Lessons From Wall Street’s Turkey Farm

Mike: Well, Jim, last week I was sitting around with my belt loosened because I was bursting with turkey . . .

Jim: And you got to thinking about the stock market?

Mike: Yes, it occurred to me that the number of corporate turkeys this year have been pretty thick on the ground. In fact, you can’t walk down Wall Street without tripping over them. So I decided we should take inventory of the market’s turkey farm to see what lessons can be learned.

Jim: Good idea. Now, our readers might wonder why we want to talk about stocks that nose-dived this year. I mean, they’re looking for stocks to buy, right?

Mike: Yes, but investing wisely means knowing what to buy, and also what not to buy. And as they often say in Silicon Valley, you learn from your mistakes. In fact, a lot of people in Silicon Valley have had a lot to learn this year.

Jim: Right, the point being that when you’re evaluating a stock, it helps to learn how to spot the red flags that should make you think twice. But sometimes you have to learn the hard way.

Mike: True. Let’s be honest: You and I haven’t escaped this year without a few bloody pecks from turkeys of our own. They looked like beautiful swans when we recommended them, but underneath all that white plumage were some rotten birds.

Jim: Are you done mixing your metaphors today? Anyway, how about if we start with Lucent Technologies [ticker symbol: LU]. The directors of this huge maker of telecommunications equipment, after seeing the company stun Wall Street quarter after quarter with lousy earnings, recently fired CEO Richard McGinn.

Mike: Not a moment too soon; he had lost all credibility.

Jim: Lucent’s transformation into a turkey was shocking. When the year began it was riding high, with the stock in the $70s. Now it trades for less than $17, and an incredible $200 billion of investors’ paper wealth has gone up in smoke.

Mike: Every quarter, investors were led to believe that things were looking up, only to have Lucent say “Whoops, guess what? We’ve just discovered things are looking down again.” You know, the DNA guys must have cloned this particular turkey, because such serious setbacks have happened at company after company this year.

Jim: And in all sorts of industries, not just telecom. The lesson for investors is that if you see a company come up short in sales or earnings one quarter, sit up and pay attention. Because a lot of Wall Street analysts took Lucent at its word, and kept recommending the stock.

Mike: Good point. Wall Street analysts these days are easily had, and they believe what they hear. I’d argue that many don’t do original research, because the basic structure of business on Wall Street today militates against analysts speaking their minds.

Jim: They have a conflict of interest.

Mike: The same brokerages that employ the analysts have other departments, like stock underwriting and mergers advice, that are trying to sell services to these companies. So if you’re trying to float stock or bonds for Lucent, God forbid that your analyst suddenly declares: “Lucent stinks!”

Jim: Now, given Lucent’s long track record of excellence--until this year--I can see why investors might have hung in with the stock.

Mike: I know. You’re talking with someone who owns Lucent, which is my way of making a very embarrassing disclosure.

Jim: In any case, Lucent certainly isn’t the biggest stock turkey of the year. That, collectively, has to be the “dot-com” stocks. As everyone knows, the whole Internet stock craze just collapsed this year, as well it should have.

Mike: And to think that, right up until March, we kept hearing that the dot-com stocks represented a new paradigm: The old rules of investing and of economics had been repealed, the bulls said.

Jim: It was just a new platter of baloney. The lesson here is that all of the basic tenets that make for a good stock--consistent profit growth, a healthy balance sheet, strong management, knowledge of your market--were and are still intact. Investors just got sidetracked by the Net-stock craze, as they have before by other fads.

Mike: It’s pretty amazing to see the carnage. Garden.com [GDEN], down 98%; DoubleClick [DCLK], a company that sells ad space on the Web, down 88%. And on and on.

Jim: You know, when dot-com mania was in full bloom, I’m sure many investors who had always followed the traditional rules of investing thought the train had passed them by. It must have been hard to listen to Uncle Joe bragging about how he was making money hand over fist trading Net stocks.

And there was money to be made, for a while. But who’s laughing now?

Mike: That brings me to our next turkey, NetZero [NZRO], a purveyor of free Internet service. Now, the ballgame for this company was in accumulating an audience . . .

Jim: . . . basically building a huge group of users.

Mike: Yes and, once you had all these “eyeballs”--people who come to your site or use your free service--you would be able to parlay that audience into some sort of revenue-producing mass by selling them goods, services, entertainment, you name it.

