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Your Money : IDB Must Prove That Its Books Weren’t Cooked

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When IDB Communications Group’s stock price collapsed on Wednesday in the wake of news that its auditors quit in a huff, the firm’s 38-year-old founder admits he faced the same basic question over and over again from shareholders: Was he a crook?

No, Jeffrey Sudikoff insists, he’s not a crook. He understands that he must prove that, he says, and probably in court. (The shareholder lawsuits are already piling up.) But whatever else people may say about him, Sudikoff has 900 employees, tons of telecommunications hardware and a long list of clients worldwide to show that his 10-year-old, Culver City-based firm isn’t some grandiose fraud.

The devil, however, is in the details, and that’s why Wall Street sent the stock plummeting from $14.50 on Tuesday to $7.125 by Wednesday’s close in wild trading. IDB’s auditors, Deloitte & Touche, abruptly resigned in a dispute over certain IDB accounting practices. IDB says the disagreements are minor. But until Deloitte gives its side of the story (expected soon) many investors will assume the worst--that IDB’s books have been cooked.

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Ultimately, this is probably what we’ll find out: IDB didn’t grossly misrepresent its sales and earnings growth over the past few years. But in remaking itself from a $61-million TV-radio signal relayer in 1989 to a $311-million global long- distance phone firm by 1993, IDB was guilty of too much hype and overly “aggressive” accounting.

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This is a game that many small companies play. Wall Street wants hot stocks, and once it identifies a “growth stock,” analysts create high standards for the firm to meet each quarter.

If your earnings come in under expectations just once, your stock may fall almost as much as if, say, your auditors were to quit. And if, like IDB, you’re using stock to make big acquisitions in your fast-growing industry--competing with giants like AT&T; and MCI--you need a high share price.

Thus, companies like IDB find themselves in the business of managing earnings. With a sharp pencil, you can adjust your numbers--take a capital gain here, delay a charge there--to make your quarterly results meet estimates. Wall Street understands this and doesn’t much care, as long as the basic trend in the business is strongly up.

Purists may argue that there is only one set of accounting rules, and that aggressive accounting is by definition wrong. But the reality is that “there’s discretion in accounting, and companies can be more aggressive” if they choose, says Bruce Miller, a professor of that trade at UCLA.

The role of the auditor is to make sure that aggressiveness doesn’t turn into outright fraud. Deloitte, in giving unqualified opinions in support of IDB’s financial reports in 1992 and 1993, effectively said IDB’s growth was for real. If it now recants, Deloitte’s liability could be enormous.

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“Do we have aggressive accounting and a unique business that has subtleties of accounting? Yes,” Sudikoff admits. But Deloitte “never had a problem with that in that past,” he says. Disagreements about the numbers in 1992 and 1993 were always ironed out, Sudikoff says. And he notes, correctly, that it isn’t unusual for companies and their auditors to have disagreements on details.

When the Deloitte partner handling IDB changed this year, the disagreements, from Deloitte’s view, evidently became insurmountable. Why? IDB President Edward Cheramy says it was a personality clash, not a major accounting issue. We’ll have to wait and hear from Deloitte.

All of this is not to paint IDB as a poor victim. There’s a reasonable argument that IDB was setting itself up for a fall. It has fed the hype machine with way too many self-congratulatory press releases about its expanding client base in global long-distance. And when Sudikoff bought into the Los Angeles Kings hockey team this year, Wall Street worried he had delusions of grandeur.

Still, there’s only one real issue here: Does IDB have a viable franchise? Tony Robertson, analyst at brokerage Alex Brown & Sons in Baltimore, notes simply that “global telecom is deregulating, and somebody is going to be a competitor to AT&T; (in international long distance).” IDB, among others, is already there; whether it can stay there, or make good money at it, is the question.

On Thursday, some investors felt intrigued enough with IDB’s potential to bid the battered stock up $1.19 to $8.31 on Nasdaq.

Sudikoff says three major accounting firms are already vying for IDB’s account. Assuming new auditors certify that IDB has grown as claimed, Sudikoff says his course in global long-distance will stay the same: Eat, or be eaten. And he concedes that with his stock cut in half, IDB is now as much a potential target as it is an acquirer.

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How IDB Grew Key financial data for IDB Communications, as reported in the company’s 1993 annual report:

Item (in millions) 1989 1993 Sales $60.7 $310.7 Costs/expenses 49.3 270.1 Operating income 11.4 40.6 Interest expense 8.4 6.4 Net income 1.8 10.9 Net per share before onetime items 0.10 0.33 Net per share after onetime items 0.10 0.19

Source: IDB Communications

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