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A problem facing many Gulf-area businesses is housing for employees. Also: divorce insurance for the merger minded; for a better IPO, expand the guest list; dark days for attracting venture capital; podcast your next conference call; and more.
CFO Staff, CFO Magazine
October 1, 2005
When a major disaster strikes, business becomes personal. After the Gulf Coast was ravaged by Hurricane Katrina, Leo Denault, CFO of New Orleans–based Entergy Corp., Louisiana's largest company, spent much of his time on each daily management call trying to confirm the whereabouts of the company's 2,800 New Orleans–area employees. "At first, the number of missing people was very, very large," he says. Within a week, though, Entergy had located 99 percent of its workers. A weary Denault says finance-department employees are pursuing all avenues to find some still-missing colleagues, including tracking down children at college to ask if they've heard from their parents. To provide assistance to displaced employees and customers, Entergy has established the Power of Hope fund, with donations thus far totaling $2.7 million.
Charles Atwood, Harrah's Entertainment's finance chief, was attending to an urgent personal matter in the midst of pre-hurricane planning for the company's three area casinos: moving his 92-year-old mother from her home on the Gulf Coast of Mississippi to Las Vegas, where he lives. Atwood, who grew up in Mississippi, and Harrah's CEO Gary Loveman, who had lost his home in North Carolina to a previous hurricane, were both acutely aware of the possibility of a high human cost as they raced to help their nearly 8,000 employees in the affected area.
While the company has yet to determine the extent of the damage to its Gulf Coast properties, Atwood hasn't yet focused on that task. "People are a lot more important than buildings," he says. Harrah's established an 800-number for employee assistance at the onset of the storm and has received nearly 5,000 calls from workers seeking aid. The company has provided cash and shelter to affected employees, opening an assistance center in Gulfport, Miss. Atwood says competitors have called to offer jobs to displaced Harrah's staffers.
Like other small businesses in the Gulf region, PetroCom LLC, a privately held mobile-communications company in greater New Orleans, is racing to care for staff and restore operations within the next 90 days, before term limits expire on its business-interruption insurance. The insurance will cover lost revenue and relocation costs, which amount to roughly $5 million including property damage.
Things could be worse. In accordance with its disaster-recovery plan, 40 hours before Katrina hit, PetroCom started making hotel reservations and relocating administrative personnel to Houston and technical staff to Lafayette, La. About half of its 70 employees were evacuated, and were provided with medium-term lodging, money for personal expenses, financial-aid forms, and maps.
By returning some degree of normalcy to those displaced, PetroCom also restored worker productivity more quickly. "In the end, I think we're saving money, because we got back online from a revenue-producing perspective a lot faster and have notified vendors that, for example, our shipping address has changed," says CFO Dennis d'Aquin.
PetroCom's major operational challenge was that dedicated phone lines it leases from BellSouth and AT&T for out-of-network calling were down from the flood. To restore service, its insurer agreed to cover costs to build a new network facility in Lafayette, where the company now reroutes calls through its satellite.
Its more troubling problem — and one facing many Gulf-area businesses — is housing for employees. While its Harahan, La., headquarters was largely untouched, about 20 percent of PetroCom's staff lost their homes. D'Aquin doesn't know how much the Federal Emergency Management Agency or homeowners' insurance will help PetroCom cover employees' personal expenses. Its board of directors has started a fund to help. "Depending on how long this [relocation] lasts, money may run out," he says.
He also worries that employees will want to return to New Orleans before PetroCom is ready to move back, or that they will decide to leave the area entirely to reunite with family members relocated to other cities. "The struggle with the employees is going to be in three to six weeks, when Jefferson Parish says it's open for business, and we tell our employees, 'You cannot move just yet, because the department needs to operate and be supervised as a group,'" explains d'Aquin. "We will need to stay together in Houston for at least 60 to 90 days."
Three young employees who were not New Orleans natives have quit since being relocated.
