Truth or consequences.

Everything you need to know about investor relations, yes, you learned in kindergarten

Three companies: one struggling after a bad quarter, one redefining itself and rebuilding confidence after an accounting misstep, and one dot-com trying to get on the map. But when they talk to investors, in essence they tell the same tale.

always tell the truth. Remember the story of the little boy who cried, Wolf? He fibbed first and then nobody believed him when at last he was telling the truth.

That's all you really need to know about investor relations. You probably learned it in kindergarten. If you weren't paying attention then, securities analysts are happy to help you review now the lesson they think you missed. "If you broke the glass, you're better off owning up to it right away," Michelle G. Applebaum, managing director at Salomon Smith Barney, said at Financial Executive Institute's financial-reporting conference last November.

Applebaum and other analysts on a panel discussing investor relations complained that companies often seem to hide unpleasant facts for as long as possible, then casually mention them months after they've ceased to be relevant - and often merely as a parenthetical aside in a conversation about something more upbeat.

"Some companies say, 'We had XYZ happen last year,"' said panelist James N. Mordy, senior vice president at Wellington Management Company. "But we never heard about it last year, when it happened!" Moms and teachers would understand. Analysts don't.

Analysts would have you believe the market rewards honesty and punishes duplicity. Sounds reasonable. But is it true? Cynics need only point to Tyco International, whose stock tumbled 23 percent in a single day last December on news that the SEC was questioning its accounting. The SEC's "informal inquiry" reportedly focused on how the company accounted for acquisitions. A company spokesman told The Wall Street Journal the firm was under no obligation to disclose the inquiry, but did so to "protect the interests of investors." The stock's hammering may have left some investors hoping Tyco will be less protective in the future. Who could blame them?

And consider the experience of AES, a successful independent power producer based in Arlington, Va. Unusual for a power company, AES also happens to be a darling of the social investment crowd, so committed to value-based management that it once spent an entire year's worth of earnings to plant trees in the rainforest to offset pollution from a power plant.

In 1992, about a year after the company had gone public, management discovered that a group of technicians in an Oklahoma plant had been fudging data a little to make it look as if the company were doing a better job with pollution control than it was, in fact, doing. The fib was discovered accidentally and, true to its values, AES immediately reported itself to the Environmental Protection Agency. As soon as AES cofounders Roger Sant and Dennis Bakke learned of the problem, they drafted a press release that minced no words: "A portion of the AES people working in the water treatment facility at Shady Point doctored a number of water discharge samples," they wrote. "We cannot comprehend why anyone would trade our integrity to make our environmental performance look better."

The EPA seemed flabbergasted that a company had informed on itself - most wait to be caught, then hire lawyers to deny wrongdoing - and fined AES only $125,000. No big deal as far as the government was concerned.

But investors weren't nearly as forgiving. The reward for honesty? In one day, AES stock fell from $26.50 to $16.50, wiping out $400 million in AES market value.

Eventually, AES stock recovered, and the company wound up on the recommended buy list of almost every major brokerage firm. But that didn't happen overnight; it took many months. Bakke, who had co-founded the company and was the clear heir apparent for the CEO's job, saw that promotion put on hold and his future with the firm in question.

On the face of it, both the AES and Tyco stories make a compelling case for keeping quiet about bad news. But John Silver, a consultant with the New York-based investor relations advisory firm Broadgate, suggests that's the wrong conclusion to draw. "Companies should always tell the truth and communicate consistently through all the cycles," he says. "Go ugly early. Break bad news yourself. Unexpected bad news gives you an opportunity to cement your credibility with investors. Do it even if there's a risk."

Silver counsels executives to look on the bright side of the punishing stock falls that often seem to follow honest disclosures of bad news. "The spontaneous combustion of market value just bums out the opportunistic short-term investors the company is better off without," he says. "The only shareholders worth keeping are those who stick with the company through thick and thin, rewarding honesty with loyalty."

