After Settling with Macy's Over J.C. Penney Deal, Martha Stewart Still Looks Bad

Talk about starting the year out right! A few weeks ago, Martha Stewart Living Omnimedia (NYSE: MSO  ) and Macy's (NYSE: M  ) announced that they had reached a legal settlement involving a lawsuit for alleged breach of contract. In the suit, Macy's claimed that Martha Stewart breached the terms of its contract with the company when it agreed to a partnership involving rival retailer J.C. Penney Company (NYSE: JCP  ) . As a result of the announcement, shares of Martha Stewart rose as high as 11% before closing more than 8% up and then fell 2.41% on Friday. Is it possible that Mr. Market is overreacting to the news, though?

A look back at the controversy
In an effort to rejuvenate each other's businesses, J.C. Penney contacted Martha Stewart and pitched the store-within-a-store concept to the company's management. Enticed by the idea, which would fetch the company at least $200 million in sales over a period of 10 years and could be worth up to $500 million, Martha Stewart jumped at the deal. It even gave an equity stake to J.C. Penney.

In 2011, Martha Stewart announced that it signed an agreement with J.C. Penney to develop a store-within-a-store format inside of J.C. Penney outlets. As part of the deal, Martha Stewart would design a range of products and sell those within the retailer's locations. This relationship would have served to benefit both companies, each of which has been struggling over the past few years.

J.C. Penney, under the leadership of Ron Johnson, saw its revenue fall by 24.8% from $17.3 billion in 2012 to $13 billion in 2013. Meanwhile, the company's net loss soared from $152 million to $985 million, largely due to the falloff in revenue. The company's results were primarily attributable to Johnson's decision to cut out coupons from the company's strategy and to offer everyday low prices. The move left consumers feeling disenfranchised and led to a massive exodus of sales.

Martha Stewart's situation hasn't been much better. The home décor company has only earned a profit in one of the past ten years. On top of that, it has seen its sales fall 30.5% from $284.3 million in 2008 to $197.6 million by 2012. Year-to-date, the company's situation has continued to deteriorate, with sales dropping 22.3% in the third quarter compared to the same period a year earlier.

Every party has a buzzkill
After the announcement of Martha Stewart's strategic partnership with J.C. Penney, Macy's filed suit alleging that Martha Stewart's agreement to sell products to its rival would infringe on its exclusive contract with the firm. Furthermore, the company filed a lawsuit against J.C. Penney in which it claimed that the company was intentionally trying to interfere with its business relationship.

During trials, both Martha Stewart and J.C. Penney claimed that their agreement should not classify as a breach of Martha Stewart's earlier contract with Macy's because the products it would sell are different and many of them would be sold under the Everyday brand instead of the Martha Stewart Collection that Macy's has the exclusive rights to. To help to settle the case, Martha Stewart and J.C. Penney significantly reduced their exposure to one another and the ownership J.C. Penney received in Martha Stewart was given back to the company. Despite this and the undisclosed settlement made between Martha Stewart and Macy's, the latter company is still pressing charges against J.C. Penney.

Does the settlement mean a brighter future for Martha Stewart?
In light of the company's settlement with Macy's, the market's reaction that pushed share prices up implies that the future is bright for Martha Stewart. However, this isn't necessarily the case. While Macy's is one of the company's largest customers (which makes revenue in excess of $250 million each year from Martha Stewart's products), the settlement likely won't involve added revenue for Martha Stewart. In juxtaposition, it will likely make it harder for Martha Stewart to enter into contracts like it did with J.C. Penney.

Add to this the fact that sales have been falling in two of the company's three segments and you arrive at the unsettling conclusion that the business is more likely on its way out than on its way toward prosperity. Between 2010 and 2012, sales fell in the company's Publishing segment as well as in its Broadcasting segment. The largest decline occurred between 2011 and 2012 as revenue in the company's Broadcasting segment decline by 45.2%. This was due primarily to the expiration of the company's contract with the Hallmark Channel in 2012, as well as to a smaller presence through Sirius XM Radio.

The only segment to see an increase over this time frame has been its Merchandise segment. From 2010 through 2011, sales in this segment rose by 13.6%, followed by another 18.4% jump between 2011 and 2012. However, a good portion of this increase was likely due to the company's agreement with J.C. Penney, so it shouldn't surprise investors if this segment's sales fall to some extent in the future.

Foolish takeaway
Now that Martha Stewart's legal battle has fizzled out with Macy's, investors can take a moment to breathe. Based on the legal actions that took place, both Martha Stewart and Macy's claimed that the result will have no material impact on their financials. While this news is positive for the company and its shareholders, the long-term trend that the company has seen still appears to be an issue. As long as annual losses continue and as long as sales fall, shareholders should remain, at best, cautiously optimistic about the company's future.

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