Legg analyst accuses Rouse of a misleading 3Q report

Fick says `record' results were achieved only with improper accounting

$25 million in expenses at issue

October 30, 2002|By Meredith Cohn | Meredith Cohn,SUN STAFF

A financial analyst accused Rouse Co. yesterday of improperly accounting for $25 million in expenses, a move that allowed the shopping mall giant to report record quarterly earnings to the public.

David Fick, an analyst at Legg Mason Wood Walker Inc., said investors were being misled by the company and recommended they sell the stock.

Rouse executives said the company did nothing wrong but acknowledged that they did not follow industry guidelines by excluding such expenses as bonuses and retirement costs from funds from operations, a benchmark of performance used by most real estate investment trusts.

"We felt what we were doing was providing the best measure of recurring income," said David Tripp, a Rouse vice president and director of investor relations. "We were upfront in how we were calculating our results. We don't think it would have given you a very good big picture to have added those charges."

The sell order did not appear to affect Rouse stock, which closed yesterday at $29.40, down 20 cents.

Fick made his recommendation a day after Rouse released its third-quarter earnings. The company reported Monday that in the quarter that ended Sept. 30, its funds from operations were $96.8 million, or $1.03 a share, compared with $69.9 million, or 92 cents a share, in last year's third quarter.

Fick said the company was able to report record results only because it excluded the $25 million it planned to spend by the end of year on a signing bonus for a new executive and costs related to buyouts, retirements and layoffs.

Rouse took an $8.6 million third-quarter charge and said it would take a $16.4 million charge this quarter. Had Rouse included the expenses in funds from operations, Fick said, the costs would have reduced per-share earnings by 12 cents, or 19 percent, in the third quarter.

"They should not be allowed to get away with this kind of misleading financial report," Fick said. "We ultimately believe that they reported their earnings incorrectly."

Fick's sell rating was also based on other factors, such as the company's handling of its development pipeline, he said, adding, "This is not a crash and burn by Rouse by any means. Our view is that over the next 18 months to two years Rouse will underperform its sector. But it's not a cancerous situation."

Funds from operations are not reported to the federal Securities and Exchange Commission, although they are a key gauge used by analysts and investors. The benchmark was developed by the National Association of Real Estate Investment Trusts to better represent the year to year earnings of companies by excluding such noncore and sometimes fluctuating expenses as depreciation of property.

Other agreed that Rouse did not adhere to industry standards.

"Severance to people who are laid off is probably appropriately a one-time cost, but bonuses to executives and that kind of stuff are not," said Howard Schilit, head of Center for Financial Research & Analysis Inc. "It seems interesting to even have those two things in the same sentence."

Matthew Ostrower, an analyst with Morgan Stanley in New York, said Rouse's expenses should have been included in the earnings. He has a positive rating on the company's stock.

"We do not agree with the way Rouse accounted for" funds from operations, he said. "We believe the $25 million charge should have been included in FFO. However, if we were to downgrade every mall REIT that violated the FFO rules at one time or another, we would likely have a sell recommendation on every mall REIT."

During a conference call to analysts Monday evening, Rouse Chairman and Chief Executive Officer Anthony W. Deering characterized the third- and fourth-quarter charges as one-time restructuring costs. He said it was proper to exclude them from funds from operations. However, he acknowledged to an analyst that challenged the accounting that the calculation violated the industry association guidelines.

Some analysts expressed surprise at the size of the one-time charges. But Rouse said it believes Fick was the only analyst to downgrade the stock yesterday. Some charges stem from a major restructuring uncommon at Rouse, known for its executives' decades-long tenures and promotion from within.

The company, which develops shopping malls and communities such as Columbia and Summerlin, Nev., is facing a depleting pipeline of development because the nation has enough shopping centers. Rouse has hired a new vice chairman and chief financial officer from outside the company, merged two divisions and has promoted a number of high-level staffers. Two senior executives have announced their retirements.

Fick and other analysts have praised the moves, which aim to reduce the company's costs by $5 million a year and infuse new leadership. But Fick noted other challenges facing the company in recommending that investors sell the stock.

He said some Rouse centers, such as Owings Mills Mall, continue to do poorly and that the general retail climate is not improving. Office building vacancies are up, and new malls in Coral Gables, Fla., and Las Vegas will require a few years to lease and start contributing to earnings.

Land sales fueled by a hot residential market will begin to decline if interest rates rise, he said. Rouse credits those sales for the record quarter reported yesterday.

Also, Fick said, Rouse is carrying a lot of debt, partly to pay for the acquisition of all or parts of eight premier shopping centers purchased this year. The debt will hamper further acquisitions, he said.

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