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Watch for Stewart bombshells -- and profit
Developments in the high-profile trial will probably whipsaw the stock of Martha Stewart Living, an opportunity for investors in search of a good thing.
By Michael Brush
As Martha Stewarts trial unfolds over the next several weeks, gripping courtroom drama will provide plenty of ups and downs -- and not just for the domestic diva.
Her companys shareholders are going to feel the urge to fix comfort food each time some courtroom twist spells doom for Stewart in gloomy headlines.
But sharp sell-offs in the shares of Martha Stewart Living Omnimedia (MSO, news, msgs) during the trial should offer a good entry point for the stock -- whether you are trading for a quick gain or staking out a long-term position. (You can track the stock during the day with MSN Moneys charting tool. Under period, click on intraday.)
Sure, it's possible that Stewart -- who is charged with securities fraud and covering up insider trading related to her sales of shares of the biotech company ImClone (IMCL, news, msgs) -- will end the ordeal with a lengthy prison term. But that outcome is just about as likely as her daffodil bulbs failing to flower this spring. As a result, her company is likely to recover nicely from the damage caused by her legal tangles.
For the benefit of investors, weve consulted some of the best legal experts in the country to put together a playbook for the trial. It identifies the potential low points that might grab headlines, tank the stock and give you a better chance to buy. Over the past few weeks, Martha Stewart Living stock has risen by more than a third to nearly $12 a share, meaning there's extra reason to wait for fallbacks before buying in.
But before we get to the playbook, which is filled with potential low moments for Stewart's company, let's look at reasons the stock is likely to survive -- and, probably thrive -- in the end.
Americans love to forgive
The No. 1 reason to believe in the future of Martha Stewart Living stock: History shows that Americans have a deep capacity to forgive or forget. Ultimately, her audience cares a lot more about her decorating tips than it does about her legal imbroglio.
Two years from now, this will be old news that only a fraction of people can recall, and it just wont mean that much to people, says Philip Anthony, CEO of DecisionQuest, a trial-consulting firm.
Recovery from scandal is a constant theme in politics and entertainment, as broadcaster Marv Albert and former President Bill Clinton can attest. The business world is similar. In the shoe industry, for example, prominent CEO Steven Madden -- who ran a company named for himself -- took a fall in the spring of 2000. He resigned from Steven Madden Ltd. (SHOO, news, msgs) when charges of stock fraud and money laundering against him emerged. His companys stock promptly lost two thirds of its value. The shares have tripled since then and nearly recovered all their losses.
Assuming Stewart actually dodges a conviction, how much will her companys stock be worth in the following months?
Company financials are strong
Based on the underlying value of Martha Stewart Livings businesses, analyst Andrew Rittenberry of the mutual fund group Gabelli & Co. in Rye, N.Y., thinks the stock could move into the high teens from recent prices of around $12. His estimate actually may be low because it is based on the currently depressed advertising-sales projections. Martha Stewart Living revenue comes from both media content (magazines and TV shows) and merchandise sales. Revenue from magazines was about 59% of sales in the first three quarters of 2003 and 62% of all revenue in 2002. The magazine business generates much of the companys operating profit.
Another financial plus: The company is holding $170 million in cash, a treasure trove that should reach $200 million by the end of 2004 because of a slight increase in revenue, declining losses in its Internet and catalog divisions, and lower costs at a food magazine launched last year. This lowers the downside risk, Rittenberry says.
Anger at Corporate America is waning
Most people simply arent as enraged with Corporate America as they were a few years back. For that reason, her jurors probably wont be looking for blood, suggests research by DecisionQuest.
A DecisionQuest survey done 18 months ago found enormous animosity toward Corporate America among potential jurors, says Anthony. More recent surveys show the pendulum has swung back. Jurors seem less interested in punishing Corporate America today, Anthony says. Large segments of the jury-eligible population have been satiated in terms of their thirst for punishment. Does this bode well for Stewart? I think it does, Anthony says.
Indeed, last October prosecutors failed to get a jury to convict Frank Quattrone, the former Credit Suisse First Boston investment banker charged with obstructing probes of alleged wrongdoing into his management of hot initial public offerings during the stock market bubble.
She's not actually charged with insider trading
Although jurors will be told not to think about it, they will be wondering why prosecutors are charging Stewart with covering up illegal insider trading -- even though theyre not charging her with the illegal insider trading itself.
There will be a credibility problem for the prosecution because they didnt charge her for insider trading, says Richard Southard, a former prosecutor in the Brooklyn district attorneys office who is now a criminal defense lawyer.
Officially, the charges against Stewart include lying to investigators, obstructing justice and securities fraud. The maximum penalty for the most serious charge, securities fraud, is 10 years in prison.
Lack of motive in a complex case
Defense lawyers can also put doubts in the minds of jurors by pointing out that the enormous losses Stewart sustained in her own companys shares far outweighed the savings she got by selling Imclone shares ahead of the bad news that tanked that stock. The evidence of Stewart's motive and intent is not overwhelming, says Wallance. She is wealthy, and she had no motive for doing this, and that is good theme for the defense.
