My Russian Roulette Pick Of The Day

Like big, big, prizes? Unhappy with "moderate" returns like 10%, 20%, or even 30% per year? Ever hold a firecracker in your hand until the last second, because you're willing to take a risk? If you are ready to swing for the fences and don't mind a few catcalls from the crowd if you strike out and end up on your ass in the dirt, this idea is for you.

Three Five Systems (TFSIQ, on the pinksheets) is a local (Arizona) public company that entered bankruptcy about a year and a half ago to clean up a few issues with its subsidaries and (hopefully) pay out the remaining cash to shareholders. I got into this over a year ago, traded it several times for a profit, and then ended up getting stuck bad as it declined from 30 cents to 8. Right now it's trading between 10-11 cents.

There are two problems with investing in companies in bankruptcy. First is that typically, the common shares are worthless. Second is that if they aren't, it's very difficult to determine what they might be worth, esp. for the amateur investor. I invested in TFSIQ because I was convinced that this was one of those rare exceptions that might be worth something, and because I thought I had a good read on what it's worth. As of early 2006 it looked reasonable that Three Five would be able to pay out 32 cents and possibly more, given a bankruptcy plan with a shareholder equity of 6.9M for 21.8M shares (the 8k of November 7, 2006 that announces the plan's approval contains contains all the details in it's addendum). Despite the approval of this plan, things have gotten somewhat murkier since the plan was created in early 2006. The last operating report I have contains a balance sheet from September 10th with a shareholders equity of 5.179M, or 24 cents per share.

Specifically, Three Five is in disputes with several parties, and the outcome of those disputes will determine our end value, which will range from zero all the way up to 24 cents, or even possibly 32 cents. The biggest problem is with a subsidiary. To quote from the September operating report

"TFS has an investment of $2 million in TFS-DI, a wholly owned subsidiary, which is subject to litigation and compromise. TFS has filed suit in U S Bankruptcy Court against a party to a contract alleging among other things breach of contract. The defendant has filed a counter claim for $5.5 million which TFS denies. However, TFS and TFS-DI together have recorded liabilities of $4.5 million for note payments to and inventory purchases from the defendant. The outcome of this litigation cannot be predicted, and could materially affect the final cash distributions."

They also have disputes with their local landlord, and a suit (against Topsearch Printed Circuits Ltd. and Avocent Corporation) that might bring in additional upside. More details can be found on Pacer (Arizona Bankruptcy court, case #2:05-bk-17104) as well as in their SEC filings and their lawyers web site. If you don't have a pacer account, it's highly recommended as it will allow you to read all the legal filings on virtually any case, for a fairly reasonable price.

To keep the blog short, I'm not going to go into any more detail, so let me finish by summation. For 11 cents right it seems you can buy shares that might be worth more than twice as much, or nothing, later this year. I believe it's more likely they'll be worth something than nothing, so I'm holding my shares for now. But given the high risk level here I'd counsel caution and doing your own research. My rule of thumb for high risk positions is to limit each to 5% of my portfolio. If you decide to invest here, I'd caution you to do something similar.

If Three Five Systems still sounds interesting (and if it does you might be as crazy as I), have fun and enjoy the wild, wild, world of bankruptcy investing. And let me know if you find anything interesting.