There may be something to that, however Pollyanna-ish it sounds. The investor spectrum stretches from Warren Buffett to the day traders, and it's increasingly clear that some of these shareholders are more desirable than others. That's why the financial executives profiled here market their stock in much the same way as they market their products. They try to identify prospective shareholders whose objectives and time horizon are compatible with the company's business, and turn them into long-term investors. But they say sometimes the hard part isn't telling the truth - it's getting the right people to listen.

BETHLEHEM STEEL 

"Hello, Did You Check Those Assumptions?"

Counting investor relations constituencies, Lonnie inert sounds like a bird-watcher ticking off sightings. "You have your sell-side analysts, your institutional investors, the indexers, the people who rotate in and out of cyclicals. In fact, a large mutual fund just became our largest stockholder within the last two or three months because it rotated into cyclicals, and saw our industry on the verge of recovering," says the vice president and controller of Bethlehem Steel. "We have another very large owner - he's not a banker, not a mutual fund, not an indexer -- who just looked at our stock and thought it was time to get into it. About 65 percent to 70 percent of our ownership is institutional, ranging from classic value to growth to index funds. A smaller percentage is retail, and lastly there are the employee owners."

Bethlehem Steel uses an outside investor information service to monitor both its own shareholders and those of its competitors.

"We may identify potential investors by looking at who may own other steel companies but not Bethlehem," says Blaise Derrico, Bethlehem's general manager of financial planning, investor relations and credit. When they identify such prospects, Bethlehem's investor relations people move to set up meetings, invite them aboard for conference calls, send them regular earnings statements and updates, and generally treat the prospects as if they were already shareholders. "The objective is to make sure that people who have a lot of investment choices get our story and understand our company," Derrico explains.

But investor relations is about more than marketing the stock. Institutional investors don't work in a vacuum. They talk to each other and, more important, to the press. "If The Wall Street Journal wants to write a story on the steel industry, they'll call one of the analysts to get a quote," Arnett says. Customers and suppliers looking for information about Bethlehem are also likely to read analysts' reports. Because the words heard on Wall Street eventually get repeated on Main Street, good investor relations can have an impact on more than the stock price.

Bethlehem's rules of investor relations are simple and clear. "The most important thing is to maintain credibility. Once you say you're going to do something, make sure you deliver," says Arnett. Bethlehem isn't shy about phoning analysts whose expectations for the company look too rosy, to ask about their assumptions and acquaint them with costs or other threats they may have overlooked. Ditto analysts whose prognostications are overly grim.

In fact, analysts' estimates of shortterm performance are generally pretty close to each other, but longerterm predictions can be all over the map. Bethlehem tries to make sure the longer-term estimates don't diverge too widely by making the same information available to all investors as close to simultaneously as possible. Though there's a limit to the number of people (typically 75 to 100) who can participate in quarterly conference calls, Bethlehem was one of the first companies to broadcast its calls live over the Internet, where there's no limit to the number of people who can listen. The company prepares a full set of financials every quarter -- including the fourth -- sends them to the frill list of owners, analysts and potential investors and posts them on the company web site.

What's the payoff for all this effort? Take for example the third quarter of 1999. Bethlehem had been generating good earnings and cash flow when it was hit by a one-two punch. Asian producers whose home markets had withered away in the regional economic crisis dumped inventory in the United States. Meanwhile, in the third quarter of 1999, Bethlehem had taken some production facilities offline as part of a strategic investment program. Prices in some product lines fell by as much as 40 percent, and because the company was producing less, fixed costs that might have been capitalized as inventory had to go right into the earnings statement. Bad news for analysts who had been expecting the good times to continue. Bethlehem could have waited until the end of the quarter to break the bad news, but decided to go ugly early.

"We felt we had to keep the world informed about what was happening, but it was changing daily," says Arnett. "Our third quarter was very disappointing. One of our competitors had an extremely difficult earnings release conference call just before ours, so I thought we'd have a very difficult call, too, But ours was mild compared to what it could have been -- because we'd kept them informed all along."

In this case, the payoff for full and frank disclosure was trust and understanding. For an example of another approach, look to the Columbus, Ohio-based Scotts Company.

