Making money off the options saga
A seasoned turnaround expert on how he's profited since the scandal began - and what you can do to protect yourself.
NEW YORK (CNNMoney.com) -- John Mutch, founder of the shareholder activist hedge fund MV Advisors, knows a thing or two about making money off troubled tech companies. These days, he's got his sights on those mixed up in the stock-options saga.
Dozens of tech companies are being investigated by the Securities and Exchange Commission and federal prosecutors over whether they "backdated" or otherwise manipulated stock options to make them more lucrative for employees.
Mutch, a former Microsoft executive who has spent much of his career executing restructurings, is seeking out companies with otherwise strong businesses whose shares have taken a beating because of the scandal.
Mutch believes if these companies cooperate with regulators, make management changes if necessary and take the proper steps to rebuild strong corporate governance, they could bring investors attractive returns.
Take Mercury Interactive (Charts), the first company to disclose that the SEC was investigating its options practices last year. The company's shares tumbled after management revealed its CEO, CFO and general counsel had resigned over their role in the back-dating of stock options at the company.
"They went from about $35 a share to about $25 after the announcement," said Mutch. That's when Mutch bought in. Within a month and a half, the stock climbed back up to the low $30s, the price Mutch sold at.
There were a few reasons Mutch felt comfortable investing in Mercury. He was familiar with the company's core business and believed it to be strong. He liked that the board of directors moved quickly to replace executives and cooperate with regulators. Finally, he thought the problems were isolated and not a sign of bigger governance issues.
In some situations, Mutch will take a more activist role, taking large stakes and pushing management changes - if he believes the underlying business is promising and could hold value for investors.
One example is software company Phoenix Technologies (up $0.04 to $4.82, Charts). Mutch, along with hedge fund Ramius Capital Group, has made a tender offer to acquire the outstanding shares of the company.
Mutch felt the firm had larger corporate governance problems. Plus, though the CEO and CFO resigned, Mutch felt the board reacted too slowly, and he felt the decision to replace the CEO with a three-person team "brought the decision-making process to a grinding halt."
Mutch and his team are trying to restructure the company, having bought up a large chunk of its outstanding shares and personally recruited a new CEO candidate.
In an e-mail message, Phoenix Technologies CFO David Eichler said the company was evaluating a number of strategic alternatives with the help of investment bank Sawian LLC. He acknowledged that Ramius Capital has made an offer to buy Phoenix, adding the offer is still being considered.
If Mutch and Ramius prevail, they will have their work cut out for them: Shares of the company plunged 31 percent after it warned last month that its third-quarter revenue would be less than half of what analysts had been expecting. The shares have bounced back since, until Thursday, when it reported results after the bell. The stock sank nearly 14 percent Friday.
What to do if you're not a pro
As a professional investor, Mutch has a bigger toolbox - and a higher appetite for risk - than most.
For individuals, Mutch thinks the No. 1 priority is to avoid getting burned. If a company in your portfolio suddenly announces it's being investigated, the next step is to determine whether to hang on and ride it out or dump the stock.
"As an investor, that's what you have to figure out - what was the real intention, and how decisively did the board react," he said.
Then, you have to determine your risk tolerance. If you decide not to sell, Mutch said, you need to react quickly and ask several questions - how deep and systemic was the issue? Was it lax corporate governance or limited to a small group of people? How did the board handle it? If senior executives got fired, are you comfortable with the replacement?
Another question to ask is whether the company in question is cooperating with regulators. Bruce Vanyo, attorney and co-chair of the securities litigation practice at Katten Muchin Rosenman LLP, believes companies that fess up and act quickly to resolve the problems will get more of a break from regulators than companies that don't.
"This seems to have become a situation where you can run but you can't hide," said Vanyo, speaking on a conference call hosted by his firm about back-dating. "I don't think a company has a choice but to take a look (into its past options granting practices). And you will get credit from the SEC if you self-report."
One example is Apple Computer, which disclosed to the SEC on June 29 that it is investigating the timing of stock options granted to some employees, including one made to CEO Steve Jobs. The company said that the grant was subsequently cancelled and resulted in no financial gain for Jobs. Shares of the company took a knock in after-hours trading but have since recovered, and then some, following a strong earnings report last week.
If it appears that a company may emerge from an options-related investigation unscathed, then investors who have a higher tolerance for risk can decide whether to stay involved and perhaps even add to the existing position, Mutch said.