Why you need to stop buying bankrupt companies

Capitalmind Podcast

What happens when a company goes bankrupt? Why do investors buy their stocks that are headed to zero? In this episode, we explore how the Insolvency and Bankruptcy Code (IBC) has changed the game. Deepak explains the many nuances of current regulations and how they've evolved. We dive into examples such as Bhushan Steel, Sintex and Ruchi Soya - which we hope will give you clarity. Listen in and decide. Would you stay the hell away from such stocks, or start hunting for bargains?

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Understanding Bankruptcy

Businesses are tough and the best ones survive. There are ample failure points for a business that can drive it to bankruptcy. One or a combination of factors such as economical, social, regulatory, political, geographical, etc can drive a business suddenly to the ground or induce a slow death. Such companies eventually stare at bankruptcy. We discuss -

- What is bankruptcy?

- Does everyone lose money when companies go bankrupt?

- Who gets what when the company is sold for parts?

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Learnings from the Sintex saga

Sintex Industries, the Ahmedabad-based company, that boasts of tanks covering the skyline of most cities of India, was dragged to bankruptcy courts after it defaulted on a meager payment of ~15.4 crores towards principal and interest on its NCDs. This was the final nail in the coffin for the firm that had mismanaged its finances for too long. We discuss -

- What Sintex does as a business

- How the company was re-structured (through demerger)

- How its issues snowballed to lead the company into IBC

Eventually, the IBC ( Insolvency and Bankruptcy Code) tribunal was able to keep the company running and also got a successful bidder to buy out the stressed company. That’s good news for almost all of its stakeholders. Except for its shareholders who will lose all of their equity in the company. So they get nothing. Zero.

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So How does IBC work? Why do existing shareholders lose everything?

The short answer: Because existing shareholders contribute nothing to the upcoming growth of the company, they get nothing. The company that these existing shareholders bought into eventually went bankrupt. So the story for existing shareholders ends here with a big zero in their hands. Sounds unfair but that’s how it is. We discuss -

- How does the IBC process work?

- Every existing stakeholder (debtors, employees, vendors) gets some part of the new entity. The current shareholders should also get a piece no?

- What actually happened to Sintex shares?

- How did things use to happen before the IBC?

There are a lot of examples discussed in this section that explain different aspects of the bankruptcy process and also highlight how each bankruptcy case is different.

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But, existing shares of Ruchi Soya went up "to the moon" while it was going through bankruptcy

All bankruptcies are different and unique. Ruchi Soya was trending on social media recently because the company came back strongly from bankruptcy and its investor (Patanjali) seems to have made a killing on its investment. There’s lots more to the whole revival story. Deepak explains -

- How regulatory rules change impacted the Ruchi Soya bankruptcy process

- The bidding by Adani and Patanjali

- Interestingly, they kept 1% of the company listed. Why?

- How does Patanjali make Ruchi Soya operating cash flow positive?

- The positive impact of Covid

- Why is a company that makes only 800 Crores has a market cap of 31000 crores?

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Does investing in distressed companies work?

We all love investing at its theoretical best - buy extremely low and sell high. We also keep repeating Buffett's quotes like “Buy when there is blood on the street”. Distressed companies feel like a value buy all time but they are almost always value traps or falling knives or whatever. We briefly touch upon this before we wind up the podcast -

- A quick reference to Buffett’s investing in the Salomon brothers

- Brookfield & Hotel Leela deal - distress investing

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