Martha Stewart seeks new stars

Martha Stewart's company may soon add some stars to extend and preserve the brand's appeal.

More from Fortune

Google turns 10: A look back An engagingly raging bull A flier strikes back

FORTUNE 500 Current Issue Subscribe to Fortune

NEW YORK (Fortune) -- Martha Stewart has endured jail, public ridicule and the near evisceration of her brand, only to stage a first class comeback. Now the Domestic Diva may face her greatest challenge yet: making room for another star personality inside the company she founded.

Fortune has learned that Martha Stewart Living Omnimedia (MSO) has held recent talks with two prominent tastemakers, the fashion designer Cynthia Rowley and Jonathan Adler, known for his home décor, with the aim of building multifaceted brands around these personalities that span television, publishing and the Internet.

The deals were not consummated and talks have since broken off, but such an acquisition would be the first significant step by MSO to build a brand around a personality other than Stewart.

Chief Executive Susan Lyne has made no secret that she is on the hunt for acquisitions. In response to a question on the company's third quarter conference call, Lyne said that MSO was looking for two types of deals. "One is Internet companies," she said. "And the second one is brands that we believe have a lot of consumer interest."

An MSO spokeswoman declined to discuss Cynthia Rowley and Jonathan Adler, saying that, "as a matter of policy we don't comment on rumor or speculation." Representatives for the two designers also declined to comment.

It is unclear exactly why the talks fell through, but Cynthia Rowley and Jonathan Adler are not the only companies that MSO has courted. One person familiar with the situation said MSO has talked to nearly half a dozen companies in 2007, including a publisher of online recipes.

Any deal would have to meet specific growth criteria. A personality-driven brand would need to demonstrate the ability to expand across multiple channels. Another requirement: Stewart's blessing. Although she no longer has full control of the company - having lost her board seat and title of chief creative officer following her 2004 conviction for obstruction of justice - Stewart still owns 92 percent of the company's stock, giving her a big say in decision making.

A person who knows Stewart said she has fully endorsed the company's strategy to diversify through acquisitions. But other people who have dealt with her paint a different picture. "The decision making at the company is dysfunctional," one of these people said. "Susan Lyne has no ability to be an effective CEO given the ownership structure."

MSO has made few acquisitions in its history, preferring instead to launch new products based on the iconic image of its founder, who at age 66 shows no sign of slowing down. (A notable exception was the 2004 purchase of Body & Soul magazine.) Last year alone, the Stewart brand expanded to include a collection of home products sold at Macy's (M, Fortune 500), a line of crafts at Michael's Stores and a series of 20 food items for Costco, the first of which, the Kirkland Signature Martha Stewart Favorite Holiday Ham, went on sale in December. Still to come: a line of Martha Stewart wines to be introduced later this year in partnership with E. & J. Gallo winery.

The pressure to do a deal will intensify this year, as MSO prepares to take a hit on several fronts. Merchandise revenue is expected to fall by as much as 20 percent in 2008 due to a sharp reduction in minimum guaranteed payments from Kmart. Because the agreement was signed before Kmart's 2002 bankruptcy filing and subsequent closure of dozens of locations, the minimum guarantees have exceeded actual royalties earned from retail sales for several years. That will come to an end this year, when the guarantee falls to $20 million from $65 million in 2007.

Royalties from new merchandise arrangements won't begin to pick up the slack until 2009, when Macy's is estimated to contribute in excess of $16 million and Costco $10 million, according to Michael Kupinski, an analyst with Noble Financial Group.

That's not the only problem. Publishing revenue, which remains the largest MSO division (accounting for slightly more than half of the company's $288 million in annual sales) is slowing down. Kupinski expects revenue from the publishing segment to grow just 7.3 percent this year, down from 17 percent in 2007. MSO's stock, which had traded as high as $32 a share following Stewart's 2005 release from a five-month prison term, now languishes around $6. On Wednesday, the shares lost 16 cents, or 2.76 percent, to close at $5.64.

"Building a platform beyond Martha Stewart is healthy for the company," said Kupinski, the analyst. But finding an acquisition that is the right fit for MSO, which is dominated by the personality of its founder, is turning out to be complicated. Some executives within the company have voiced opposition to devoting resources to non-Martha brands, sources said. "At the end of the day," said one person, "Martha doesn't want to share the spotlight with anyone."