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Don't Hurry Up and Wait

Second thoughts on stock splits; defined-contribution jitters; CFOs ditching dot-coms; the Streamlined Sales Tax Project; and more.
CFO Staff, CFO Magazine
December 1, 2000

For years, there has been plenty of anecdotal evidence of what might be called merger malaise--that palpable office slump when morale drops and productivity slips. Now a study by three accountants-turned-academicians has produced quantifiable results with a resounding conclusion: The longer it takes to seal a merger, the more the deal's value erodes.

Randolph P. Beatty, Hemang Desai, and Steven L. Henning, of Southern Methodist University's Edwin L. Cox School of Business, in Dallas, surveyed 328 mergers of publicly traded companies between January 1990 and January 1997, searching for financial evidence that companies falter once they learn they've been targeted for a merger. "We knew when we started what people's perceptions of behavior were once a merger was announced," says Beatty. "We wanted to know if we could identify accounting measures to corroborate those perceptions."

Beatty and his colleagues examined profitability and sales revenue to determine the impact of an acquisition announcement on targeted companies' cash inflows. They found that, on average, companies that took more than 90 days to seal a merger from the day of the public announcement to the final purchase date saw the targets' profitability drop 1 to 2 percent on an annualized basis and sales revenue fall by a whopping 8 percent.

Beatty says there are two major reasons for these declining numbers. For one, competitors jump in after a takeover announcement to lure nervous customers away from target companies. At the same time, the target's management, believing they will ultimately be dismissed, consider incentives to stay lacking in credibility and quickly abandon normal planning initiatives to look for other employment.

To Beatty, this underscores the critical connection between employee incentives and maximizing company value--even during normal operations--as well as the importance of speed in finalizing a merger. "It's not that we're surprised by this," he notes. "We're just glad to finally have numbers to back it up." —Leslie Schultz

Market Mover

You know the CFO has arrived when rumors of his demise catalyze a sharp drop in a company's stock price. The unfounded rumor early last month that Oracle Corp. CFO Jeff Henley had abruptly resigned tanked the stock by 13 percent at one point during the day. Oracle issued a statement clarifying the matter, and Henley himself said, "Somebody has been floating rumors that are totally false. I think it's a nervous market or short sellers trying to create [an opportunity]." Nearly 150 million Oracle shares traded hands that day, activity that was fueled further by the rumor that Oracle CEO Larry Ellison had died.

Two things were at play here: One, the status of the CFO as the standard-bearer of financial integrity has risen to the point that his or her sudden departure is seen as a sign of very bad things to come.

Two, the markets have become so volatile that almost any news stimulates buying and selling. But unlike the press release hoax involving Emulex Corp. in August, this event had no pretense of official substance. One annoyed securities analyst told CFO.com: "This is total hedge-fund nonsense. This story should die." —George Donnelly

Divide and Conquer?

Investors have been reeling lately over the volume of opportunistic stock splits--and we aren't talking the usual twofers. Many small companies have been trying to influence market interest with splits that range anywhere from a modest 4-for-1 (Rambus Inc.) to a middling 15-for-1 (stereoscape.com) to a dizzying 100-for-1 (Biofiltration Systems Inc.). But can the companies involved expect any measurable benefits from splits?

"The stock might get a bounce from a split," says Carl Hagburg, a Jackson, N.J.-based investment consultant and publisher of Shareholder Service Optimizer. "But in the case of a 100-for-1, you're going to get the bounce of a dead cat."

Indeed, Sarasota, Fla.-based Biofiltration's mathematical turn took its stock from $12 per share to 12 cents per share last April, attracting a slew of speculators but no serious investment funds to this marketer of waste-treatment and wireless Internet technologies. (The company still reports operating in the red.) On the other hand, Mountain View, Calif.-based Rambus--a developer of chip-connections technology whose stock went public at $12 per share in 1997, only to hit $230 per share before this summer's split flattened it to $51--was looking less for bounce than for rationality. "We wanted to quell volatility," says CFO Gary G. Harmon. Did it work? "That's hard to measure," he says, admitting, "It probably had a neutral effect at best."

Which leaves many observers wondering why companies even bother with this costly exercise. Hagburg notes that stock splits result in added issuing and listing fees, yet generate no stock market value. "They're economically irrational," he says. "They attract individual investors who see them as a bullish sign that the company expects the stock to go up. But a $60 stock that splits in half is not twice as good as the two $30 stocks it becomes. Investors can buy more stock after a split, but they don't get a better deal." —L.S.


