Long arm of the law
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Long arm of the law Long arm of the law Document Transcript

  • Barrons Online Page 1 of 4 Monday, March 26, 2007Long Arm of the LawBy NEIL A. MARTINSHARES OF WORLD WRESTLING ENTERTAINMENT have been smacked down 13.4% in the past 10months, to 15.60, as some of the companys television superstars, including "The Rock," have defectedto Hollywood. But better days could lie ahead for the Stamford, Conn., provider of wrestling-relatedproducts and entertainment (ticker: WWE), especially if it wins several lawsuits filed in recent yearsagainst licensees it alleges have illegally acquired the rights to its name and franchise.Though World Wrestling has mentioned these suits -- against videogame-software publisher THQI(THQI) and a joint venture controlled by THQI and toy maker Jakks Pacific (JAKK) -- in its regulatoryfilings, you wont hear much about them on the companys quarterly conference calls. Thats all themore reason for investors to turn to Nick Rodelli, an analyst at the Center for Financial Research andAnalysis and head of the forensic-accounting firms new Legal Edge research service. Rodelli, who joinedCFRA last fall, specializes in dissecting legal "events" likely to influence companies earnings and shares."Litigation has always been out there, but in the wake of Sarbanes-Oxley, legal issues have becomemore prevalent," says Rodelli, 34, a former corporate litigator, Securities and Exchange Commissionlawyer and legal analyst for a hedge fund. "More often than not, the shares of companies withoutstanding legal issues are mispriced because they fail to reflect the potential negative or positiveimpact of recurring issues. Awareness of mispricing can be the difference between profit and loss for aninvestor."For World Wrestling, which derived almost a fourth of its 2006 revenue from licensing, a win in court"could provide a significant, recurring boost to financial results, specifically a 14% to 22% increase inearnings before interest and taxes. An indication that things are moving in the right direction for the plaintiff could come within a few months if the company succeeds in defeating a pending motion to dismiss its federal racketeering suit against the THQI-Jakks joint venture. "Such an event may provide the catalyst for investors to begin reassessing World Wrestlings earnings power, based on expectations of a higher royalty-income stream from WWE- branded videogame sales," Rodelli observes. DOW JONES REPRINTSNick Rodelli joined the Center for FinancialResearch and Analysis and heads its new LegalEdge research service. This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers,use the Order Reprints tool at the bottom of any article or visit: www.djreprints.com. • See a sample reprint in PDF format • Order areprint of this article now.http://online.barrons.com/article_print/SB117469862642147608.html 3/26/2007
  • Barrons Online Page 2 of 4CFRA was founded in 1994 by Howard Schilit, a former accounting professor at American University, andquickly attracted a faithful following on Wall Street by spotlighting questionable accounting andbookkeeping practices at publicly traded corporations.Short sellers, in particular, came to rely on the firms research, which helped expose problems at NewCentury Financial (NEWC), Delphi (DFG), Krispy Kreme Doughnuts (KKD) and Shuffle Master(SHFL), among others. In an admiring profile two years ago, Barrons called CFRA "one of the trueleaders in forensic accounting" ("Super Sleuths1," Feb. 28, 2005).The legal issues affecting corporations have multiplied in recent years, in part because of greaterregulation, more attention to corporate governance and the growing importance of technology innumerous businesses. Yet the risks and opportunities inherent in legal decisions are even lessunderstood by equity analysts and investors than accounting issues."We try to provide a real-time perspective on emerging legal and regulatory events," says RichardLeggett, who succeeded Schilit in 2005 as president and CEO of CFRA. Schilit sold his controlling interestin the Rockville, Md., firm in 2003 to the venture-finance firm TA Associates, but he remains an adviserto the company.Consider MasterCard (MA), the Purchase, N.Y.-based credit-card issuer, which faces not only antitrustsuits brought by American Express (AXP) and Discover, seeking billions of dollars in damages, butregulatory efforts to reduce fees and encourage more competition. In Rodellis view, none of the risksassociated with these issues is reflected in MasterCards shares, which have almost tripled since thecompany came public last May and now trade for 108, or 22.5 times consensus 2007 estimates."THE MARKET HAS BEEN mesmerized by the great numbers posted by MasterCard since it wentpublic, but is ignoring the greater threat to its operations from current legal risks," he says.Rodelli expects these risks to gain more attention in coming Table: On the Docket2months as the antitrust suits move toward trial and regulatoryscrutiny of the companys fee structure heats up. Not onlycould damages be in the "tens of billions of dollars," he says, but "the market fails to appreciate thestrategic interest of both American Express and Discover in using their strong antitrust claims to gainlong-term advantages in the marketplace, as opposed to a one-time settlement payout."If MasterCard appears to be the