Boom in The Bust

By Eugene Linden/New York

Like Jim Lebenthal and Charles Schwab, Randy Smith owns a successful securities firm. But unlike those two familiar financial pitchmen, the head of Manhattan's R.D. Smith & Co. would never think of hawking his services on TV. Reason: R.D. Smith deals in stocks and bonds that would seem far too risky to the typical investor.

The two-year-old company is the undisputed leader in a peculiar new segment of the brokerage business that finds profits in the casualties of the American economy. Known in some corporate boardrooms as "vultures," the traders at R.D. Smith specialize in buying and selling low-priced stocks and bonds issued by companies that have filed for bankruptcy protection or are perilously close to taking that step. This dishonor roll ranges from such well-known hard-luck cases as Texaco, Manville and LTV to obscure ailing firms like Crystal Oil.

Smith and his growing legion of clients realize that investments in troubled ! companies may turn out to be worthless. But the prices of such cheap stocks and bonds can surge if the firms get out of difficulty. Only ten years ago, for example, Toys "R" Us, then called Interstate Stores, was wallowing in bankruptcy proceedings, and its stock was selling for as low as 12.5 cents. Today a share of the resurgent toy-store chain goes for more than $38, a 300- fold increase. Windfalls can also be made from convalescing companies like LTV, the giant steel firm that is still reorganizing under Chapter 11 protection but has made strides toward renewed profitability. This year the price of LTV bonds maturing in 2003 has nearly tripled, from 11% of face value to 30%.

Wall Street has always had contrarians who hunt for fallen angels, but the number of available so-called distressed securities was not large enough to support many specialists in this field. In recent years, however, a surge in bankruptcies has created a boom in the bust market. The value of investments made in distressed securities could reach $20 billion this year, in contrast to less than $1 billion a decade ago.

Smith, a graduate of Cornell and the Wharton School, started dabbling in distressed securities in the late 1960s while a trader at Manhattan's Bear Stearns. He made clients and himself a tidy profit on bonds issued by the bankrupt Penn Central railroad. In 1985 Smith left Bear Stearns to create the first company devoted to dealing in distressed securities. As a privately held firm, R.D. Smith does not report earnings, but the staff at its cluttered Manhattan office has expanded from eight to 35 in two years.

In the process, a whole new growth industry may have been born. Smith was followed into the business by Basil Vasiliou, a former Bear Stearns colleague, who launched a competing firm last year. In the meantime, several full-line investment houses, including Goldman Sachs and Salomon Brothers, have set up special distressed-security units.

One of Smith's first moves was to hire James Bennett, a Harvard M.B.A. and now the firm's chief operating officer. Bennett, an aggressive trader who was a national champion wrestler as a Yale undergrad, has shown an uncanny knack for spotting gems among securities that, as he puts it, "scare 99% of investors." When a company files for Chapter 11, Bennett goes through troves of financial information that surfaces in court papers. Even firms that may never emerge from bankruptcy are worth a look, he says, if the value of their / assets is not fully reflected in the price of their securities. Earlier this year, Bennett decided that bonds issued by Louisiana's Crystal Oil, a Shreveport-based company in bankruptcy, were worth more than 4 cents per dollar of face value. Four months after he recommended the bonds, the price jumped to 16 cents.

At the moment, Bennett is getting interested in Public Service of New Hampshire. Financially strapped by its inability to open the controversial Seabrook nuclear plant, Public Service is close to becoming the first major utility to file for bankruptcy since World War II. That might mean trouble for its shareholders, creditors and customers, but it could lead to another golden opportunity for R.D. Smith & Co.