THE SCOTTS COMPANY

Think Consumer the Scotts Company is the undisputed market leader in an array of lawn care products: fertilizers, pesticides, herbicides and sundry other pillars of suburban weal. Although he company traces its roots back a century and a quarter, in fact many of its businesses were cobbled together through a series of acquisitions of chemical company spin-offs and divestitures. So investors looked at Scotts as a chemical company, and management had a chemical company mindset. Chemical companies sell to other companies, not to consumers. So it's understandable that Scotts' management thought its customers were the companies that bought its products. But they were wrong.

The companies that bought Scotts' products were retailers, and they were just middlemen. Scotts learned this the hard way. Going in to the mid-1990s, Scotts' management decided to boost earnings by pushing more product out the door. They choked the retailers with inventory and booked the shipments as sales. Retailers understandably balked at being used as de facto warehouses to store Scotts' excess production, but Scotts overcame their reluctance by offering special terms and allowances. Shareholders might have balked at this marketing policy, too, if they had known about it. But they didn't know because the company's financial statements were somewhat less than forthright about the situation.

All good things must end. In 1996, the same year the lawn-care company merged with Miracle-Gro, the fertilizer hit the fan at Scotts. Auditors demanded that the company restate its earnings for the prior year, reducing EPS from $1.12 to 99 cents per share "to reflect the understatement of the 1995 accrual of advertising and promotional allowances." The president and CEO was forced to resign, and the chairman was effectively demoted to interim CEO while the company searched for new leadership.

Scotts had kept the market happy with aggressive numbers. But nobody was laughing now. The company was caught in a credibility crisis.

Within a few months, new management was in place. Among its first priorities: Move the investor relations function from the PR department into the finance department, because the CFO at the time wanted financial data to be at the center of Scorts' story.

Rebecca Bruening joined Scotts in September 1997 as vice president and treasurer. "My boss gave me responsibility for investor relations on day one," she recalls. "When I came on board, some investors said, 'Give us the straight story; we're tired of being misled.' The biggest hurdle for me my first year here was to build credibility."

Her job was complicated by the fact that Scotts' new management aimed to redefine the company and market it to investors as a consumer goods rather than a chemical sector play. The new chairman and CEO, Chuck Berger, had been recruited from Heinz, a consumer brand if ever there was one. The company had abandoned its previous strategy of pushing product on retailers by offering special allowances and incentives, and had begun to market directly to consumers through intensive advertising. But Scotts was still in investors' portfolios as a chemical sector holding.

It seemed the only way to get the message across would be to deliver it face to face, over and over again, in as many venues as possible. Says Bruening, "We did many one-on-one IR tours. We got ourselves invited to consumer brand conferences we'd never been part of, at Merrill Lynch, Salomon, etc. We pushed our way in, beat our chests and said, 'We're not a chemical company! Look at us as a consumer company!'"

It was an uphill fight -- and Bruening is still fighting -- to change investors' perceptions. It seems Wall Street keeps moving the goal posts. "At first when new management came in, it was 'Show me management is credible.' After a year, investors agreed management was credible -- but then it was Management is credible, but you have a lot of acquisitions, so let's see if you can deal with that.' We did, and now they say, 'Let's see how you run these businesses.' We have our champions and cheerleaders, but we also see a lot of skepticism. We have to step back each time and prove ourselves all over again," Bruening says. But, she concedes, "We can understand the skepticism, because of our history and some uncertainty about our acquisitions in fiscal 1999."

In recent months, there have been signs of progress that investors are changing the way they perceive Scotts. Bloomberg and First Call now treat the company as a consumer brand rather than a chemical stock, says Scotts' new CFO, Dave Harrison. The next big hurdle will be to increase the stock's liquidity, to bring more institutional investors on board. Harrison explains, "Before institutional investors invest in a company, they want to see liquidity so they'll be able to get out when they want to. You encourage liquidity by getting more people involved in the trading. So we're encouraging more sell-side analyst reports. Our target is to get between eight and 10 major national sell-side analysts covering the company on an ongoing basis. We now have four."

