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Making Bad News Pay


David W. Tice has a reputation for analyzing anything that comes his way. Just ask 15-year-old daughter Abby. When she was five, her father helped her set up a lemonade business. "Dad would sit and analyze the best time of the day and what the best location for the lemonade stands would be," she says. Abby set up her lemonade concession on Saturdays along the bike trails winding through Dallas. Little wonder that she ended up making more pennies than most other kids in her neighborhood.

The analysis Tice gets paid for earns him far less adoration than he got for his lemonade advice. Tice is a professional stock-market bear. He writes scathing research reports, which he sells to institutional investors, detailing why the stocks of some companies could be headed for a fall. He also runs a mutual fund called the Prudent Bear that sells stocks short. While the typical investor wants to buy low and sell high, short-sellers do the opposite, borrowing stock and selling it at a high price and then buying it back cheap after the price falls. Because he bets that a stock's price will tank, Tice benefits from the misery of others. "Whenever we make money, lots of others lose money," he says.

Being a bear is paying off these days. Over the past year, the Prudent Bear Fund has racked up a return of 35% while the Standard & Poor's 500-stock index has tumbled 19%. That puts Tice among the top 1% of all fund managers over the last 12 months. His fund is up 3% in 2001, while the S&P is down 10%. Lately, his gains have been tempered because brief market rallies have forced him to cover short positions and take losses in stocks, such as telecom equipment maker Juniper Networks.

His research is getting more popular, too. His client list has increased 40% in the last three years, to 200 people. While his "Behind the Numbers" service is still much smaller than most investment newsletters, he charges $15,000 a year, about 15 times the price of a high-end newsletter. He takes pride in being a reality check on Wall Street analysts, who are coming under fire for producing overly positive research to boost their investment-banking business. "I feel particularly responsible about warning people that there's a cliff down below, and Wall Street will never say that," he says.

Gobbledygook. Despite the stock market's decline over the past 18 months, he thinks there's still a cliff ahead. About 75% of his investments are short bets, he says. Among favorite targets these days are top tech players, including Amazon.com (AMZN), Yahoo! (YHOO), Dell Computer (DELL), and eBay (EBAY). He thinks some, including Dell and eBay, are good companies that are simply overvalued. For example, he says analysts have been egging on investors to buy Dell stock at a lofty 35 times their estimate of 2003 earnings. He calls the estimates "gobbledygook" because a price war among PC sellers will hurt profits. By contrast, he thinks Yahoo still needs to prove it has a legitimate business beyond being an Internet portal dependent on online advertising. Many continue to consider Yahoo a strong growth company, but Tice calls its operating performance "horrific," with 2001 revenues likely to be 35% below last year's. "If it's a growth company, how come it's more cyclical than General Motors?" he questions. Yahoo didn't return calls seeking comment.

Tice finds his targets by playing the role of a sleuth, going over balance sheets, income statements, and cash-flow statements with a fine-toothed comb. He looks for misleading numbers or bogus information that, once uncovered, will cause a stock to tumble. His analysis is almost always the opposite of Wall Street's. For example, Tice warned his clients in 1996 that special charges at then-soaring Sunbeam Corp. (SOCNQ) were concealing underlying problems at the business. In 1998, the company restated its financial results and CEO Albert J. Dunlap resigned his post. Sunbeam declined to comment.

But critics argue that Tice sometimes overreaches. In October, 1999, Tice wrote a report that questioned conglomerate Tyco International Ltd.'s accounting practices, particularly its frequent use of one-time charges related to acquisitions. That led to a 23% drop in the company's stock in one week. In a conference call, Tyco CEO L. Dennis Kozlowski blasted Tice's research as "false and misleading" and vowed "there are no restatements coming from Tyco." In December, the Securities & Exchange Commission's Division of Enforcement opened an inquiry into Tyco's acquisition-related charges. In June, 2000, Tyco (TYC) said that the SEC's Corporation Finance division had requested, following review of a Tyco securities registration, that the company make several changes to its financial statements. The changes were essentially a wash, reducing diluted earnings per common share, after non-recurring charges and credits, by two cents in the first quarter of fiscal 2000, and increasing the same earnings per share number by two cents in fiscal 1999. Tyco's stock surged 13% the day of the announcement. In July, 2000, Tyco said the SEC's Enforcement Division had ended its inquiry without taking any action.

