Is Martha Stewart's Run-Up a Good Thing?
Troy Wolverton
09/22/04 - 06:15 PM EDT
Updated from 7:19 a.m. EDT
So, just what is up with shares of
Martha Stewart Living (MSO Quote)?
The company's namesake and founder is headed to prison for a five-month stay after being convicted of obstruction of justice; the company has posted a loss in five of its last seven quarters; advertisers have fled its flagship title,
Martha Stewart Living, like rats from a ship; and the company's turnaround hopes rely on the strategy of launching magazines and television shows without what was the company's most valuable asset: Stewart's imprimatur.
Despite all this, the company's stock price has jumped by one-third since Stewart asked to serve her prison term as soon as possible. On Tuesday, shares rose $1.64, or 12.5%, to $14.81. The stock is now trading where it was immediately before Stewart was convicted, when optimism about the trial's outcome pushed shares upward.
"I have no idea why it's here," said one fund manager, who asked not to be named and doesn't have a position in the company. "People do crazy stuff."
Indeed, the fund manager and other investors believe the run-up has little to do with fundamentals or a newfound faith in the company's prospects. Instead, they attribute the movement to the massive short position in the company's shares. As of the second week of September, the number of shares being shorted was equal to about 41% of the company's float.
"A lot of people are short this thing," said Stephen Monticelli, president of Mosaic Investments. "You've got some people throwing in the towel." (Monticelli's fund has no position in Martha Stewart Living.)
With other stocks, investors get nervous when the short ratio exceeds just 15% of a company's float. With such a high short ratio in Martha Stewart Living shares, any tidbit of good news can send the stock upward -- and generate a short squeeze and force short-sellers to the exits.
That seems to be what's happening lately. On Tuesday, the judge in Stewart's case
endorsed Stewart's decision to serve her sentence before her appeal is heard. On Wednesday afternoon, the company announced that it has signed a deal with Mark Burnett, the television producer behind such hits as
Survivor and
The Apprentice. Under the deal, Burnett will consult with the company to help develop upcoming television productions, including a revived edition of the company's signature
Martha Stewart Living show.
As part of the agreement, Martha Stewart Living gave Burnett a warrant to purchase up to 2.5 million shares of the company's common stock at a price of $12.59 a share. The company's announcement confirmed a report in the
New York Daily News on Tuesday.
Stewart's move to go to prison early removed some of the uncertainty about her fate that had weighed on the company's shares, analysts have said. At the same time, the collaboration with Burnett offers hope that the company might be able to rebound once she's out of the slammer.
But analysts have their doubts about whether these tidbits will help the company's fundamentals in the foreseeable future.
While Burnett has had great success with his shows, reviving Stewart's TV show would present a significant challenge, said Dennis McAlpine, who covers Martha Stewart Living as the managing partner of McAlpine Associates. The show was already struggling before Stewart ran afoul of the law, McAlpine said. Stewart's conviction has damaged her image, he said.
And Burnett's statement to the
Daily News that he would focus on Stewart in the act of "helping people" leaves McAlpine scratching his head.
"I can't imagine anyone less suited to helping people than Martha Stewart," he said. "An Oprah Winfrey she's not. It would be very difficult to get a show that's good and that people would want to see other than for the curiosity factor." (McAlpine does not own shares of Martha Stewart Living, and his firm does not have investment banking business with the company.)
Martha Stewart Living posted its most profitable year in 2001, when it earned 45 cents a share. At the company's current stock price, it's trading at about 33 times earnings of that year, a relatively rich valuation for any company.
"That seems like a very generous valuation," the fund manager said.
The valuation seems especially rich given that Martha Stewart Living now posts steady losses and faces a much different environment:
Since 2001, Kmart(KMRT Quote) -- which sells Martha Stewart Everyday products under a license from Stewart's company -- has gone in and out of bankruptcy, losing millions of dollars in sales and closing hundreds of stores in the process.
Earlier this year, the company ceased production of its primary syndicated television program, Martha Stewart Living. Although the company is airing reruns and has signed deals for a couple of new programs, analysts doubt it will be able to charge advertisers the same rates as before.
Competition has increased. Time Warner's (TWX Quote) Real Simple has hauled in more advertising revenue this year than Martha Stewart Living magazine. Budget Living and other titles also are luring away the company's readership and advertisers. In contrast, Martha Stewart Living has seen its advertising revenue plunge 53% this year after dropping some 31% last year.
And don't forget Stewart herself. A still-pending civil case could result in Stewart being barred from a significant role in her company. While the company has taken steps to distance its products from Stewart, most are still clearly identified with her.
In the wake of all these problems, Monticelli is somewhat optimistic about the company's long-term prospects, and sees Stewart's early prison term as a positive for the company.
But even he thinks that the company's valuation has gotten ahead of itself. "I had trouble convincing myself it was worth $11," Monticelli said. "I don't know anybody who is saying they love this thing or has a clear idea of how the company will perform. It's a muddy situation at best."