MORTGAGE.COM 

Misunderstood

What toiler in the industrial rust belt hasn't imagined thumbing an easy ride to riches on the I-way? Ed Johnson, senior VP and CFO of Mortgage.com, has done what many merely dream of. But he's found real thorns in the virtual rose garden.

Until January 1999, Mortgage.com had been known as First Mortgage Network. With one eye on a planned IPO, the company changed its name to something more techy-sounding -- and turned itself into a dot-com. It was the third big change of direction for the firm. Founded in 1994 as First Mortgage Network, the company initially had gone into the business of helping mortgage brokers originate their own mortgage loans. Plenty of mortgage brokers signed up, because the technology was free. But they didn't use it -- and the company only got paid if they did. "So we changed our strategy," Johnson says. Instead of targeting mortgage brokers, the company decided to help realtors and homebuilders enter the mortgage origination business. Then the Internet came along.

First Mortgage Network acquired a company that had begun to use the Internet to originate mortgages directly for consumers. It was a good but not a great business. In its third major strategic change, the company decided to make businesses rather than consumers its primary focus. "Eighty percent of our revenue now comes from the business-to-business channel," Johnson says.

Doing consumer business on the Internet is tough slogging. Consumer sites have to develop their brand names through advertising, and in 1999 Wall Street began to recognize how costly that would be. "On the business-to-business side," Johnson says, "we operate under someone else's brand name, sometimes as a private-label kind of arrangement where our own name isn't even mentioned."

That turned out to be a significant advantage when freshly renamed Mortgage.com launched its IPO in August 1999. Its timing could hardly have been worse. "The first two weeks of August, the market took a nasty downward turn, especially nasty for Internet companies," Johnson recalls. "Fifteen Internet firms wanted to price deals the same day we did. Only two got out. The reason we were successful in getting the company public is that our story was business-to-business. We gave 66 presentations on our roadshow. Quite a few investors commented that their interest was in the business-to-business and not in the direct-to-consumer channel. They said they didn't believe people in our industry would be successful if they had to spend millions to brand their product."

In its presentations, Mortgage.com made sure to mention its big business-to-business customers - including names like GMAC, Fleet and First Union. Skeptical prospective investors and analysts hit the company over and over again with a suggestion that it concentrate on one channel or the other - either business-to-business or consumer business. "We answered that we didn't believe we had to pick, because our direct-to-consumer business was a proof of concept to our business customers. When they asked whether our technology worked, we could show them how we did things for ourselves, and how we could use the same platform to provide services for them," Johnson recalls.

They made a strong case - but not quite strong enough. Mortgage.com had planned to go public at $10 to $12 per share. But because of the early-August shakeout, the company was faced with the fact that it could get only $8 at best. "The board decided it would be better for us to take it and become a public company when we had the opportunity," Johnson notes.

Day traders and other momentum players took the stock as high as $22 per share in the weeks following the IPO, but it soon settled back into the $8 to $12 range, where it has traded ever since.

Vexingly, though, Mortgage.com's stock trades as if it were joined at the hip with the stock of a major consumer-oriented Internet mortgage originator that went public several months before - at a substantially better price.

Johnson scratches his head over that one. "There must be a lot of retail investors who think the consumer model is the way to go," he guesses. "It's a huge source of frustration that consumers trading stock online have become a more important factor in pricing stocks, but there isn't a good mechanism to communicate to those investors. You can have one-on-one meetings with institutional investors. When we announced our first numbers since the IPO, we had a conference call with analysts that we replayed through the Internet for consumers. But we're still a complicated story for retail investors who are probably trading online for $8 or $12 commissions, don't have the analyst's report and don't necessarily have the expertise to analyze the company as an analyst would. Something happens in the news that has nothing to do with your company, but retail investors may think it does, so you get downward pressure or a false pop up in your stock, It's definitely a problem."

Johnson hopes to combat misunderstanding by simplifying the company's message and relying on repetition to drive the point home, eventually.

In the meantime, Mortgage.com will have to live with volatility, and get used to trading in lockstep with companies whose business models and economics are totally unrelated to its own.

Who said the market was fair?

Greg Millman is a freelance business writer based in New Jersey.