In the post-Enron environment, investors want to see accounts that show real substance, writes Mary Canniffe, Investment Editor
Elan shareholders were severely punished yesterday when the company shocked the market with far worse than expected earnings and revenue forecasts for 2002.
In a post-Enron market where nervous investors can be expected to react sharply to unpleasant surprises, the company said the current year would be "tough", profits would be down and revenue growth would be "slower than anticipated". Stockbroking analysts who were forecasting earnings per share of $2 to $2.30 for the current year were told yesterday that the company expected to generate eps of just $1.55 to $1.65, down from the 2001 outcome of $1.91. In Dublin the share dropped €14.5 to close at €19.50.
While company chairman and chief executive Mr Donal Geaney said Elan had made difficult decisions to put the company on a path for future growth and said double- digit earnings growth would resume in 2003, the market reacted swiftly and sharply to the surprise forecast. Elan shares fell more than 30 per cent at the opening in New York as the market digested its forecast, and continued to fall through the day's trading.
The latest fall in the share price follows a 25 per cent drop in the share price last week on market nervousness about the company's accounting policies. In New York, the primary market for Elan shares, the share price had fallen to $29.95 by Friday last, close to its then 52-week low of $22.40 and well off its 52-week high of $65. In Dublin the shares closed last week at €34 - well off their 2002 high of €50.27 reached on January 17th.
Elan shares started to slide sharply in mid-January when it announced the suspension of testing on its new AN-1792 Alzheimers treatment. At that stage almost €2 billion (£1.6 billion) was wiped off the value of the company as investors sold in heavy volume. Last week nervous markets reacted to concerns about Elan's accounting policies following a highly critical article in the Wall Street Journal.
While the company dismissed the article as "a rehash of old news", the sell-off of shares was almost inevitable in the post-Enron environment where investors are shunning companies whose accounts are seen as lacking clarity and too complex. Investors are now highly suspicious of complex structures, including off-balance sheet operations which could be used to limit their ability to see how a company is generating its revenue.
Investors want to be able to see clearly where revenue is coming from so that they can judge its sustainability as well as future growth prospects. They are wary where companies appear to boost revenue/earnings by setting up complex webs of operations/investments or use accounting policies which obey the letter but not the spirit of the rules. In the post-Enron environment investors now want accounts that show the real substance of whatever arrangements a company puts in place. Accounting in any other way is now seen as potentially misleading investors and companies.
The particular concerns about Elan ranged around the complexity of its accounts, the way it conducts its research and development and licensing activity through some 55 joint ventures and partnerships and how it accounts for sales of non-core product portfolios. One concern involves the treatment of the sale of product portfolios - non-core operations being sold as part of a rationalisation programme. Elan takes the proceeds of these sales into its profit and loss account as revenue while some accounting sources consider that should be booked as exceptional gains because they are once-off, non- recurring income.
In 2000 Elan restated its profits - reducing them by $344 million (€396 million) when the US Securities and Exchange Commission said it could not take in licensing revenue from its joint venture/partnerships in one lump sum but had to spread it over the life of the agreement involved. Because this "revenue" comes from the capital Elan and other pharmaceuticals invest, it is effectively recycling funds from its balance sheet onto its profit and loss account. Elan used to take in the full amount of this licence fee into revenue immediately but in 1999 the US Securities and Exchange Commission said the company could only take in this revenue over the life of the agreement.
Elan said it had 55 R&D joint ventures but stopped creating them in mid-2001 and that this contracted revenue stream was of less and less importance in Elan's overall revenue growth.
While Mr Geaney was adamant yesterday that Elan was determined to have fully open and transparent accounts and welcomed "scrutiny from any quarter", the markets main concern now seems to be have changed to the robustness of its product earning and its pipeline. While the market may have overreacted in correcting the Elan share price, the bottom line for Elan is that investors need to be convinced.
