What's Ahead For The Bad News Bulls: A Phone Company With The Wrong Kind Of Hum

Short selling is back in vogue again. After three years of suffering through negative or breakeven returns, short sellers, who profit from stock declines, have been churning out their best returns since 1990. Mainly, they can thank the lackluster stock market, which has has exposed a bevy of inviting targets--such as Western Water and Incomnet.

For investors in Incomnet Inc., the Information Highway seems to be paved with gold. The Woodland Hills (Calif.)-based long-distance carrier is expected to bounce back in 1994 from a $949,000 loss last year and earn a tidy $3.5 million. Incomnet predicts it will rack up $35 million in sales, more than triple last year's volume. And the company's stock has soared over 60% since January, to about $10 a share.

But investors may be in for a bumpy ride. The signs of trouble: Sales representatives are leaving the company in droves, some griping the company hasn't paid them what they are due. Others complain that top executives are more concerned with recruiting reps--who pay up to $695 for a package of training material and phone calling cards--than with signing up customers. Sales of material to the marketing force accounted for 38% of revenues last year. In states like California, multilevel marketing concerns that generate a large percentage of revenues from sales to a company's own staff can be in violation of antipyramid laws.

Short sellers--who have pushed short interest in the stock to 1.2 million out of 7 million shares that trade--have spread the word about the ties of two top company advisers to a fraudulent 1980s-era multilevel marketing operation.

Incomnet Chairman and CEO Sam D. Schwartz denies the company is in trouble. He insists he's engaged in a legitimate business: reselling long-distance service by buying time from other carriers. And he boasts that Incomnet's 20,000 sales reps signed up 100,000 new customers in the first half of 1994 and will add another 150,000 in the second half. "We are as straight an arrow as you'll find," he says.

Schwartz takes particular exception to suggestions that Incomnet might be a pyramid scheme. Salespeople get bonuses for signing up reps, but only after the new recruits sign up at least 10 customers. Schwartz denies that the company focuses on new reps and estimates the percentage of revenues from sales to sales staff will drop to 20% by yearend.

California Deputy Attorney General Albert N. Shelden says his office is considering whether to require Incomnet to register with the state, which regulates some multilevel marketing plans that require a substantial investment by reps. He won't say if Incomnet has run afoul of his state's antipyramid laws.

SERVED TIME. Shorts are trying to raise that specter by noting the links between an earlier fraud involving two Incomnet officials. Christopher J. Mancuso, director of product development for Incomnet subsidiary National Telephone & Communications Inc., pleaded guilty in 1986 to mail fraud. The charges stemmed from a multilevel cosmetics marketing scheme involving a company called Culture Farms Inc. that fleeced investors out of an estimated $40 million. Culture Farms went bankrupt in 1985. Mancuso was fined $10,000 and served nine months in federal custody. Incomnet's Schwartz says Mancuso has "done nothing dishonest since I've known him."

Jerry W. Ballah, NTC's marketing head, helped set up Culture Farms in late 1984. But he says he was merely a grower of cultures used in the cosmetics and lost money himself. He was, however, named in a civil suit filed by the bankruptcy trustee, who claimed Ballah received money from the operation.

Schwartz now seems to be having more trouble with former sales reps than with regulators and short sellers. Current and former reps gripe that NTC failed to pay commissions and bonuses. Several blame this on mismanagement, including weak computer systems. One dispute has turned ugly. Former rep Raymond Leonard, who is involved in a legal tussle with the company, claims he is owed $106,800 in commissions. Now a partner in another long-distance reselling business, Leonard also contends the company has hired a private eye to trail him. "We've had people break into our cars and go through our garbage," he says.

FIGHTING BACK. NTC President Edward R. Jacobs says that while the unit has had some growing pains, every salesperson owed money has been paid. He declined to comment on whether the company has used a private eye to trail Leonard.

But NTC is going after some of its critics with a vengeance. It is suing five onetime reps, including Leonard, contending they used confidential NTC lists to woo away large customers. The complaint alleges that the former staffers have been recruiting other NTC reps by warning that NTC "is run by a group of crooks." The company is seeking to recover $500,000 and undetermined punitive damages. On July 29, a California judge barred the defendants from using NTC's customer and sales-rep lists. Leonard's lawyer says his client hasn't used proprietary information.

The rancor is taking its toll. In its suit, the company admits losing "innumerable" salespeople due to the group's tactics--and that in some parts of California, it has lost more than half of its customers and reps.

As the disarray mounts, some insiders are lightening up on their holdings. Since November, Incomnet director Joel W. Greenberg has sold nearly 376,000 shares, reducing his stake to about one million shares. Jacobs has sold more than 36,000 shares since April but still holds about 47,000 shares. Both say they sold for personal reasons, and Greenberg says he recently bought 20,000 shares.

If the sales reps and the shorts are right, holders might want to exit this Information Highway.

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