While d'Aquin claims that nothing other than the hurricane's severity surprised him, he would still like to improve disaster preparation. For starters, he hopes to guarantee long-term lodging in Houston and Lafayette to his employees. He also wants to rebuild the new Lafayette hub in Houston and is in negotiations with the company's insurers to have them cover that cost, but says that reimbursement "remains to be seen." — Craig Schneider and Kate O'Sullivan
The More the Merrier
When planning an initial public offering, companies should carefully consider whom they plan to invite to the party — and then expand the guest list, according to a University of Notre Dame study.
Companies that go public with the support of a large syndicate, and, in particular, more co-managers, tend to obtain better pricing, generate more analyst coverage, and secure more market-makers than those with just one or two underwriters, say the study's authors, Shane Corwin and Paul Schultz, of Notre Dame's Mendoza College of Business. The report was based on more than 1,500 companies that went public between 1997 and 2000. "We expect larger syndicates to uncover more information, resulting in a greater number of accurately priced IPOs," says Corwin.
When Builders FirstSource, a $2 billion building-products seller based in Dallas, went public in June, a large syndicate was a vital part of the successful offering. In addition to two lead underwriters, UBS and Deutsche Bank, the company enlisted three co-managers. "We were looking for a blend of national and regional coverage," says CFO and senior vice president Charles Horn. The firms divided road-show duties according to which underwriter had the closest ties with each potential investor, says Horn.
The offering was three-times oversubscribed at the offering price of $16, giving the stock a boost in aftermarket trading. (Builders's stock recently closed at $21.57.) Trading support and analyst coverage have also been strong.
Managing such a large group is not easy. "It's a challenge with the upfront diligence," says Horn. "Each of the five firms wants to get comfortable with the company." Meetings and phone calls clogged the CFO's calendar in the days leading up to the offering, and haven't abated now that he's working with multiple analysts. "It did put a lot more pressure on me," he says, "but I think the payback is really worth it." — K.O'S.
The phrase financial engineering has acquired a bad rap. But when used narrowly to denote financial innovation and risk management through sophisticated mathematics and models, the phrase has an honorable, if brief, history.
Two recent books may bolster the good name of financial engineers. In Fischer Black and the Revolutionary Idea of Finance (John Wiley & Sons, 2005), Perry Mehrling presents a rigorous but rewarding biography of the man who, along with Myron Scholes and Robert Merton, revolutionized modern finance. The "revolutionary idea" of the title is not the famous Black-Scholes option-pricing model however, but rather the capital-asset pricing model (CAPM), the wellspring, according to Mehrling, of Black's work in finance and economic theory. As peculiar as he was remarkable, Black, who died in 1995, was once described as a "computer with blood in its veins" by Nobel laureate Franco Modigliani.
At Goldman Sachs during the 1980s, Black worked with Emanuel Derman and Bill Toy to develop a widely used interest-rate option model. Derman recounts that collaboration in his engaging memoir, My Life as a Quant: Reflections on Physics and Finance (John Wiley & Sons, 2004). A physicist by training, Derman spent 15 years at Goldman; today, he is the director of Columbia University's financial-engineering program. His book is leavened with discussions of particle physics and options theory, snapshots of colleagues, and unsentimental observations: "If you didn't mind wasting the best years of your youth," Derman muses, "graduate-student life at Columbia was paradise." — Edward Teach
"This podcast may contain forward-looking statements."
It might not be what Apple Computer Inc. had in mind when it launched the now wildly popular players, but iPods are the latest investor-relations medium. A number of companies are producing podcasts of investor news and information, including IBM, Cisco Systems, and military-products company EDO Corp.
The podcasts are audio files, usually in the MP3 format, that can be played on handheld audio devices like the iPod. What sets them apart from normal Webcasts is that investors can subscribe to a service that automatically pushes the content out to their computers and MP3 players, and then regularly updates it.
"It makes life easier for analysts," says Nancy Christman, a spokesperson for VCall Inc., which is offering the service to its IR clients. "Now they don't have to go surfing through Websites for conference calls. They can just listen to the podcasts on the train on their way home." — Joseph McCafferty
The golden age of venture capital this is not.
