Cook & Schmid Partner Quoted in SAIC Controversy

Negative magazine story on SAIC draws collective yawn from financial circles

By JERAN WITTENSTEIN , San Diego Daily Transcript, Wednesday, March 7, 2007

Less than five months after its initial public offering, San Diego-based defense technology services company SAIC Inc. has come under fire from an unlikely place: Vanity Fair magazine, a national monthly known more for glossy photo spreads than hard-hitting investigative journalism. The story, an exhaustive 9,000-word piece written by two Pulitzer-prize winning reporters that appeared in the magazine’s March issue, details a series of unflattering allegations, lawsuits and anecdotes going back more than 30 years. They range from alleged egregious ethics violations to charges of war profiteering and shoddy work on multimillion-dollar contracts. In a statement, SAIC dismissed the story as biased, preconceived and containing false information.

Despite the negative publicity, in financial circles the story seems to be a big effort to which no one has paid any attention.

"The bottom line is, unless something is going to lead to less contracts coming their way, the market tends to overlook those things and look at the long-range issue," said Bud Leedom, publisher of the San Diego-based California Stock Report.

Since the story hit newsstands, there has been no apparent effect on the company's operations, which involve 44,000 employees and annual revenues of approximately $7.8 billion. On Wednesday, shares of SAIC (NYSE: SAI) fell 8 cents to close at $17.84, about 15 percent above the $15 price the company debuted at in October.

In fact, in the month of February SAIC was awarded contracts with a potential value totaling $366.1 million and was party to awarded contracts with potential values of $20.93 billion. "The issue that The Street has are not ethics violations," said Alex Hamilton, an analyst with The Benchmark Co. in New York. "The issue is that given its size, how is it going to grow going forward and given the fact that it's been a well-known, closely-held culture that is now changing."

Analysts contacted by The Daily Transcript, all of whom were unaware of the Vanity Fair story, said such reports typically have no effect on operations at a company unless they spark regulatory investigations or in some way portend future financial impacts to the company's balance sheet.

They also noted the story might have had more effect if it had been published in a respected business magazine.

Does public opinion matter to nonconsumer-product companies?

Unlike consumer-product companies, which rely on individual customers for the majority of their revenues and consequentially can be devastated by negative media reports, defense companies are not as subject to the vagaries of public opinion because they have complicated relationships with their clients, most of which are governments, according to Rick Cook, a partner at the San Diego public relations firm of Cook & Schmid.

Even Halliburton Co. (NYSE: HAL), a name that has been frequently associated with allegations of war profiteering and subject to scrutiny for overcharging on government contracts, has had little financial effect on its stock from the negative publicity, according to analysts. Part of this is because it is such a large conglomerate, operating in numerous sectors, they said.

"I don't cover them, but Halliburton clearly has (negative publicity) issues all the time," said The Benchmark Co.'s Hamilton. Another big reason defense company operations are less likely to be affected by bad press, according to Cook, is because of the war in Iraq and concerns over homeland security, which create a compelling need for companies like SAIC.

For instance, SAIC is involved in a U.S. Army project called Future Combat Systems, or FCS, which aims to transform the army into a lighter, more cohesive fighting force.

James Friedman, an analyst in New York with Susquehanna Financial Group LLP, called the seven-year, $14.9 billion contract, which SAIC was awarded along with The Boeing Co. (NYSE: BA), "one of the most important contracts in the world" and "the future of the American military."

In today’s heightened security environment with numerous theaters of operation for the U.S. military and increasing participation from big-business defense contractors like SAIC, making major contractual changes can create security risks, according to Cook.

Crisis situations

Although there have been a number of media reports that have devastated defense companies in recent years, such as the one that shut down Poway-based ADCS Inc. and resulted in federal criminal charges that are pending against founder Brent Wilkes, many defense companies seem to be relatively immune to bad press.

Despite this trend, according to Cook, bad publicity within the defense industry, even if the reports don’t allege illegal actions, might begin to have more of an effect in coming years.

"Corporate reputation is not something that shows up on the balance sheet, but I think it does have operation and financial value for companies," Cook said. "There have been so many crisis situations that have occurred in the last few years in the defense industry, I think that eventually, if the trend continues, then you will start to see market valuations erode."

However, Susquehanna’s Friedman said negative media portrayals of defense companies are less likely to have an effect on business unless the government departments from which they receive their business come under review.

"If one of the major agencies comes under scrutiny and one or more of the sponsors of the supplier are at risk," Friedman said, "then appropriations or projects can get canceled -- and ultimately that's what can kick a supplier in the teeth."

Mitigating damages

"As a general rule, it's extremely important when a company is trying to recover from an attack on its corporate reputation for it to be open and accessible and proactive in terms of getting the real story out," Cook said.

Like most defense contractors, given the highly sensitive nature of their work, SAIC is a constitutionally secretive organization.

Shortly after the Vanity Fair story came out, a leaked memo surfaced on the Internet, apparently written in response to the magazine article and posted on SAIC’s employee intranet ISSAIC (pronounced eye-zik). In the two-page document, the company rebutted some of the article's assertions. The letter was attributed to Arnold Punaro, executive vice president and general manager of Government Affairs Communications and Support Operations General Manager for the company's Washington, D.C., operations.

In the letter, Punaro concluded SAIC was planning to work with the news media to ensure "they have an accurate picture of SAIC." When contacted by The Daily Transcript, however, Ron Zollars, a spokesman for SAIC in San Diego, declined to discuss the article and instead issued a small statement. He refused to elaborate on further questions, including whether SAIC had taken any legal action against Vanity Fair or why the company had not followed through with its stated intention to work closely with the media to present its side of the story.

"The story about SAIC in the March edition of Vanity Fair Magazine distorts SAIC's record of successful performance on tens of thousands of contracts and highly ethical business practices," Zollars wrote in an e-mail. "Using innuendo and false information, the article pieces together isolated incidents and a handful of lawsuits, many of them decades old, to fit a preconceived story and place SAIC in a false light."

The statement was pieced together from the leaked memo.