Now, NetZero got a big audience by giving away something for nothing. But the more it has added indirect costs--more advertising on its Web page, for instance--people see what the real price is of a “free” service. And the question is whether that realization will make them less willing to remain customers.

So far, the market isn’t buying it: The stock, once $40, now is under $2.

Jim: I’m happy to say that when we reviewed NetZero in May, we agreed there was a certain value to the customer database. But we also said the stock market was no longer willing to accept on faith that there was a huge pot of gold at the end of the rainbow for this company, just because it had a database.

Mike: Indeed, the value of that database was probably far overestimated by investors.

Jim: Now I want to go back to the telecom sector, because it’s packed with turkeys--namely long-distance providers. I’m talking about AT&T; [T], WorldCom [WCOM] and Sprint [FON], to name three.

Mike: They’re competing at a time when the price of long-distance service is eroding sharply. At worst, the cost is about 4 cents or 5 cents a minute, and it’s often free if you use your wireless phone and you’ve got free long-distance service on it.

Jim: And it seems that wherever you go, everyone is talking on a wireless phone these days.

Mike: But their money doesn’t end up in the long-distance companies’ pockets. AT&T; decided it was going to solve the problem by moving into cable television and all sorts of other telecom services. And for a time it looked like a good strategy.

Jim: But as we and many others said at the time, it also was going to be a logistical nightmare. And that’s just what happened.

Mike: Right. AT&T;’s transformation hasn’t moved fast enough to make up for the erosion in its core long-distance business. So now AT&T; is planning to split itself apart again.

What AT&T;’s case points up is that if you own an established company whose core business is declining you’ve got to question whether the company’s strategy for growth elsewhere is viable--and how quick the payoff will arrive.

Frankly, one of the questions that AT&T;’s breakup plan raises is how committed management now is to its new strategy.

Jim: Another telecom turkey, Global Crossing [GX], provided a related lesson--one about the dangers of over-reaching in your corporate strategy.

Global Crossing has had ambitious plans to provide telecom transmission lines both above ground and under the oceans. But then it went and spent a ridiculous $10 billion to buy--guess what?--a long-distance provider called Frontier. Need I say more, after what we just said about AT&T; and its ilk? That’s one big reason Global Crossing’s stock has lost 70% of its value this year.

Mike: I should note that telecom is still a great business for the future. And I’m not sure that some of these turkeys in telecom won’t one day sprout the wings of an eagle.

Jim: Do what?

Mike: Never mind. Let’s wrap up with what I consider to be one of the truly succulent turkeys not only of 2000, but going back quite a few years. I’m talking about Warnaco Group [WAC] and I’m taking the name of its chief executive, one Linda Wachner, in vain.

Jim: This is the big apparel company.

Mike: Now, for much of Wachner’s reign as CEO, Warnaco has put out some pretty horrible numbers. In the last year the stock has lost about 78% of its value. The company’s average return on equity over the last five years is a meager 4.8% and in the last 12 months it’s a negative 25.4%, compared with an average five-year ROE in the apparel industry of 18.5% and in the last year 17%-plus.

But there’s reason to admire Wachner, because she has added something to business management that’s really worth noting: She has come up with an absolutely fool-proof method of job security.

Jim: And what’s that?

Mike: According to our friend Graef Crystal, who’s an expert in executive compensation and a columnist for Bloomberg News, Warnaco apparently may not have enough cash in the bank to pay Wachner a severance package if it wanted to fire her. Can you believe this?

Jim: What’s the lesson for investors?

Mike: That if you see a company operating this poorly while the CEO is hauling down a very healthy paycheck, run for the hills. Sure enough, while Wachner has been raking in millions of dollars in compensation, Warnaco’s stock--which peaked at $44.38 a share in July 1998 . . .

Jim: . . . now trades for less than $3.

Mike: Right. Warnaco shareholders should have recognized that performance on Wachner’s watch was terrible and that she was arguably overpaid.

Her very forgiving board of directors should have recognized this, too--which is why I believe they have a lot to answer for.

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Write or e-mail with a stock you would like to see discussed in this column. Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment.Either can also be reached at Business Section, 202 W. 1st St., Los Angeles, CA 90012.

You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).