Defined Contribution Jitters

The defined contribution health plan, a new and controversial benefit concept, is less popular with employers than one might suspect, considering its cost-savings potential. A recent survey, conducted by The Kaiser Family Foundation and The Health Research and Educational Trust, showed that only 20 percent of employers believe it is very or somewhat likely that within the next five years they will stop negotiating with health insurance companies and instead provide employees with cash to buy their own insurance directly.

This approach, referred to as a voucher plan, is the most extreme version of a defined contribution plan. Although few if any companies currently offer pure voucher plans, just the fact that companies are considering it has drawn heavy fire from employee and consumer advocate groups, many of which believe that the approach shifts too much responsibility for complicated insurance decisions to employees.

In reality, most defined contribution plans resemble that used at Carlson Cos., a travel, lodging, and customer relationship marketing firm based in Minneapolis. The Carlson plan offers its 6,000 Minneapolis-based employees a health plan grouped into three different price points, but it will contribute only 75 to 80 percent of the cost for the least-expensive group, according to Charles Montreuil, senior director of benefits. Employees cover the difference.

"We've made our employees into consumers," says Montreuil. "They need to look at cost and quality in making their choices." But Carlson has no plans to shift to a voucher system just yet, says Montreuil. "The voucher system has some potential over time," he adds. "It's certainly the next evolution we want to see." However, like Carlson, no large employer is likely to abdicate the role as administrator of employee health plans anytime soon. According to a recent study by consulting firm William M. Mercer Inc., 70 percent of firms surveyed think it unlikely that they would be exiting the practice of providing health benefits in the next two to three years.

"There will be a few companies that try the voucher approach," says Robert O'Brien, Mercer's national health-care practice leader. "Our research shows a high correlation between willingness to take that approach and companies that are nonunion, high tech, or are having trouble financially. They are experimenting with different forms of defined contribution plans, but they're not getting out of the benefits business."  —Kris Frieswick

Careening Dot-com CFOs

Call Gene Godick a survivor. No, the CFO of VerticalNet Inc. wasn't a made-for-TV castaway on an exotic island. Rather, he was a made-for-online apostle in an exuberant stock market.

In June, just after the markets swooned and investor demands for profitability intensified, CFO magazine profiled five Internet CFOs to find out about their plans to build New Economy businesses that would, well, survive (see "Waiting for the Dough"). The five companies are still going concerns, but Godick is the only finance chief in the bunch still in the same job.

"The velocity of the CFO market is unbelievable," says executive recruiter Peter Crist, a vice chairman of Korn/Ferry International. Given the number of broken or questionable E-business models, he explains, some big-company CFOs who went panning for Internet gold are having second thoughts. But more often than not, Crist is seeing finance chiefs skipping from one platform to another, or, if possible, simply cashing out to enjoy an early retirement.

Tom Caldwell, CFO of MyPoints.com Inc., is a "skipper." In fact, he skipped out the door on May 26, before the issue of CFO featuring him even reached subscribers. A company press release said he left "to pursue an opportunity at a start-up company," though no one seems to know exactly which start-up. What is known is that MyPoints's shares lost 55 percent of their market value in mid-October, after the direct-marketing firm announced that third-quarter revenue and earnings would fall sharply below expectations. Before he left, Caldwell exercised options worth about $2.6 million.

Over at Covad Communications Group Inc., a broadband services firm, CFO Tim Laehy decided to call it quits altogether on August 2, when a press release announced the retirement of the 43-year-old executive. Calls to his Silicon Valley home were not returned, although apparently he got out at the right time. News that third-quarter revenues fell 15 percent because of delinquent customers sent Covad shares down 59 percent, to $3.41, in October. But don't worry about Laehy: he'd already amassed a nest egg of $18.6 million selling options and restricted shares.

Six months ago, Steve Valenzuela of PlanetRx.com Inc. was the least sanguine of the five CFOs. That didn't stop him from securing $50 million in equity financing from a venture firm and pushing a cost-cutting headquarters move from California to Memphis, where PlanetRx has its distribution center. But by late August, he was on his way to joining Silicon Access Networks Inc., a pre-IPO Internet infrastructure firm in San Jose, Calif., as CFO. Although PlanetRx shares haven't traded above $1 since July, Valenzuela, who never sold any options, insists he didn't leave because the situation was hopeless. "I had previous offers," he says, "but I stuck it out until I found the right opportunity."