With $5.8 billion invested in 750 companies in second-quarter 2005, venture-capital funding is down slightly from the same period last year, according to a study released in July by the National Venture Capital Association (NVCA). Venture-investment levels have consistently ranged from $4.6 billion to $6.1 billion per quarter over the past two years, a far cry from the peak reached in 2000, when funding topped $25 billion a quarter.
As always, VC firms play favorites. Life-sciences companies still claim a disproportionate share of the action, an advantage they have held since the dot-com bust. For the first half of 2005, for example, biotech claimed a quarter of all VC dollars; telecom, in contrast, garnered just 9 percent. Increased federal investment in biotech research has also helped spur the VC market.
But even biotech start-ups can find capital-raising tedious. "It took us a year and a half," says Stephen Roth, president and CEO of Immune Control Inc., which is developing compounds to treat immunological diseases from its base in West Conshohocken, Pa. "We underestimated the effort involved." Roth adds that competition for dollars has grown fiercer as universities intensify efforts to commercialize their findings.
Venture capitalists admit they are treading cautiously. "There is money, but investors want to see proof that a concept works," says Geeta Vemuri, senior associate at Quaker BioVentures Inc., one of Immune Control's backers.
David Reuter of LLR Partners Inc., a private equity firm in Philadelphia, says potential investors have been holding young businesses to ever more stringent standards since 2000. "There are fewer prerevenue deals being funded," he says. "Today the expectation is that you'd have several customers."
Companies looking to raise their first financing round may soon find a bit of relief, however, says Mark G. Heesen, president of the NVCA, as many VCs are wrapping up older funds and beginning to invest new money. In the second quarter of 2005, venture firms raised $6.1 billion for new funds, nearly twice the amount raised in the same period last year. "With a new fund, the natural inclination is to go out and start investing in early-stage companies," he says. Until that happens, entrepreneurs will be forced to start small and hope to grow into VC candidates. — K.O'S.
It's not often that executives take on the Securities and Exchange Commission and win, but that's exactly what officers of Siebel Systems, including CFO Kenneth Goldman, did when they succeeded in having their case, which alleged violations of Regulation Fair Disclosure (Reg FD), dismissed last month.
Judge George B. Daniels, of the U.S. District Court for the Southern District of New York, ruled that the executives' statements didn't violate the rule, which prohibits companies from revealing material information to select individuals without also informing the investing public. "The SEC has scrutinized, at an extremely heightened level, every particular word used in the statement, including the tense of verbs and the general syntax of each sentence," the judge wrote in his ruling. "No support for such an approach can be found in Regulation FD."
The ruling is likely to increase the comfort level when executives speak one-on-one to analysts and investors, but it is not expected to remove the responsibilities of Reg FD. "Companies still need to have the proper disclosure controls in place," says Louis Thompson, president of the National Investor Relations Institute. — J.McC.
Dividend or Buyback?
Since the tax on dividends was reduced, conventional wisdom has held that they would become a more-popular option for companies with cash to spare.
But what conventional wisdom overlooked is that a dividend, once scheduled, is hard to rescind. Brian Jennings, CFO of Devon Energy Corp., says companies are still worried, tax changes notwithstanding, that any future reductions in dividend payments would send a negative signal to investors. "When you raise that dividend, you need to make a very firm commitment that you can sustain it through perpetuity," he says. So instead of offering the increase, the Oklahoma City–based company is buying back its stock. In September 2004 and August 2005, Devon Energy announced plans to purchase an aggregate 100 million shares, about 20 percent of its total, from stockholders.
The company is not alone. During the first half of 2005, U.S. companies announced plans to repurchase $126 billion of their own shares, 76 percent more than during the same period of 2004, according to Thomson Financial. The prize for the largest buyback goes to Procter & Gamble, which declared it would borrow $24 billion to buy back up to $22 billion of its own shares, as well as those of Gillette.
Larry Hess, who covers P&G for Moody's Investors Service, says that while his agency "prefers in general to see firms invest into their own corporations," P&G has successfully used the buyback as a tool to convert its "stock-for-stock" Gillette acquisition into a cash transaction. Despite the strain on creditworthiness posed by the cash expended on buybacks, he sees companies' logic from the CFO point of view all too clearly. "Share buybacks can be turned on and off quickly," he says. "As opposed to cutting dividends, which companies are loath to do."
