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The Honolulu Advertiser
Posted on: Sunday, February 3, 2002

Fear of cooked books may make investors pull back

By Peter Robison
Bloomberg News Service

NEW YORK — Investors are fleeing from companies that have any hint of flawed accounting after Enron Corp.'s collapse.

Employees continued to come and go from Enron's Houston headquarters last week. The company filed the largest bankruptcy in history on Dec. 2 and laid off thousands of workers who lost 401(k) savings loaded with Enron stock, which lost almost all its value.

Associated Press

"You can't trust the numbers" of many companies, said Louis Navellier, manager of $5 billion in investments at Navellier & Associates Inc. "It's going to hurt the market's credibility."

Investor confidence in financial reporting was rattled by the failure of energy trader Enron, the biggest bankruptcy ever, amid disclosures it used secret partnerships to conceal debt and boost profit.

"There's a serious problem out there," said Harvey Goldschmid, former general counsel of the Securities and Exchange Commission. "The SEC ought to be rigorous in trying to make our numbers, which are the best in the world, even better."

David Yucius, president of Aurora Investment Counsel in Atlanta, said he has shunned Tyco, General Electric and Cisco Systems Inc. because their accounting might mask slowing sales growth. Cisco relies on a so-called pro-forma profit measure that excludes some costs, while General Electric uses excess pension income and one-time gains from its financing unit to lift earnings, he said.

"I kind of grade companies based on how many of the levers they're using," Yucius said. "Cisco is using all the levers. GE is using a lot of the levers. And you have to watch acquisitive companies like Tyco."

Tyco, General Electric and Cisco all said that they don't use accounting to manipulate earnings.

Recent history is one reason investors are so nervous. Enron's collapse erased $26 billion in market value in seven weeks, the culmination of a string of accounting mistakes by U.S. companies, from Sunbeam Corp. to Waste Management Inc.

The number of public companies restating results rose to 156 in 2000 from 33 in 1990, according to Financial Executives International, a trade group of 15,000 executives based in Morristown, N.J. Between 1998 and 2000, investors lost $73 billion in market value because of stock plunges after restatements, compared with $9 billion from 1990 to 1997.

Many of the battered companies are those with complex balance sheets that have made several large acquisitions, such as AOL Time Warner, which has dropped 10 percent in two days.

Investors said companies haven't helped their cases by popularizing pro forma profit measures, which depart from generally accepted accounting principles, or GAAP. The companies often pick and choose what to highlight, excluding costs such as inventory writedowns or investment losses.

Thomson Financial/First Call research chief Chuck Hill calls many of the measures that companies use to report earnings "junk."

"This has gotten out of hand," said Hill, whose firm tracks analysts' earnings estimates.

AT&T Corp., for example, on July 23 issued a news release saying second-quarter earnings were 4 cents a share excluding certain items, while never providing a corresponding dollar amount. In the table attached to the release, AT&T showed a loss of $191 million, or 5 cents, from continuing operations.

Three weeks later, the biggest U.S. long-distance telephone company filed its quarterly SEC report. The loss based on GAAP: $2.27 billion.

AT&T spokeswoman Eileen Connolly said the loss included Liberty Media, a cable-television company run by John Malone that AT&T spun off Aug. 10. It wasn't mentioned in the release because AT&T had "no economic interest" in Malone's company, she said.

Ed Paik, an analyst with Liberty Funds Group, which owns 7 million AT&T shares, said he's still confused by AT&T's reports. "There's nothing fraudulent, but it's very difficult to determine what they have and where they're going," he said.

Investors are starting to press regulators to rein in the most misleading accounting and reporting practices. They want companies to use more uniform standards and to file earnings under traditional accounting methods more quickly.

Navellier, the Nevada fund manager, said he's given up on most big companies.

"What you find is that they've actually manufactured some earnings through acquisitions," he said, citing Compaq Computer Corp.'s 1998 purchase of Digital Equipment Corp. as an example.

Shortly after the purchase, the combined company had a $3.6 billion second-quarter loss on a writedown of acquired technology and other costs. By the fourth quarter, it rebounded to a record profit of $758 million, helped by tax credits after the purchase. Compaq's shares more than doubled to $49 by January 1999.

Within months, Compaq ousted chief executive Eckhard Pfeiffer as profit lagged and the company sank to a $184 million loss in the second quarter of 1999.

Compaq's shares now trade at about $11. That history is one reason some investors oppose Hewlett-Packard Co. chief executive Carly Fiorina's plan to buy Compaq, Navellier said.

Navellier says he has one question for Fiorina: "Are you doing this for accounting tricks?"