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The Martha Mess Becomes a Monster

June 2003

JUNE 4, 2003

NEWS ANALYSIS 

The Martha Mess Becomes a Monster

With Stewart's indictment and resignation, the big question haunting her company and investors is: How will they get along without her?

The rain fell on Martha Stewart's white umbrella as she rushed into a downtown Manhattan courthouse on June 4, facing arraignment on criminal charges filed by the Justice Dept. But on Wall Street, speculation continues to focus on what the Stewart indictment will do to Martha Stewart Living Omnimedia (MSO ), the $296 million company she founded. 

A day earlier, with no Stewart in attendance, it fell to director Arthur C. Martinez to speak to the frenzy of reporters gathered curbside after the annual MSO board meeting. Martinez, the former CEO of Sears Robuck, left little doubt as to the domestic doyenne's role. "Categorically," Martinez said, "Martha Stewart remains the chairman and CEO." 

That all changed abruptly on June 4 when Stewart stepped down from both posts, allowing her No. 2, Chief Operating Officer Sharon L. Patrick, to become CEO and ValueAct Capital Partner's Jeffrey W. Ubben, MSO's newest board member and its largest outside shareholder, to take over as chairman. In civil proceedings, the Securities & Exchange Commission also is seeking to bar her from ever again serving as a public-company executive or board member. If Stewart choses to fight this second front, getting such an civil order could take a year or longer. 

A FALLING SKY.  It's hard to remember that just a year ago, Stewart, 61, was at the top of her game. The company bearing her name was growing, its shares traded at $17, and her reputation as both tastemaker and businesswoman was truly a good thing. Then the sky fell, in a drama worthy of a made-for-TV movie (for a review of one, see BW Online, 5/19/01, "What the Made-for-TV Martha Misses"). A congressional committee announced that she had sold shares in ImClone Systems (IMCLE ) the day before bad news was to break over the drugmaker. Her broker, it was alleged, may have tipped her off that ImClone CEO Samuel D. Waksal was selling. 

Her lawyers are denying the charges of conspiracy to obstruct justice, making false statements, and perjury involving Stewart and her broker, plus four counts against Stewart individually on obstruction of justice, making false statements, and securities fraud. 

One of America's best known media personalities, Stewart has long proclaimed her innocence, saying she had a prearranged order to sell the stock at a certain price. But investors don't seem to be convinced, and her reputation has taken a beating. Making matters worse, MSO revenues are down, largely on a drop in magazine advertising. After a further 18% slide when news of the impending indictment broke, the shares closed at $9.52 on June 3, before rising to around $10 on news of the indictment. But that's still about a 45% drop in share price in a year. 

SOLID SUPPORTERS.  Technically, an indictment by Justice wouldn't have prevented Stewart from continuing as CEO of the company she built. Her lawyer, Robert G. Morvillo, declared even before the indictment was handed down that she "intends to declare her innocence and proceed to trial." Pretrial proceedings could take anywhere from six months to a year, experts say. 

The MSO board steadfastly stood by Stewart, even as the media mayhem around her swelled to the point where she decided not to attend her shareholder meeting. In addition to Martinez, who has been a director for two years, the board includes longtime business partner Patrick, well-known investor Darla D. Moore, e-commerce consultant Naomi O. Seligman, and Ubben. Stewart will stay on as an MSO director and its "chief creative officer." 

Actually, the board may have little choice but to stick with Stewart because she remains their No. 1 asset. "She is the company -- more than the face of the company," says Ken Marlin, managing director at Marlin & Associates, an investment-banking firm specializing in media. "People buy Martha Stewart products because they are Martha Stewart products." 

HOLIDAY SELLOUT.  And they're still buying. Despite a sharp drop in advertising in MSO publications, her home-decorating line is moving at Kmart (KMRT ) even as the until-recently bankrupt retailer has shut stores. Last year, she sold more than $1 billion worth of towels, sheets, and other items to Kmart shoppers. A new line of holiday ornaments and decorations introduced last fall sold out before Thanksgiving. 

For Kmart at least, says Ulysses Yannas, an analyst who follows the discounter for New York brokerage Buckman, Buckman & Reid, "Martha Stewart the name does not seem to have been significantly affected by the problems of Martha Stewart the person." And unlike the scandals affecting CEOs at WorldCom and Adelphia Communications, who were shown the door after regulators came after them, the charges facing Stewart don't relate to the company she runs. 

U.S. Attorney James Comey, who brought the criminal case against Stewart, said at a press conference that it would be "a tragedy" if it affected the fortunes of MSO shareholders and employees. But he added, "It's a tragedy that could have been averted if [Stewart] had only done what parents have told their children for decades -- not to lie." 

RALLY OR FADE?  Even before the scandal hit, Stewart and the well-regarded Patrick were discussing the challenge of corporate life after Martha. Now that transition will be harder with Stewart herself under indictment and no longer atop the company. And it's even less clear how long her loyal fans will stick with her as the government unfurls its case against her. They may rally to her side even more -- or slowly lose their reverence for her amid new revelations. 

At this point, however, MSO's fortunes seem tied tighter than ever to Stewart and her gamble in defending herself against the charges. "I don't think she'll admit defeat," says Morgan Stanley analyst Arthur Douglas. "She'll go on fighting." That means the company will have to fight, too.

By Nanette Byrnes in New York with Amy Borrus and Lorraine Woellert in Washington 

Edited by Douglas Harbrecht

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