Both sides have claimed victory. Tice, who says he doesn't short stocks before he issues new research and was not shorting Tyco's stock when he made the report, says he feels vindicated because the SEC asked Tyco to restate financials. Maryanne Kane, a Tyco spokeswoman, says the restatements were "a completely separate matter" from Tice's allegations, which have "proven to be unfounded." The SEC declined comment. Tyco's stock was 1% above its level the day before Tice issued his report, while the S&P 500 has dropped 9% over the 22-month period. That performance helped Tyco rank No. 1 this year on BusinessWeek's BW 50 ranking of top-performing companies.

No question, the late 1990s were rough years for Tice. As the bull market galloped ever higher, Prudent Bear was hit with negative returns of 34% and 23% in 1998 and 1999. Tice, like many others, kept guessing that stocks were overvalued only to see them rise higher. Many shorts closed shop, reducing the field from 25 managers in 1990 to six at the end of the decade, according to Harry Strunk, a Palm Beach (Fla.) investment consultant who tracks short-only managers.

Sanity Check. Whether Tice is right or wrong about a stock going down, clients value his insights. Monica Graham, a partner at the New York hedge fund Graham Partners, thinks Tice is one of the most talented analysts she has ever worked with. "For me, he is a sanity check at a time when it's easy to be swept away by all the euphoria," she says. Bob Holmes, who runs hedge fund Gilford Partners in Chicago, values Tice's deep analysis of financial statements. "David sees the company's fundamentals deteriorating, but the stock continues to ramp up as it takes time for the rest of the world to discover it," he says.

Consider his research into Amazon.com. Tice wrote his first negative report on the company in October, 1998, arguing that its business was flawed because it hadn't shown the ability to translate rising sales into profits. The stock continued to soar in 1999. Finally, last year, Tice made money shorting Amazon as its stock fell 80%.

He's still not convinced of Amazon's business. He blasts the pro forma earnings reported by the e-tailer as "nonsense" that suits the company more than investors. While the company also reports financial results under standard accounting rules, it highlights pro forma earnings that exclude many expenses. Tice also points out that Amazon's growth in its core business of books, music, and videos has slowed to a crawl, and it now emphasizes its faster-growing consumer electronics business. He calls it a classic case of "Don't look over here, look over here." He also says that CEO Jeff Bezos has sold 1.1 million shares in the last three months. Amazon spokesman Bill Curry says that Bezos has sold only 2% of his holdings to diversify his portfolio and still owns 32% of the company. He added that pro forma earnings are widely accepted.

One short position that Tice has regularly lost money on is America Online, now AOL Time Warner (AOL). In 1994, Tice released a report questioning the validity of the business, especially in the face of increased competition. "I miscalculated the power of the brand and the customer's loyalty," says Tice, who has an AOL account himself. That doesn't mean he has quit: Tice still believes that AOL is overvalued. One reason is that Internet use may be slowing. As evidence, he cites a study by researcher Telecommunications Reports International Inc. that shows U.S. households with Net access dipped for the first time ever by 0.3%, to 68.5 million in the first quarter. Another reason is AOL's accounting. The company reported that free cash flow, which usually comes from operations, was $651 in this year's first quarter. Tice figures it was only $70 million after the cash settlement of a lawsuit related to the sale of Six Flags Theme Parks Inc. (PKS) and several other one-time charges. AOL spokesman Ed Adler says that its operations did generate $651 million and argues that, under standard accounting rules, special charges such as the settlement do not need to be counted as expenses in the quarter in which they occur.

While investors often rip Tice apart on online bulletin boards, he says they're barking up the wrong tree: "We protect investors with our analysis. The bad guys are the brokers that were promoting the outrageous valuations of those companies," he argues. Tice recently went to Washington to make his point. On June 14, he testified before a Congressional committee chaired by Representative Richard Baker (R-La.) that is looking into the erosion in the so-called Chinese wall that has traditionally shielded analysts from investment-banking interests. Tice testified he believes the conflict of interest between analysts and investment bankers encouraged stock market speculation and pushed capital toward the tech sector at the expense of other industries.

Tice attributes his skepticism to his Missouri upbringing. "It's a show-me state where we aspire to be as fiercely independent as Harry Truman," says Tice who, like Truman, was raised in Independence. These could just be the days for Give 'Em Hell David Tice. By Pallavi Gogoi


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