Eric Edelstein, executive vice president and CFO of Griffon Corp., a $1.4 billion manufacturer of specialty building products and systems, notes that his company has debated offering a dividend, but has never done so. "We consistently bought back our own stock over the past 12 years," he says. "A buyback is effectively similar to a dividend program, but you have more control." — Ed Zwirn
Employees raid their 401(k) plans when they change jobs.
Plenty of employees are still not getting the message that they could jeopardize their retirement if they tap into their 401(k) plans. According to a Hewitt Associates study of nearly 200,000 workers, almost half of employees cash out their 401(k) plans when they change jobs. And it's not just younger workers: more than 42 percent of those age 40 to 49 elected to cash out upon leaving their jobs.
Corporate Divorce Insurance
When mergers go south, untangling them can be costly. "If a deal goes bad after it's completed, you almost never see the eggs successfully unscrambled," says Frederick Joseph, co-founder of investment-banking firm Morgan Joseph & Co. "Both sides will see litigation, huge breakup fees, and possibly a major decline in stock value."
To alleviate the pain, some suitors are structuring stock and cash deals to produce a positive tax treatment in the event of a breakup. Sometimes called corporate divorce insurance, such deals are structured as taxable reverse mergers, in which the targets are considered the surviving entities. The selling stockholders are forced to pay a 15 percent capital-gains tax up front on the cash as well as the stock portions, but the combined entities are protected from paying a 35 percent tax if the acquired assets are later resold. This type of structure was used in Whirlpool Corp.'s recent purchase of Maytag Corp., and in Johnson & Johnson's deal to buy medical concern Guidant Corp. "We expect this trend to gather steam and eventually become standard operating procedure for these so-called cash-option mergers," says Robert Willens, a tax expert at Lehman Brothers Inc. in New York.
While cash and stock combinations are commonplace, some firms include nominal amounts of cash in mostly stock deals. For example, after discount broker Ameritrade announced its plan to buy the TD Waterhouse unit of the Toronto-Dominion Bank, it tossed an additional $20,000 in cash into the mostly stock offer, thus changing it from a tax-free deal to a taxable transaction.
"It's tax arbitrage," says Willens. "It creates a disadvantage to shareholders of the target by making them pay tax now for a benefit down the road."
But pondering an exit strategy isn't the best way to start a relationship, notes Alan Alpert, global transaction services managing partner at Deloitte & Touche. "It's all about the right purchase price and making sure the acquisition is in line with current corporate strategy," he says. Focus on that, he adds, and marrying companies won't have to worry about a breakup. — Jim Montalto
In the minutes immediately following the London terrorist bombings in July, leaders of the Bank of England, the Financial Services Authority, and HM Treasury logged on to a secret Internet chat room to talk about how major financial institutions were coping.
Such a quick response is the key to keeping markets stable when disaster hits, says Jim Brooks, senior vice president of crisis and security management at Control Risks Group. The United States maintains a variety of communication mechanisms to keep its markets open and relatively stable in emergencies, or to allow leaders of financial institutions to discuss closing the markets, as they did after September 11. "When a problem occurs, the Securities Industry Association is the command center," says Steven J. Randich, CIO of The Nasdaq Stock Market Inc. Prescheduled conference calls are planned to keep the leaders of the major exchanges and financial institutions informed in the event of an attack. The exchanges are also linked by a prioritized phone network designed to work even if normal phone lines are overloaded.
The Securities and Exchange Commission, the Federal Reserve, and the Office of the Comptroller of the Currency are working to improve emergency plans. In 2003 they issued an interagency paper on the subject, and the Department of Homeland Security has conducted several exercises that assess the readiness of the SEC, the Federal Reserve, and Treasury. In addition, the DHS and Treasury are developing emergency programs to coordinate communication and activities between the financial sector and federal, state, and local government officials. — Laura DeMars