Judging Martha Stewart the Stock

With the trial about to go to jury , investors who have been treating shares of Martha Stewart Living ( MSO) like a lottery ticket on its founder's fate might soon be forced to rethink the company's fundamentals ahead of earnings due out Thursday.

The jury's verdict could still determine the company's fate: a guilty finding might permanently damage it, particularly if the former CEO goes to jail. Thursday's earnings report is primarily useful as a clue about how much of a rebuilding effort the company will face if she's acquitted, and whether it has the strength to carry on without her.

"The stock will probably go up if she's found innocent, but I don't think that's going to bring the company back," said Dennis McAlpine, who covers Martha Stewart Living as the managing partner of McAlpine Associates. "I think the company's got serious problems regardless."

McAlpine doesn't own shares in Martha Stewart Living, and his company has no investment banking business with her.

Indeed, the company's problems were clear in the first three quarters of last year, a period when it swung to a loss of 15 cents a share from year-ago earnings of 19 cents a share. Revenue plunged 19.5% in the first three quarters of last year from the same period a year earlier.

Chief among the company's troubles was a decline in advertising at Martha Stewart Living, its flagship magazine title. For all of last year the total number of advertising pages in Martha Stewart Living fell 35% from 2002, while the title's advertising revenue dropped 31%.

But the company's trouble extended beyond the magazine. Revenue from the company's syndicated television programs fell in the first nine months of last year, as did sales through its catalogs and Internet site. Meanwhile, the company's general and administrative costs surged, in part due to legal expenses related to the charges facing Stewart.

Along with her former broker, Stewart is charged with lying to investigators about the circumstances of a December 2001 personal stock trade in ImClone Systems. Prosecutors allege that Stewart acted on privileged information she got at the behest of her co-defendant, Peter Bacanovic. The jury could begin deliberating the case as early as Tuesday.

While trial observers are divided about Stewart's chances with the jury, Wall Street isn't expecting a lot from her company when it reports earnings on Thursday.

Analysts surveyed by Thomson First Call expect the company to earn 7 cents a share from continuing operations on $72.13 million in sales. For the full year, Wall Street expects Martha Stewart Living to lose 7 cents a share, excluding a discontinued wedding registry business, on $246.08 million in revenue.

In the fourth quarter of 2002, the company earned 12 cents a share -- 13 cents from continuing operations -- on $77.56 million in sales. For all of 2002, the company earned 15 cents a share -- 27 cents a share on continuing operations -- on $295.05 million in sales.

While Wall Street expects Martha Stewart Living's bottom line to firm up this year, it expects the company's revenue to keep declining. In 2004, analysts are calling for a loss of 2 cents a share on sales of $229.67 million.

Pessimists on Wall Street think Stewart's trial has seriously damaged her company, almost regardless of its outcome. Trial revelations about Stewart's temperament and her attempt to expense a $17,000 vacation probably won't sit well with her core group of readers and viewers, analysts say.

"This comes down to the fact that this business builds its competitive advantage on the persona of Martha Stewart," said Morningstar analyst T.K. MacKay. "Regardless of what happens, this company has a lot of rebuilding to do."

MacKay does not own shares of Stewart's company, and Morningstar doesn't do any investment banking.

That rebuilding could prove tough because the competition for Martha Stewart's audience has increased. Magazines such as Real Simple and Budget Living are targeting the company's core readership, giving an option to media buyers.

"The advertisers are saying they don't need Martha Stewart anymore," said McAlpine.

Meanwhile, the company is involved in a potentially costly battle with Kmart ( KMRT). Under a marketing agreement, Martha Stewart Living offers branded home products through the discount chain. Kmart pays Stewart's company a royalty on the products sold. But Kmart, which has been battling slumping sales due to a recently completed bankruptcy filing and store closures, has sued Martha Stewart Living to reduce the minimum royalty it owes this year.

Even if the operational issues are resolved advantageously, a guilty verdict could be all she wrote for Stewart's company.

"If that happens, I think the company implodes," said Scott Rothbort, contributor to Street Insight, a sister site of TheStreet.com. "You can't have your only product in jail."

Of course, not everyone's a pessimist.

Believers in Martha Stewart Living's stock have blamed much of the company's trouble on the negative publicity and uncertainty surrounding the trial, which they believe is based on weak charges and reeks of sexism. Bulls argue that the advertising and circulation decline are temporary setbacks. Once Stewart is exonerated, advertisers and subscribers will return and the company will rebound.

Investors may already be expecting that outcome. On Friday, after the judge in Stewart's case threw out the most serious charge against her, securities fraud, the stock spiked $1.43, or 10.9%.

And Friday was not unusual. The bull case has been winning out of late. Although shares of Martha Stewart Living fell 61 cents, or 4.2%, to $13.92 on Monday, they are up 41.3% since the beginning of the year.

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