Is an insolvent company a good short or a bit risky?

[aquaswim47]

I was looking at the financials of CHH. It's only down 8% as an insolvent company (a company that has more total liabilities than total assets).

Would such a stock be a good short or should you use puts to protect you against unlimited upside risk. I think that people should use a stop-limit order to limit losses from a short-squeeze.

Looking for opinions. What happens if the company files for Chapter 11 bankruptcy protection? Is it equivalent to Chapter 7 or is there a risk that the stock could rebound (15% likelihood) and wipe out your short position (or your portfolio)? Any way to sell the stock back to the broker for between a penny and a nickel per share to safeguard against any possible turnaround? I am wondering if people have ever shorted a potentially bankrupt company (or if that's too risky).

2002 2003 2004 2005 12/2006
Total Current Liabilities 84,308 102,211 102,055 120,316 139,791 Source: Yahoo Finance & Scottrade


Their current assets on December 31, 2006 was $87,082,000 and their current liabilities was 139,791,000; their assets are $303,309,000 and their total liabilities are $365,689. Their operating cash flows and net income are increasing, but they are always at risk. I don't understand their BBB rating since their competitors, i.e, CTRP. GET has a potential liquidity problem but its total assets exceed total liabilities. GET has cash outflows from operating activities, while CHH and CTRP have positive operating cash flows. Of the three, CTRP is by far, the strongest of the three hotel chains. I like that they (CTRP) cater to business travelers in China. I personally believe that insolvent means not having enough assets to cover your liabilities, while I consider liquidity to be the ability to pay off debt.

I see this as a consumer debt situation; the company is earning money and that's why it's trading at $36.92 per share. I guess lenders feel this company is a safe bet and will be able to get out of the insolvent hole it dug itself into. That means the company is at risk of bankruptcy at any time. If you're shorting the stock, your hoping that management files for chapter 11 bankruptcy protection or that the company is forced into bankruptcy since the cash-flow from operations deteriorates over a sustained period (such as 2-3 years).

Moreover, I heard on a radio show that someone had difficulty covering the bankrupt shares (he gets to keep the proceeds for now). But if the entity is in chapter 11 bankruptcy and recovers, your at risk. So I would attempt to negotiate with the broker to buy it for a penny to a nickel a share and then you get to keep 99.86% of the money since the shares are virtually, but not completely worthless. So if you invested $1,000 in the short and you bought the shares back at a nickel a share, you would get $998.60 and have to pay $1.40 for your $1,000 short.

About 15% of companies recover from a chapter 11 bankruptcy, yet they are much smaller than the original entity. Very few reach their former size; take MCI for example. However, I don't know if WorldCom holders would have lost all of their money, as a result of the reorganization or 90% of their value. My prediction is that new shares are issued as a result of the reorganization and that existing shareholders are left in the dust.

Just my two cents.

Now a person can determine for themselves if the company is insolvent or not. Thanks for providing the information. What you don't realize is that the creditors could close on the debt at any time this company defaults on payment. They won't because the company appears to be strengthing in capacity. But a bad quarter or quarters could result in the company being brought into bankruptcy. Also, if management wants to strategically eliminate debt, it might go through chapter 11 bankruptcy to lower its debt load. That would really hurt shareholders though.

I am glad you provided the SEC information so people can judge whether this company can pay bills or not. I take the dictionary definition to mean that either the company cannot meet its obligations as they come due or liabilities exceeding assets (negative equity) as being insolvent. I feel the ability to meet obligations as they come due is specifically an issue of liquidity.

Thanks for the notes below and for the SEC filings.

[Stocktrading101]

I am wondering if people have ever shorted a potentially bankrupt company (or if that's too risky).

Well, in theory, if you short and the company goes bankrupt, then you get to keep everything since those shares are no worth $.0 and you can cover for free.

I think what you are getting involved with those is very risky and speculative. If a company is nearing bankruptcy, then it is safe to assume it is being traded for pennies. So, regardless if you are buying to hold or shorting, any movement could have a big impact on your underlining position.

One other thing to consider, depending on the stock, you might not even be allowed to short it. I have run into situation where I was not allowed to short a stock because of random reasoning.

The question of chapter 7 versus chapter 11 though is a good one that I cannot answer. I'd be curious to know the difference myself

[WallStGolfer31]

Originally Posted by aquaswim47

I was looking at the financials of CHH. It's only down 8% as an insolvent company (a company that has more total liabilities than total assets).

Would such a stock be a good short or should you use puts to protect you against unlimited upside risk. I think that people should use a stop-limit order to limit losses from a short-squeeze.

Looking for opinions. What happens if the company files for Chapter 11 bankruptcy protection? Is it equivalent to Chapter 7 or is there a risk that the stock could rebound (15% likelihood) and wipe out your short position (or your portfolio)? Any way to sell the stock back to the broker for between a penny and a nickel per share to safeguard against any possible turnaround? I am wondering if people have ever shorted a potentially bankrupt company (or if that's too risky).

Recent SEC filings I'm looking at they have current assets and opperating income well over current liabilities. Is there some other data out?

Insolvency is where a company can not meet its debt obligations, not just more liabilities than assets.

[WallStGolfer31]

Originally Posted by aquaswim47

Official dictionary definition: Insolvency - When a person or organization cannot meet its financial obligations when they are due, or when assets are smaller than liabilities.

Insolvent is when a company has less assets than liabilities (at least that's the academic definition of insolvency). However, the company can continue operating if it has liquidity; insolvent is a bad situation to be in because if something happens, you won't be able to pay existing bills. My definition of insolvency is when liabilities exceed assets. I consider the ability to pay current debt as liquidity.

