Homestore's Recovery Hurt By Ongoing Legal Struggles

Corporate Focus by Anthony Palazzo

Homestore.com Inc. cleaned up one legal mess last week, but remaining issues, including an ongoing shareholder lawsuit and a Securities and Exchange Commission investigation, threaten to overwhelm the real estate oriented dot-com's attempts to rehabilitate itself.

The settlement involved Homestore's August 2001 purchase and subsequent sale of a company called iPlace, a provider of consumer credit services. Homestore made the purchase for $150 million, including $78 million in stock, from MemberWorks Inc.

Problem was, Homestore's stock price reflected financial results that have since proven to be overblown. Shortly after the purchase was completed, Homestore shares began to plummet, effectively lowering the price MemberWorks received.

Eventually, Homestore restated $172 million in revenues during 2000 and the first three quarters of 2001, adding $144 million to previously reported losses.

Homestore stock, trading in the low $20's at the time the deal was made, has remained below $5 since November, and recently traded below $1.

Earlier this year, Homestore sold the unit to Experian Holdings Inc. for $130 million in cash. MemberWorks sued, trying to block the sale. A federal judge made Homestore put $58 million of the proceeds into an escrow account.

Last week, Homestore agreed to give MemberWorks $23 million of the money in the escrow account. It gets to keep the rest.

AOL dealings

That settles one problem, but more daunting is the thicket that has arisen from Homestore's dealings with America Online, the AOL Time Warner Inc. unit.

AOL's involvement in Homestore.com's questionable transactions, first reported by the Business Journal in April, have drawn more attention as details emerge from a consolidated, amended complaint recently filed by the California State Teachers Retirement System, lead plaintiff in the shareholder lawsuit against Homestore.

The complaint focuses on a three-way deal between Homestore, AOL and a company called SFX Technologies. According to the complaint, Homestore, seeking to boost sales at the end of a quarter, purchased $2,030,000 of "worthless technology" from SFX nearly all of which SFX, in turn, passed on to AOL in the form of a $2 million advertising purchase. As part of a marketing deal with AOL, Homestore was entitled to receive half of the $2 million in revenue it had steered to AOL, treating the cost of SFX's technology as an investment. SFX got to keep $30,000 for its troubles.

Dan Wool, a Homestore spokesman, declined to comment on the ongoing litigation, citing company policy.

In Homestore's second quarter conference call, Chief Executive W. Michael Long said the CalSTRS case "remains in a very preliminary stage."

Long also addressed other issues dogging Homestore. The company expects a decision in the fourth quarter on an arbitration it filed against AOL over the companies' marketing deal. A positive result could free up an additional $90 million in restricted cash held by Homestore. The hearing took place in July.

Not much is clear about whether anyone at AOL knew about the circumstances of the advertising purchase by SFX or by any other customers with Homestore ties who may turn up in pending reviews.

On Aug. 14, AOL-Time Warner said in an SEC filing that its AOL unit may have improperly booked $49 million in advertising and commerce revenue over six quarters. It said the three transactions it had identified are still under review, as are others relating to the AOL unit's advertising and commerce revenues.

AOL-Time Warner said in a statement that it was acting upon information learned within the previous 10 days. One of the AOL unit's top dealmakers, David Colburn, left the company days before the announcement.

Meanwhile, outside probes into Homestore.com and AOL are proceeding.

"We are continuing our investigation, and we believe this to be the tip of the iceberg," said Peter Borkon, CalSTRS outside counsel.

CalSTRS will be able to obtain additional information during discovery, but that won't occur until Homestore's motions to dismiss the lawsuit are resolved, Borkon said.

Meanwhile, the SEC is pressing its investigation of Homestore's accounting revisions. "The SEC investigation is going hot and heavy," said one source familiar with the matter. This person said that at this point, the SEC hasn't drawn in the U.S. Attorney, which would signal the possibility of criminal charges.



Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224, or at tpalazzo@labusinessjournal.com.

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