Last month, toy retailer FAO (OTC: FAOO) was talking liquidity. Now it's talking liquidation.
The company said yesterday that it will file for Chapter 11 bankruptcy protection for itself and its ZB and FAO Schwarz businesses. It's sad news for those of us raised on regular trips to New York or on the '80s movie Big. (Think how silly Tom Hanks and Robert Loggia would have looked dancing in a toy store surrounded by moving men and downcast sales associates -- Loggia looked silly enough hawking orange juice.)
Alyce Lomax took a quick look at the broader issues surrounding the company in a story last month. Instead of recounting them here, this time might be better spent revisiting a worthy topic: What happens when a company's stock is delisted from a major exchange and begins trading, as bankrupt companies often do, over the counter with the letter "Q" affixed to the end of the ticker. (FAO has already begun the process of delisting its stock from the Nasdaq.)
We've seen some well-known companies follow this route over the years, and the temptation to follow them down in hopes of picking up a bargain can be strong. Don't give in. If you already own such a company, your best bet is probably to use it as a tax write-off. If you don't, the simplest advice we can give is: Stay away, Fools.
If a company has filed for Chapter 7, which FAO hasn't, a trustee is appointed to oversee the liquidation of all of the company's assets. Whatever money's made is distributed to the creditors. Generally speaking, common stockholders don't see dime one of this.
If a company does as FAO did and files for Chapter 11, it keeps operating while it works out a reorganization plan. Assuming the bankruptcy court approves it, the company gets protection from its creditors while it works on its plan -- and, with luck, returns to profitability. In this case a stockholder is playing the long odds that the company emerges from bankruptcy and will become a market-beating investment within a reasonable amount of time. This is asking an awful lot.
FAO isn't trying to mislead anyone. According to yesterday's press release, the company attempted but failed to sell part or all of the business, and thus it doesn't expect "any recovery would be available to its common stockholders." In short, it looks bad.
Fool Bill Mann probably put it best in a January 2002 article: However little you may be investing in a bankrupt company, and however "tempered" your expectations might be, "Putting some money in these companies is a bad idea, a monumentally bad idea. You are going to lose it all, so don't."
Revisit our Q&A on "When Good Stocks Go Bankrupt" for more information on what it means when a company "goes chapter."
Dave Marino-Nachison can be reached at email@example.com.