It's the other current liabilities that has me concerned. Are those long-term liabilities that became current? The company is currently insolvent and is working its way towards solvency. It is my opinion that they will not make it.

I checked the financial statements (balance sheet) on Yahoo Finance and Scottrade and the company has excess current liabilities over current assets and excess total liabilities over total assets. I also checked the SEC filing and I don't think you read it right. It has growing net income and growing net operating cash flows. However, the company has been paying off less debt each year (while not expanding its operations). That's why it is my opinion that it is a company that will not get out of insolvency (liabilities exceeds assets). I don't believe there will be a day that this company will become solvent (assets exceed liabilities). They seem like they're losing their liquidity, since they have nearly $140 million in other current liabilities.

The dictionary defines insolvent as follows: not solvent; unable to satisfy creditors or discharge liabilities, either because liabilities exceed assets or because of inability to pay debts as they mature.

The key here is that is a conditional situation. Either they can not meet their obligations due to their assets being less than liabilities or becasue they can't pay their debts for some other reason. Now since they can meet debt obligations, the situation of having less total assets than total liabilities des not equal insolvency. Liquidity and insolvency are mutually exclusive events.

The last reported results of the company are reporting financial data from Sep 30th 2005 to Sep 30th 2006. (See link at the bottom to view the 10-Q) I'll be using the data from there below: Both figures are annual.

Their opperatng income is $181,291,000

Their current liabilities are $128,991,000
The current liabilities include the current portion of long term debt that is comming due within one year of the report.

Fom opperatng income alone they have enough to cover their current financial obligations.


(I don't use Yahoo for the reason they often have incorrect numbers. You can get the statements submitted to the SEC at their website. Those statements are exactly what they are reporting. Here's CHH's last Quarterly report. I'm not saying yo're looking at the wrong numbers, but yahoo does not theaccurate numbers reported sometimes. The SEC always does because the documents you're looking at are the same ones the company gave to the SEC for rportng puroses.)

[WallStGolfer31]

Originally Posted by aquaswim47

Now a person can determine for themselves if the company is insolvent or not. Thanks for providing the information. What you don't realize is that the creditors could close on the debt at any time this company defaults on payment. They won't because the company appears to be strengthing in capacity. But a bad quarter or quarters could result in the company being brought into bankruptcy. Also, if management wants to strategically eliminate debt, it might go through chapter 11 bankruptcy to lower its debt load. That would really hurt shareholders though.

I am glad you provided the SEC information so people can judge whether this company can pay bills or not. I take the dictionary definition to mean that either the company cannot meet its obligations as they come due or liabilities exceeding assets (negative equity) as being insolvent. I feel the ability to meet obligations as they come due is specifically an issue of liquidity.

The definition from Dictionary.com is: not solvent; unable to satisfy creditors or discharge liabilities, either because liabilities exceed assets or because of inability to pay debts as they mature.

If the comapny can't pay it's debt, it usually has less assets than it does liabilities. But if it has less assets than it has liabilities, that doesn't mean it can't pay it's debt.


Unless there is some special provision creditors can't just demand their money back (refered to as a put feature on a bond, and this put feature is very rare). When a company is not in bankruptcy, the bond convenant holds.



In their annual report they cite the following:

"While our senior debt is currently rated investment grade by both of the major rating agencies"

"The Company’s weighted average interest rate as of December 31, 2005 was 5.96%"

Now S&P Ratings and Moody's wouldn't be rating an insolvent company investment grade, would they? S&P Ratings has it at BBB. Would ledners also give 6% financing to a company that looks as if it was going bankrupt?


Here's their debt schedule.

Contractual Obligations - Long-term debt
(all numbers in millions)

Less than 1 year $7.3
1-3 years $109.7
3-5 years $173.8
More than5 years None



Looking at the opperating income, and the options they have with the revolving credit facility, they won't have a problem at all retiring this debt.

[aquaswim47]

CHH has an interest-coverage of 9.6 (144,000,000/15,000,000). It's EBIT / Interest Expense. From (cash flow from opeating activities - capital expenditures) /interest expense, their ratio is 9.11 and their cash / interest expense is 2.4. To be fair, their current assets / interest expense is 5.81.

The company has about 6 months of an emergency fund in its holdings. That's not that solid. If they are unable to collect their debt obligations, they have about three months of an emergency fund. Moreover, they bring in operating income that is 9.6 times the amount of their interest expense. Great work.

By the way, BBB is not that great of a rating; Enron had the same rating in 1999. It shows how brilliant FirstConsul is; he went right to the heart of the issue. It's cash flow from OA is strong, but all it takes is one or two bad quarters.

[WallStGolfer31]

Originally Posted by aquaswim47

CHH has an interest-coverage of 9.6 (144,000,000/15,000,000). It's EBIT / Interest Expense. From (cash flow from opeating activities - capital expenditures) /interest expense, their ratio is 9.11 and their cash / interest expense is 2.4. To be fair, their current assets / interest expense is 5.81.

The company has about 6 months of an emergency fund in its holdings. That's not that solid. If they are unable to collect their debt obligations, they have about three months of an emergency fund. Moreover, they bring in operating income that is 9.6 times the amount of their interest expense. Great work.

If this stock is at such a high risk of bankruptcy in your opinion ; why is it rated Investment grade at both S&P Ratings and Moody's. You can't tell me they have overlooked these things.

[WallStGolfer31]

Originally Posted by aquaswim47

BBB is only barely investment grade; besides, Moody's and Standard & Poors missed Enron's plight as well.

BBB is still investment grade though, which means it isn't by far on the path to bankruptcy.

Enron was also involved heavily in accounting fraud. Ratings agencies can only go off what the company gives them. Are you suggesting that CHH is involved in accounting fraud as well?