Paul Francis, the founding CFO of Priceline.com, joined the ill-fated Priceline WebHouse Club last March. Francis was the architect of Priceline's unique business model for selling airline tickets on the Web, but the fall has brought a double whammy: WebHouse was shut down, and shares of Priceline plummeted when the company announced that third-quarter revenues would miss expectations. Francis, who sold $20.4 million in restricted shares earlier this year, did not respond to several messages.

As for Godick, the past six months haven't exactly been a walk in the park. VerticalNet, which runs 57 online communities for industry professionals, continues to beat expectations and reduce its cash losses quarter-over-quarter. But analysts remain concerned that only a fraction of the company's revenues come from E-commerce transactions, raising questions about long-term growth prospects and the path to profitability.

Godick, who has cashed in $4.8 million in options and restricted shares, has no plans to go anywhere. "I remain excited about this company and its prospects," he asserts. As it was in June, VerticalNet is expected to make money in the second quarter of next year. "Time will tell who executes and fulfills the promise of profitability," cautions Godick.

In just six months, at least four have reneged. —Stephen Barr

No Dough 
Sinking valuations of Internet-related companies.

Company3/10*4/14** 10/30
Covad Comm.$66.63$24.81$5.22
MyPoints.com$66.13 $14.94  $2.31
PlanetRx.com$9.50$3.00$0.36
Priceline.com$94.00$58.55$5.56
VerticalNet$136.59$28.00$25.06

*Date of the Nasdaq Composite Index's all-time high
**End of the week when Nasdaq dropped by 25%

Can States Unite?

The fiefdomlike collection of tax jurisdictions in the cities, counties, and states across the nation poses a massive burden for multistate corporations. Although only 45 states impose a sales tax, retailing giant Wal-Mart Stores Inc. files between 10,000 and 11,000 sales tax returns a year. "By the time you break it down and file for the local cities and counties, it becomes a nightmare," says Warren Townsend, director of sales use and product taxes at the company. A wide collection of states, recognizing that the volume of idiosyncratic regulations hurts the collector as well as the taxpayer, is devising a plan to diminish the complexity by establishing common ground rules.

Forty states have banded together to organize the Streamlined Sales Tax Project, which has been holding meetings this fall to address issues that vex multistate companies. In some states, there are overlapping local and state sales tax rates, which help to create the 7,000 sales tax jurisdictions across the nation. These rates are always changing, creating headaches and potential liability. One of the project's suggestions is to limit tax changes to once per quarter and standardize the notification period before a tax takes effect. Another headache: Definitions of what is and isn't subject to tax vary widely from state to state.

The project is not a purely altruistic movement on the part of states. They recognize that simplicity will reduce the effort it takes them to collect the taxes; moreover, the project addresses the issue of remote vendor sales through the Internet and catalogs, a trend that is costing states hundreds of millions of dollars in lost revenue. Although the buyer is technically required to pay a use tax on a sale from a vendor that doesn't have a taxable presence in the state, there is no realistic mechanism for collecting the tax. The Streamlined Sales Tax Project has proposed a plan to allow vendors to voluntarily collect and remit the tax through a third party, which would install a software system. —G.D.


Collapsing COLI

While nonleveraged, corporate-owned life insurance programs remain popular, the leveraged version of COLI continues to draw the ire of the Internal Revenue Service. In the latest in a series of recent cases against companies that succumbed to the lure of leveraged COLI, the IRS won a substantial decision against Camelot Music. Upholding an IRS claim, a senior judge from the U.S. District of Delaware disallowed $13.8 million in tax deductions for interest payments on loans.

In a leveraged COLI, companies borrow to pay premiums from their insurers and then deduct the loan interest payments, explains William MacDonald, president and chief executive officer of Los Angeles­based Clark/Bardes Consulting­Compensation Resource Group. Although very popular in the early 1980s--companies used COLI for an assortment of purposes--changing legislation eventually dismantled the tax-avoidance attraction of the leveraged COLI. —Steve Bergsman

Trademark Deal Languishes

An international plan to make trademarks easier to secure and renew abroad still awaits U.S. adoption, after Congress failed to act on the measure in its last session. The trademark agreement, part of the Madrid Protocol, would simplify the trademark registration process, making it easier and less costly to protect intellectual property.

