Martha Stewart Can't Seem to Figure It Out

Do you remember when Martha Stewart went to jail for obstruction of justice? It was late 2004 to early 2005, less than half a year behind bars. In that brief time, the company's stock rose 93% and hit highs above $36 per share. Yesterday, Martha Stewart Living Omnimedia  (NYSE: MSO  ) stock fell 5% by midday to about $2.90 on news that the company's fourth quarter failed to live up to expectations. Revenue was down, with merchandise revenue being the only bright light on the income statement. But even that was clouded by the thought of what's yet to come -- the company spent $800,000 on legal fees in its fight against Macy's  (NYSE: M  ) .

At stake is whether Martha Stewart broke its contract with Macy's by agreeing to open stores-within-stores at J.C. Penney (NYSE: JCP  ) . Stewart contends that Macy's broke the contract first, and that the company's recent contract with J.C. Penney isn't a breach. With all that swirling around, investors are left wondering what the plan is -- if there even is a plan.

The failure of Omnimedia
Martha Stewart founded the business in 1997 to cover merchandise and media tied to her personal brand. But the company has failed to keep up with the changing times, and the broadcasting and publishing business is slowly sinking. Last quarter, publishing revenue fell 9% while operating income dropped from $886,000 last year to a loss of $2.3 million this year. The company blamed lower advertising revenue and declining circulation. Digital results were down 4% to top it off.

Broadcasting fared even worse on the revenue side, plummeting 51% due to the absence of The Martha Stewart Show. But the fall in revenue wasn't reflected in operating income, where the business increased from a $1.1 million loss last year to a $2.9 million gain this year. However, $1.2 million of that was from residual payments associated with overseas rights.

Although publishing and broadcasting were weak, merchandise had a fairly successful quarter. Revenue grew 24% and operating income was up 29%. On the earnings call, management highlighted contributions from Home Depot and Macy's. The company also said that while it was happy with the partnership with Home Depot, that retail outlet was presenting the biggest non-legal challenge. Sales of paint and patio styles were soft last quarter, and the company expects that to continue through the first quarter. 

The future of Martha Stewart
As with all companies that report an underwhelming result, Martha Stewart's call focused on the great things just over the horizon instead of dwelling on the past. The company is making a very cost-focused shift in its operations, and is closing down parts of the business that just aren't working. One of the biggest moves recently was to shut down the daily Martha Stewart show in the middle of 2012. Combined with cost savings in the publishing division, the company is predicting an overall cost savings of $45 million over the next year.

A big chunk of that is going to be dropped right into digital programming, which falls under the company's publishing division. In 2012, Martha Stewart made $21 million in digital advertising revenue, and it sounds like that's going to be the focus in the future. The company is creating and distributing more digital shorts, and over December it produced a holiday entertaining Web series that pulled in millions of viewers.

The bottom line
Investors have a lot to watch at Martha Stewart this coming year. Moving to digital media should cut costs and give the company added relevance with a younger audience, but it's no guarantee. The strength that the company boasted about in its merchandising division could take a serious hit if the Macy's lawsuit falls the wrong way. Given the possible outcomes, I'm very concerned about how this is going to affect the bottom line.

Along with the lawsuit, one of the biggest things that investors need to keep an eye on is the cash that Martha Stewart sinks into JCPenney stores. Right now, the company seems to be planning to spend the setup costs before the court cases are finalized. That means that if Macy's wins, Stewart could be looking at completely sunk costs. With so much hinging on the outcome of this litigation, I can't imagine putting a sizable investment into Martha Stewart right now.

Figuring out JCP
J.C. Penney has been a train wreck whose comeback always seems just around the next earnings corner, but people are beginning to doubt if CEO Ron Johnson can weave the same magic that he did at Apple. Investors wondering whether J.C. Penney is a buy today are invited to claim a copy of The Motley Fool's must-read report on the company. Learn everything you need to know about JCP's turnaround -- or lack thereof -- and as a bonus, you'll receive a full year of expert guidance and updates as key news develops. Simply click here now for instant access.


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