loser, American Express conceivably will benefit from the litigation,which focuses on the so-called exclusionary rule by which MasterCard effectively sought to preventbanks that issue its card from issuing AmEx or Discover cards. (The Department of Justice challengedthis rule and won; the American Express and Discover lawsuits piggybacked off the DOJ action.)Consequently, the two stocks might make for "an excellent pair trade," says Rodelli, with an investorbuying American Express at 16.5 times "07 estimates, and shorting MasterCard. (Shares of MasterCardhave fallen about 2% since CFRA issued its first report Feb. 1, while American Express is roughly flat.)Paint maker Sherwin-Williams (SHW) also faces potentially significant risks from litigation, saysRodelli. The threat to Sherwin-Williams comes from a recent ruling by a Rhode Island state judge,upholding a jury verdict that found the Cleveland company guilty of creating a "public nuisance" andhealth threat with its lead paint products, sold many decades ago.The court also is demanding a statewide cleanup. Although Sherwin-Williams has said that it will appealthe ruling, other cases against it are pending in Ohio, New Jersey, Wisconsin and California, promptingfear that lead paint could become "the next asbestos."The companys shares have held up well in the face of legal threats and decisions, and its operatinghttp://online.barrons.com/article_print/SB117469862642147608.html 3/26/2007
  • Barrons Online Page 3 of 4performance has been strong. Sherwin-Williams has rallied more than 52% since mid-July, to 67, andcurrently trades for 13.5 times Wall Streets 2008 earnings estimate of $4.98 a share.The companys valuation "doesnt reflect the significant risk," insists Rodelli. If law firms begin to seelead-paint litigation as "an attractive return on investment," he adds, todays trickle of cases could turninto a torrent.JUST AS INVESTORS ignore legal risk, they sometimes overreact to litigation and miss potentialopportunities in mispriced stocks. That may be happening with Qualcomm (QCOM), a provider ofwireless technology, which is embroiled in legal controversies with Nokia (NOK), Broadcomm (BRCM)and others.The disputes center largely on the future division of royalty payments on third-generation, or 3G,mobile-phone technologies; Nokia has charged that Qualcomms royalty rates of around 5% are toohigh, while Qualcomm has filed patent-infringement claims against Nokia.The disagreements have weighed heavily on Qualcomms stock, which peaked at 53 in May, troughed at33 in August and now trades around 43. But with the shares fetching 24 times expected earnings (minuscash) -- a valuation near historic lows -- Rodelli argues that theres little downside risk, and substantialupside if "any positive catalysts" arise on the legal front."Nokia already has done its damage to Qualcomms share price, expending a great deal of its bargainingleverage in the process," he says. The end result could be a compromise that tilts in Qualcomms favor. The Bottom Line LEGAL EDGE, which CFRA launched in January, also has followed Advanced Micro Devices (AMD) antitrust suit against Intel (INTC). Rodelli sees strategic benefits for AMD, World Wrestling, American Express and Qualcomm could be helped by court cases. as the litigation overhang could provide the semiconductor MasterCard and Sherwin-Williams could be company a window of opportunity to establish relationships hurt. with computer suppliers like Dell (DELL). Moreover, Intel allegedly failed to preserve key business documents, he says.Rodelli warned clients early on that a probe of Dells accounting practices by the SEC could be moreserious than the company initially had indicated. He argued investors were overreacting to a disclosureby Commerce Bancorp (CBH) of investigations by the Comptroller of the Currency and the FederalReserve, which involved charges of "related-party dealings" by the banks CEO and his wife; they fellshort of "major investigation" status, he said.He also expressed concern that Steve Jobs might yet be forced to leave Apple (AAPL) because ofongoing probes into the companys alleged backdating of stock options. And he highlighted how Crocs(CROX) potentially could beat back knockoffs as a result of a decision involving the footwear makerspatent-infringement claims before the International Trade Commission."THE MARKET TENDS to look at these kinds of legal issues in a binary way: either this or that is goingto happen and, when it does, its all over," says Rodelli. "The reality is that legal issues are like onions.You peel away one layer and theres another one below, and another."Small wonder it often is hard for investors to distinguish good news from bad in matters before thecourt. Or that, with companies increasingly incorporating litigation into their business plans, Rodellisdocket is likely to stay full.E-mail comments to editors@barrons.com3http://online.barrons.com/article_print/SB117469862642147608.html 3/26/2007
  • Barrons Online Page 4 of 4 URL for this article: http://online.barrons.com/article/SB117469862642147608.html Hyperlinks in this Article: (1) http://online.barrons.com/article/SB110939465308864962.html (2) http://online.barrons.com/article/SB117470043907947672.html (3) mailto:editors@barrons.com Copyright 2007 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.http://online.barrons.com/article_print/SB117469862642147608.html 3/26/2007