Trademark enforcement has become an increasingly contentious issue as competition in the global marketplace heats up, and the Madrid Protocol promises some administrative relief for both small companies and multinationals. Instead of filing a form in each country (which involves enlisting the aid of a local lawyer, filing in the local language, and paying in the local currency), an individual or company would be able to file one form, pay one fee, and simply check off other countries in which it would like to apply. Keeping track of multiple renewal deadlines would be a thing of the past.

Moreover, companies would save more than 60 percent in filing fees, says Bruce MacPherson, director, external relations, and group coordinator of the International Trademark Association. In addition, he says, the Madrid Protocol "is the only system that requires countries to act on international applications in 18 months."

However, an application will not always be approved, even in a country that subscribes to the protocol, says Clark Lackert, a partner in Nims, Howes, Collison, Hansen & Lackert, a New York law firm.

It is likely backers will have to wait until Congress reconvenes in January before the matter can be taken up again. —Joan Urdang

Toxic Cash-burn Solutions

Internet companies on the prowl for financing to stave off getting charred by cash burn have found themselves on the wrong side of a mugging.

Desperate for new capital, dot-coms have turned to private investment in public equities, or PIPEs. Although not inherently bad, some forms of PIPEs contain serious downsides, depending on how the financing deals are constructed. The most notorious PIPEs involve "floating" or "floorless" convertibles, which, because of their potentially destructive clauses, have become better known by such colorful appellations as "toxic convertibles."

The structure of these convertibles is fairly basic. The price at which investors can swap securities for common stock is usually set slightly above market. However, the security also establishes a timeframe at which the stock either gets to that level or the investor can swap at a lower price. The kicker is that if the price of the company's stock declines, conversion prices are reset at lower levels.

"If the stock never gets to the conversion price, investors get more shares to compensate them for having to sit on the convert," explains Rudy Scarito, a banker with Robinson Humphrey, in Atlanta. "The issue of new shares dilutes the value per share." This drives down the price of the stock even more, causing what some have called a "death spiral."

Sometimes unscrupulous capital sources become involved with these toxic convertibles, says Scarito. "As the company's stock creeps toward the conversion price, these investors short the stock, putting downward pressure on the price, causing more shares to be issued to them."

Sometimes Internet firms don't really understand the ramifications of PIPEs: They think their stock prices would never fall so low that the potential penalty level of a swap would be breached.

Judson Schmid, CFO of ProxyMed Inc., frankly admits that's what happened to his company. In December 1999, the Fort Lauderdale­ based health-care information services company raised $15 million through a convertible deal with Promethean Asset Management LLC of New York. "There was a clause in the deal that said if the stock went below a negotiated stock price for 20 consecutive days, all these provisions, such as mandatory redemption and conversion, would begin," says Schmid. "When we entered into the deal, we never expected that level to be reached," he says.

"PIPEs are a very good way to finance if you know what you are doing," says Harlan Kleiman, a principal with Shoreline Pacific Institutional Finance. "If you understand what the limits are to the transactions, there are plenty of advantages." —Steve Bergsman


Planning Relief for Insiders

Overshadowed by the new fair-disclosure rules that took effect in October were companion regulations that promise to let insiders sell shares without the worry of being accused of trading on material, nonpublic information.

With this new safe harbor, known as Rule 10b5-1, the Securities and Exchange Commission expects to protect executives from the appearance of illegal insider trading as long as they unload their company holdings according to a preset selling plan. "This is a very positive step," says David Priebe, a securities lawyer at Wilson Sonsini Goodrich & Rosati, in Palo Alto, Calif. "Most executives want to follow the rules, and the SEC has just made it easier."

Currently, most executives are permitted to sell stock during a "trading window," the period each quarter when a company is least likely to have material information that has not been released publicly. But this approach often results in trades being bunched, and it still raises suspicions about what the executives might know that investors do not. In contrast, the new rules permit insiders to sell shares on a regular basis throughout the year, and should insulate them from shareholder lawsuits and concerns about management bailing out.

The new trading plans are expected to come in different forms. Some may set a date and volume for regular sales; others may specify the proceeds the executive is looking to accumulate over a certain period of time. More sophisticated plans may tie the number of shares sold to a certain share-price range, or give a broker the discretion to sell a certain number of shares over the next year in amounts and at prices deemed appropriate.

One potential downside is that these plans may lock an executive into selling shares during a time when the stock is crashing. But fiddling with the trading formula would foster the notion that it is a sham. "You may call the whole thing off, but it would be harder to use the plan as a defense to insider-trading allegations," says Priebe. —Stephen Barr




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