Bankruptcy Beneficiaries

07/02/2004 12:00 am EST

Focus:

Jon Markman

Editor, Trader's Advantage

"Any sign the economy is faltering is good news for those companies that handle the messy details of bankruptcy," says Jon Markman, columnist for CNBC on MSN Money and editor of StockTactics Advisor. Here, he looks at two firms that benefit from bankruptcies.

"If you think filing bankruptcy is tough, try making a living at it these days. Epiq Systems (EPIQ NASDAQ), provider of software and support for the bankruptcy attorneys and trustees, has seen its shares plunge to $14 from mid-2003 highs around $23. FTI Consulting (FCN NYSE), which built a big part of its business around helping large corporations restructure and emerge from bankruptcy, has sunk to the $15 area from mid-2003 highs around $32. Both stocks have stabilized in recent weeks as short-sellers have paused to catch their breath. The question now is whether renewed fears that the economy may falter in the next six months will yield a positive revaluation of these companies’ prospects, sparking a rebound in their shares.

"Is there a case for a rebound? It’s not as unlikely as you might think. The Economic Cycle Research Institute’s Weekly Leading Index, which has accurately forecast the last several recessions, has persistently turned down since the fall but has started to sink in a more pronounced way over the past three months. A good recipe for an improvement in the shares of bankruptcy-related companies is one in which the economy stumbles at the same time interest rates and the price of energy are rising. Companies that are on the edge financially can find themselves pushed over a cliff in this environment, as expenses go way up and sales flatten or decline. This view requires a contrarian stance, however, because at the moment, business bankruptcy filings are not on the rise. Meanwhile, let’s take a closer look at the two companies that would probably be the best investments if complex corporate bankruptcies were to increase over the next year, rather than decrease as most believe.

"Epiq Systems primarily provides software and hardware to attorneys, trustees, and companies that help them manage the myriad documents, assets, and funds associated with a major bankruptcy. Through an acquisition made in January, Epiq also provides the same sort of software and support to participants in class action, mass tort, and other complex legal proceedings. Unlike most ordinary software companies, however, in addition to site licenses, EPIQ earns a monthly fee from financial institutions based on a percentage of total liquidated assets on deposit and on the number of trustees. It also gets monthly fees based on the number of cases that a client has in a database, as well as the number of claims in a case. So the bigger and more numerous the corporate bankruptcies, in other words, the more EPIQ earns. If a rise in bankruptcies catches investors by surprise, it will come at a time when Epiq rests at its lowest valuation in years. Since 1997, the company has sported a price-to-sales multiple ranging from 4.5 to 9.2 and a price-to-earnings multiple of 23 to 47; the multiples now are down to 1.9 and 16.4 on consensus forward sales and earnings estimates. Economic skeptics with a taste for risk could consider the shares at the current level with an initial target around $17 a 20% move if it happens. If a gloomier mood on the economy takes hold, the stock should be able to get back to the $19-$20 range over the next six to nine months, which would be a 40% move from recent levels.

"Likewise, FTI Consulting also looks cheaper than it has in years now that most believe bankruptcies are on the wane. FTI provides higher value services such as forensic accounting, corporate refinance and restructuring, economic consulting, and litigation support. Billing hours is the name of the game here. FTI has been rebuilding itself to become less reliant on bankruptcy and other complex financial consulting business. Its other lines are not as profitable, but they are more consistent from year to year. In the 12 months ending March 31, the company earned $51.5 million on $384 million in sales. If the company can retain more bankruptcy-related business than generally believed while at the same time improving its other lines, then the stock should be revalued upward. If not, then this already cheap stockP/E and price-to-sales multiples are near historic lows could get a lot more inexpensive. Insiders appear to be betting on a rebound, as they have bought 250,000 shares on the open market since November, at prices ranging from $16 to $19. (There was also one very large sale, of five million shares, by a major shareholder around $14 in early February.) The chart is also constructive, as shares have stopped going down even in the face of relatively negative news and are hugging their rising 200-week moving average. FTI would not be an easy stock to buy, and may require a lot of patience, but the skepticism and negativity surrounding the company would probably reverse if the economy begins to visibly weaken in the coming months. First target would be $18.65, and if that is breached, then bulls will set their sights on $22."

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