life. There can be buying opportunities. Here's what to look for.
By Jeffrey R. Kosnett, Senior Editor, Kiplinger's Personal Finance
May 1, 2007
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Enron and WorldCom are history. Adelphia? Dismembered. Peregrine Systems? Table scraps for Hewlett-Packard. The list of recent corporate deaths from accounting fraud and CEO malfeasance is a long one -- just check out the White Collar Crime Prof blog sometime.
But before you consign all notorious companies to the investors' dust bin, consider the curious duo of Tyco (TYC) and HealthSouth (HLS). Former Tyco CEO Dennis Kozlowski is serving an eight-year prison sentence for misappropriating at least $400 million of company funds. Yet Tyco, a conglomerate, is thriving. From June 3, 2002, when Kozlowski quit, through May 1, 2007, Tyco stock is up 145%, thanks to leadership by respected ex-Motorola honcho Edward Breen and a good mix of core businesses. Longtime Tyco investors are still underwater. But opportunists and bottom-fishers have cleaned up.
HealthSouth is a chain of rehabilitation hospitals and sports-medicine clinics. Ex-boss Richard Scrushy was convicted in 2006 of bribery and conspiracy charges, and ordered to repay HealthSouth $51 million. In April 2007, he agreed to pay a $81 million settlement to the Securities & Exchange Commission. But HeathSouth shares, which fell below $1 in March 2003 when the government first charged Scrushy, are now at $21. They could head higher if Wall Street likes the decision to sell its surgery and diagnostics divisions, invest the proceeds smartly in new operations, and fix its balance sheet by downsizing the huge corporate "campus" Scrushy built.
Two flukes? Maybe not. The rate of CEO dismissals is three times higher now than in the 1990s, and while that's not all because of personal or financial misconduct, boards of directors are less tolerant of shenanigans in the post-Enron era. This means investors can expect more probes and, possibly, more impaired corporate reputations. So can you expect to invest for next to nothing and score a big return? "If you have nerves of steel, sure," says Peter Henning, a law professor at Wayne State University in Detroit and co-editor of the White Collar Crime Prof blog. But be careful.
Henning is a former federal prosecutor and SEC investigator, so he knows of what he speaks. He offers these two key factors to consider when you see a company like HealthSouth trading for 40 cents. First, ask yourself about the fundamentals. If there's still a functioning business with clean management (often the key people are new to the organization), you have a good chance for a turnaround.
Second, is the company bankrupt? "If they go into bankruptcy, you're dead," says Henning. Don't fight this. In most bankruptcy reorganizations, even if the company survives, the "old" common stock is likely to be canceled with no value while bondholders and other secured creditors get first dibs on new shares. Delta Airlines is a current example. Tyco never ran out of money, so it didn't have to file for Chapter 11. HealthSouth escaped bankruptcy reorganization when a restructuring expert found enough assets to sell to raise cash.