NEW YORK (Reuters) - News Corp (NWSA.O) and Discovery Communications (DISCA.O) have been flagged as two of the top 10 riskiest American companies based on a new gauge that looks at weak corporate governance, accounting red flags and high leverage.
Education company Apollo Group Inc APOL.O topped the first Risk List from GMI Ratings, which tries to flag potential pitfalls for investors that don’t show up in traditional ways of valuing a company.
Less than 5 percent of companies receive an “F” grade, said GMI. On average, the ten stocks on the list are down 9.81 percent in 2011, compared with a 3.5 percent drop for the S&P 500.
Paul Hodgson, senior research associate for the New York-based GMI, which was formed from the merger of GovernanceMetrics International, Audit Integrity and well-known corporate governance monitor Corporate Library, said the firm was not making specific calls on share price performance.
GMI did not contact the listed companies for responses prior to compiling the list.
“What we’re doing is to indicate that if someone has an investment in a company on this list, they need to address the risk that these issues represent to their portfolios,” Hodgson said.
GMI noted that a number of major corporate blowups, such as the collapse of Lehman Brothers and Bear Stearns, were “presaged by failing governance ratings.”
With a market capitalization of about $44.3 billion, media giant News Corp (NWSA.O) is by far the largest company on the list.
GMI cited the recent phone-hacking scandal at News Corp, which “brought additional scrutiny of the company’s journalist standards and ethics, as well as its relationships with various government agencies.” The company’s now closed News of the World newspaper has been accused of paying bribes to British police officers in exchange for information.
“Although there have been some high-profile management resignations and a few name changes at the board level since the recent scandal, there is little indication that the quality of the company’s governance is improving — particularly in the crucial area of the relationship between the board and <Chief Executive Rupert> Murdoch,” it added.
News Corp didn’t immediately respond to requests for a comment. News Corp is the best performer among the 10 companies with its stock up 18.5 percent so far this year.
The other media company, Discovery Communications (DISCA.O), which operates such channels as the Discovery Channel and Animal Planet, is on the list because of concerns over the level of the company’s debt and goodwill, as well as questions about its corporate governance and executive compensation policies, according to GMI.
Footwear company K-Swiss Inc KWSW.O is the worst performing stock on the list with a decline of 63 percent year-to-date.
According to GMI, the company may be under-reserving for doubtful accounts and “its business may thus be doing even worse than is immediately apparent.” K-Swiss was not immediately available to comment.
GMI said an analysis of Apollo’s financial statements suggested “it may be inappropriately capitalizing assets,” noting about $400 million in impaired assets on the company’s books and deferred income tax assets that have been growing as a percentage of operating expenses.
“This may point to an understatement of current period expenses that have instead been capitalized as assets,” said Agnes Grunfeld, managing director at GMI.
GMI also expressed concern over the company’s governance, which it said gave little influence to investors outside the company’s founding family.
Apollo declined to comment on the report.
Other criteria used for evaluation of companies include executive compensation issues, poor disclosure of environment or health or safety risks, and high leverage.
Hodgson noted that many GMI clients were indirectly invested in Apollo, News Corp and Discovery though index funds because they are components of the S&P 500 .SPX.
Scientific Games Corp (SGMS.O), which was listed for “accounting red flags” in the form of high leverage and goodwill compared with the gaming industry medium, as well as what GMI describes as transactions that favor company insiders, said it had no official comment.
The ten companies on the GMI list, all of which were graded “F,” include two energy companies, SandRidge Energy Inc (SD.N) and Comstock Resources Inc (CRK.N). The other companies listed were EZ Corp (EZPW.O), MDC Holdings (MDC.N), and Comtech Telecommunications Corp (CMTL.O). None of these companies were available for comment.
Editing by Martin Howell