Carnival Cruise Lines Sailing in Tough Waters

There is some good news among the bad, and company execs are providing a steady hand at the helm.
Author:
Publish date:

On Wall Street, appraisals of bad news inevitably degenerate into talk about bugs. You'll get a cockroach here, a

Kafka

reference there, if you're lucky, the obligatory other shoe about to drop. Personally, I like to keep my metaphors nautical. I might, for instance, fear that the recent spate of bad news at

Carnival Cruise Lines

(CCL) - Get Report

is just the tip of the iceberg. Or that it's batten-down-the-hatches time. One thing's for sure: If this baby takes on any more water, we may see a rush on

Leo DiCaprio

mastheads.

Once seemingly indomitable, Carnival has suffered a year of mechanical snafus, cancelled acquisitions, pricing weakness, skyrocketing fuel costs, earnings warnings and enough shareholder lawsuits to keep its legal hands occupied for the better part of a decade. To top it off, Carnival may be sailing dead into the dreaded overcapacity, brought on largely by its own ambitious shipbuilding campaign.

The news itself surprised no one, but investors took notice when CEO Micky Arison announced in March that the liner would fall well short of Wall Street expectations. Should Carnival's second-quarter earnings indeed come in below those of the same quarter last year, it will mark the first year-over-year decrease in almost a decade. For the Carnival faithful, this uncharacteristic announcement must have been almost as bitter as it was for Arison himself, a major stockholder and son of the company's founder.

To their credit, Carnival executives have provided a steady hand at the helm. Prolific profit-takers in the past, insiders at the company refrained from selling into the recent decline. In fact, as the stock settles at what appears to be a bottom, Carnival directors have begun to exercise nonqualified stock options. Three long-time directors exercised to acquire 51,000 shares seven weeks ago, while another purchased 1,000 shares on the open market at $23.68 per share last month. Thus far, they have held on to all the acquired shares.

Again, it's particularly encouraging to find insiders exercising nonqualified options. Unlike in the case of an ordinary Incentive Stock Option, when they exercise nonqualified options insiders immediately incur a tax liability on the difference between the exercise (or strike) price of the option and the market price of the stock on the day of the exercise. Obviously, this encourages the exercise of the option when the stock is trading at the lowest possible price. Put another way, an insider would be foolish to exercise nonqualified options should he or she even suspect that the stock price will come down in the future. After all, in an extreme situation, should the market price actually fall below the exercise price, the insider would be taxed on a gain, though he or she has in fact incurred a loss.

There are no guarantees, but years of experience have taught me to expect upside surprises when insiders step forward to exercise nonqualified options. This is especially true when those insiders have established a track record of selling the shares thus acquired. In this case, the two largest acquirers -- Stuart Subotnick and Uzi Zucker, acquiring 20,000 shares apiece -- each sold stock at higher prices back in 1998.

Most likely, however, Carnival is a good old-fashioned valuation story. The company has spent $300 million buying back shares of the ailing stock and plans to spend much more. For those with a lingering interest in such things, the stock trades at just over two times book value. Also lost in all the bad news is the fact that the company's annual revenue numbers are in the billions, and that even in its darkest hour, Carnival management expects year 2000 earnings to grow by about 10%.

And what about the capacity issue? Management says, bring it on. COO Howard Frank not only defends the company's plans to build $6.5 billion worth of new ships, but boasts about them. According to Frank, far from battening down the hatches, Carnival will "continue to grow its business, and grow it profitably." Arison, too, has been steadfast in his belief that despite the recent setback, aging U.S. and European populations will all but ensure that Carnival can continue to expand indefinitely.

Even so, a few money managers have publicly jumped ship. Recent declines in institutional holdings numbers suggest that at least a few others have done so more discreetly. Wall Street analysts have been somewhat more loyal, with many retaining their buy ratings throughout. Even now, you can spot the occasional analyst saying as much to the mainstream financial press. But yes, like any worthwhile disaster, if this baby goes down, Carnival's going to take a lot of good souls with it.

Bob Gabele has been tracking and analyzing insider trading since 1978, most recently for First Call/Thomson Financial. This column is not meant as investment advice; it is instead meant to provide insight into the methods of insider trading. At time of publication, Gabele held no position in any of the companies discussed in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabele appreciates your feedback at rgabele@thestreet.com.