Originally created 02/28/05

Big investors go for scandal-plagued stocks

NEW YORK - So much for being scared off by all those risks that can be associated with buying scandal-ridden stocks. That doesn't seem to bother some big investors who see great deals in those kind of holdings.

Goldman Sachs Group Inc., Citigroup Inc. and some other large Wall Street players have disclosed in recent weeks that they have taken substantial stakes in companies that have been plagued by trouble. Their buy lists include Martha Stewart Living Omnimedia Inc. and Fannie Mae.

Those are the kind of bets that could eventually pay off handsomely - or leave them with not much to show.

Unlike most average investors, large financial institutions can afford to take such a gamble because they have a range of diversified holdings. So if one bet goes wrong, they have other interests to offset those losses.

Still, it's interesting to watch where big players are going, especially when they take a stake of significant size. That can signal their thoughts on a company's prospects.

Consider the kind of returns realized by those who invested in Tyco International Inc. at its worst of times.

Beginning in the middle of 2002, Tyco shareholders started bailing out after its top executives were accused of stealing millions of dollars from the industrial conglomerate that makes everything from security systems to medical devices.

The stock lost almost three quarters of its value in the summer of 2002, plunging to a low of $8.25 a share when the allegations mounted against former CEO L. Dennis Kozlowski and CFO Mark Swartz. For months after that, the stock struggled.

But Tyco turned a corner in the spring of 2003, and hasn't lost ground since. Shares now trade about $33 apiece - a nice windfall for anyone who was willing to risk buying the stock during those turbulent times. Among those buying back then: Legg Mason Inc. and T. Rowe Price Associates Inc.

Yet every investment doesn't turn out like Tyco. Look what happened to Adelphia Communications Corp. after the cable television provider's former executives were accused of stealing from the corporate coffers and cheating investors out of billions of dollars. The company filed for bankruptcy court protection and its stock now trades on the over-the-counter market for pennies.

An outcome like that, though, hasn't stopped some investors from taking more chances with troubled stocks. Their view: Bad news could mean bargain prices.

Look at the money that has been going into Fannie Mae, the mortgage giant that has come under investigation for improper accounting. Its stock is off sharply from its 52-week high above $80 a share.

Citigroup Inc., the world's largest financial institution, recently disclosed that it boosted its ownership of Fannie Mae stock by 11 million shares to bring its total holdings to more than 61 million, a 6.3 percent stake, at the end of last year. At the same time, Capital Research, one of the nation's largest money managers, has boosted its stake in Fannie Mae to 11.1 percent at year's end from 6.9 percent the year before.

Both companies, though, might not be making much money on their recent investments into Fannie Mae given the downward slide in the stock in recent months. Since the beginning of this year, the company's stock has slumped from about $72 to $57 a share - its lowest point since 2000.

Also getting lots of attention in recent weeks is Goldman Sachs' investment in Martha Stewart Living Omnimedia. The investment firm held nearly 1.49 million shares as of Dec. 31, or about 7.1 percent of the shares outstanding, making it the company's largest institutional shareholder.

That surely has helped boost Omnimedia's stock price, which has climbed from a closing low of $5.26 a share in October 2002 - when allegations mounted against Martha Stewart regarding her sale of ImClone Systems Inc. shares - to now trade around $36 a piece.

Much of that rise has happened in recent months after Stewart, who was convicted a year ago of lying to investigators about that stock sale, announced plans to start her five-month prison term early rather than waiting for the completion of her appeal. She is expected to be released from prison March 6.

Goldman Sachs is clearly counting on more good times to come, but given the run-up in the stock as of late, not everyone is convinced those gains have staying power.

"While the company has passed an important inflection point (of uncertainty and negative publicity surrounding Ms. Stewart's legal situation), we believe that recent price strength has been overdone," said Bear Stearns analyst Michael Meltz in a recent note to clients.

Meltz points out that the current share price seems to be "embedding a level of earnings power that we had trouble comprehending." The company lost $1.20 a share in 2004, and analysts surveyed by Thomson Financial expect it to lose 31 cents a share this year. That's far from the gain of 53 cents a share in 2001 - yet the stock today is trading at an even higher level than it was back then.

And even after the company warned Wednesday that its first-quarter losses would be wider than expected, investors weren't rattled.

Maybe those who are plunging money into these troubled companies understand that it could take a long while for their investments to pay off. That is, if they ever do.


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