The complexity of the charges also works in her favor. In a complicated case where there are multiple theories, says John Coffee, a securities law professor at Columbia University, there is an increased probability that jury will be in conflict and split the difference. In this case, that could mean prosecutors dont get all they want out of the trial, and Stewart will get off lightly.
The trial playbook for investors
Despite the solid chances that Martha Stewart Living stock will recover, media coverage during the next several weeks is bound to spook holders of this stock into selling whenever things take a turn for the worse. Heres a look at key points in the ordeal where things may look really bad for Stewart, sparking a sharp sell-off in the shares of her company -- and a buying opportunity for shrewd investors.
The jury is stacked against her: Courtroom pundits know cases are often won or lost in jury selection. If headlines scream that Stewart got a bad jury, expect pressure on the stock. Whats a bad jury? Prosecutors want rigid, dogmatic jurors who believe the rules are the rules, no exceptions, says Anthony. Theyll also look for signs of disdain for corporate culture.
Favorable jurors would include people who have overcome adversity -- such as the challenge of starting a business -- and gone on to succeed. Defense lawyers have an edge in that they can eliminate 10 potential jurors for no reason. Prosecutors only get six free passes.
The prosecution's opening argument is strong: At the opening of any trial, both sides have a chance to present the big picture. Tightly argued opening comments by prosecutors that convince the press things look bleak for Stewart would damage this stock.
Douglas Faneuils testimony appears damaging: An ace in the hole for prosecutors could be damning testimony from Faneuil, the young assistant to Peter Bacanovic. Bacanovic was Stewarts Merrill Lynch broker who supposedly tipped her off to inside information that convinced her to sell her ImClone shares just before news of the Food and Drug Administration's rejection of an Imclone drug tanked the stock.
Faneuil initially backed Stewart's claim that her sale was innocent because she had an agreement with Bacanovic to sell her ImClone stock if it sank to $60. But then Faneuil reversed his story.
Now Fanueil is expected to testify that Bacanovic ordered him to tell Stewart that former ImClone CEO Sam Waksal was selling -- and that that was the real reason Stewart sold. Fanueil will also say Stewart told him to tamper with phone records.
This is a case that hinges on the credibility of Martha, and the direct examination of Douglas Faneuil will be devastating for Martha, says David Marder, a former prosecutor in the Securities and Exchange Commissions Boston office, and now at partner at Robins, Kaplan, Miller & Ciresi in Boston. That will be the low point for Martha. You could see a period there where things look really bad for her.
On the stand, prosecutors puree Stewart: Talk about pressure. Most of Stewart's personal wealth is tied up in her business; she owns 61% of the outstanding stock in Martha Stewart Living. If she takes the stand, prosecutors will have a shot at making her look bad in front of jurors. Will she crack?
Cross-examination is the greatest engine for determining the truth ever invented, says Gregory Wallance, a partner at the New York law firm of Kaye Scholer and a prosecutor in the famous ABSCAM bribery trials against U.S. Congress members. That is when a lot of juries make up their minds about defendants. How Stewart explains allegations that she altered documents will be crucial for the jury. That could be a turning point in the trial.
Prosecutors will no doubt try to goad Stewart into flashing what critics believe is one of her biggest character flaws -- her arrogance. Indeed, DecisonQuests Anthony thinks Stewarts main challenge, if she testifies, will be to dispel the notion that she is haughty. If she demonstrates some shade of gray on the facts, coupled with a lack of humility, you will have a significant cross-section of the jury alienated by her behavior.
And if Stewart declines to take the stand, that could be damning, too. That will speak volumes to the jury, even though the judge instructs them not to consider it, Marder says. They want to see her deny the allegations. If she doesnt deny them, that will be a credibility problem for her.
Surprising evidence blows a hole in the defense: One big risk is that there is some smoking-gun email or memo that hasnt been revealed yet, says Anthony. There is going to be a day when something like that comes out, and that will have an impact.
Watch the testimony, if any, of Mariana Pasternak, a close friend who was with Stewart on a trip to Mexico during which she decided to sell Imclone. If she testifies that Stewart knew Waksal was selling, that would spell trouble for the shares of Martha Stewart Living.
The benefits of high-priced lawyers
To be sure, any seasoned courtroom lawyer will tell you its tough to predict what a jury will do. But the bottom line is this: For her to come out of this with just a light prison sentence at most, Stewarts pricey legal team has only to create enough doubt to convince one juror shes not guilty of the securities fraud charge carrying the longest potential sentence and most of the obstruction-of-justice-related charges.
Says Thomas Ross, a former Wall Street attorney who now teaches at the University of Pittsburgh School of Law: You cant underestimate the power of high-priced legal talent, at least in terms of getting a hung jury.
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