Corporate Finance

Gillette Deal Gets Nicked

Why the finance chief's job is becoming a revolving door; is outsourcing on the outs?; what's buried in the new bankruptcy bill; the battle over Gi...
CFO StaffJune 1, 2005

Gillette Corp. markets its shaving products as “the best a man can get,” but is its planned sale to consumer-products giant Procter & Gamble the best deal it can get? Regulators in Gillette’s home state of Massachusetts don’t think so.

Secretary of State William Galvin has launched an investigation into the terms of the deal that is testing the limits of how far regulators can go to protect shareholders and the public interest when a large company is pursued by an out-of-state suitor.

At issue is whether Gillette managers accepted a low-ball bid of $57 billion in exchange for massive payouts to approve the deal. Gillette CEO James Kilts stands to earn as much as $165 million upon completion of the merger. Galvin asserts that the managers have withheld material information from shareholders and that the company hasn’t been honest about planned job reductions. “The huge payouts certainly raise a red flag,” says Scott Harshbarger, the state’s former Attorney General. “People don’t like the idea of state regulators nosing around and asking questions, but the questions are appropriate.” While Harshbarger insists Galvin is fulfilling his public duty by investigating the merger, he acknowledges that politics, and the fact that the state has lost two other major employers — Fleet Bank and John Hancock — to out-of-state acquirers, have figured into the inquiry.

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Critics charge that Galvin is overstepping his bounds if his goal is simply to save jobs or protect against the loss of a massive corporate taxpayer, as some have asserted. After all, the purchase price included an 18 percent premium on top of Gillette’s share price on the day before the deal was announced. “It’s not the province of state governments to weigh in on a merger just to [protect against] losing a blue-chip company headquarters,” says Bill Rodgers, a partner at Boston law firm Tarlow Breed Hart & Rodgers PC.

Gillette voluntarily released some information, but challenged Galvin’s subpoenas. A judge ruled that the first set of subpoenas were indeed beyond the authority of the Secretary’s office. However, the judge went on to say that Galvin has jurisdiction over the investment banks — Goldman Sachs and UBS — that issued fairness opinions on the deal and that information used to create those opinions is fair game. Galvin has since issued new, narrower subpoenas. He also subpoenaed four Gillette executives, including CFO Charles Cramb, after the company said it might have deleted E-mails related to the merger. (At press time, a judge had yet to rule on the legality of the new subpoenas.) Shareholders are expected to vote on the merger on June 14. —Joseph McCafferty

FX Effect

Companies looking to hedge against the falling dollar are finding the currency markets a little crowded these days.

During the past 12 months, mediocre performances by stocks and bonds have pushed financial institutions, hedge funds, and other traders into currencies. As a result, foreign-exchange trading nearly doubled in volume in 2004. With current daily trading volume of $1.9 trillion, FX is the largest of the world’s financial markets.

The increased speculation in currency works to the advantage of corporate treasurers who rely on hedging to offset FX costs, because the increase in volume creates a more efficient market. “Although many people have observed that markets have become ‘choppy,’” states Bernard Sinniah, global head of corporate FX sales for Citigroup, “the growing number of participants in the FX market has brought with it a larger pool of opinions. As a result, the risk of dysfunctional market movements has decreased.”

Corporate treasurers are also using more currency options instead of forwards to reduce costs, says Justin Pettit, head of the strategic advisory group at UBS Investment Bank. “For longer-dated hedging two and three years out, out-of-the-money options can be more cost-effective,” he says. —Harlyn Aizley

Reeling In Outsourcing Deals

Even as outsourcing turned into a dirty word, plenty of finance executives still viewed it as a necessary evil. More recently, some of them have begun to view it as just plain evil.

At least that’s the conclusion of a survey released in April by Deloitte Consulting. “In the real world, outsourcing frequently fails to deliver its promise,” wrote researchers, who surveyed 25 companies with average revenues of $50 billion. The study revealed that 70 percent of its respondents have had significantly negative experiences and are outsourcing business processes and IT with increasing caution.

While the survey hardly lays to rest the outsourcing debate, especially since it covers so few companies, there is growing evidence that large companies are rethinking massive outsourcing contracts. Big-name defectors that have unwound at least part of their arrangements include Conseco, Dell, Capital One, and Lehman Brothers.

A sure sign that outsourcing isn’t working is the amount of renegotiation surrounding the vendor agreements, says Deloitte senior strategy principal Ken Landis. “There wasn’t a single participant in the study whose contract went to term,” he says. “All of them had renegotiated prior to the contract expiration period.”

Companies are souring on outsourcing, the survey asserts, for the same reasons it has been criticized for years: failure to live up to cost-reduction promises, risks to intellectual property and confidentiality, and lack of transparency.

“What you’re seeing is a shift,” says Gordon Coburn, CFO of Cognizant Technology Solutions, an outsourcing vendor based in Teaneck, N.J. “Clients are saying that traditional, megadeal outsourcing no longer makes sense.” Companies still want to outsource activities to “best of breed” providers, he explains; they just don’t want to send everything to one provider.

Despite concerns, companies have been hesitant to unwind outsourcing deals completely. While more than two-thirds of those that outsource have had bad experiences, only a quarter have brought outsourced functions back home. “You’ll find fewer organizations moving outsourced services back in-house than vice versa,” observes Michael A. Eck, a vice president in the HR practice of The Segal Co. in New York. That’s because, for the most part, the business case for outsourcing remains strong, he argues. The labor arbitrage, especially for offshore outsourcers, makes the economics work, asserts Coburn. “We can generate significant savings for our clients,” he says. —John P. Mello Jr.

Going for Broke

Think the Bankruptcy Act of 2005, passed in April, was aimed solely at individual consumers? Think again. Major provisions in the act affect Chapter 11 business bankruptcies, and “some of them are profound,” says Jack Williams, a law professor at Georgia State and director of BDO Seidman Financial Recovery Services.

Strict new rules place financial and other limits on the corporate practice of offering retention bonuses to executives who stick with a company during restructuring, for example. Moreover, those executives now must actually prove they have a competing job offer to be eligible for retention pay. “I thought that was one of the crazier things to come out of this,” says Emanuel Grillo, chair of Goodwin Procter LLP’s Insolvency & Business Reorganization Practice. “The whole point of retention bonuses was to keep people from going out to find a job.”

Bankrupt companies must now move more quickly. Their exclusive right to file a reorganization plan may no longer be extended beyond 18 months. That’s plenty of time for most overleveraged companies, says Grillo, but not for unplanned “free-fall” cases. “This will harm companies with significant operational issues,” he observes. For example, industries like airlines or heavy manufacturing that have to negotiate with unions are likely to find themselves pressed for time before predatory creditors submit their own plans. A provision that gives firms just 210 days to accept or reject a lease without the landlord’s consent is likely to put a time crunch on troubled retailers as well.

The act also deleted “investment banker” from the list of those whose conflicts of interest make them ineligible to advise bankrupt firms. As a result, even if they previously underwrote the failed company’s securities, investment banks may now compete with boutique firms to act as restructuring advisers.

Williams worries that the code is moving away from its traditional emphasis on restructuring and toward asset sales. “The notion that Chapter 11 was designed presumptively to permit the restructuring of existing business will be a quaint concept,” he says. “Now, Chapter 11 is going to be primarily an M&A tool.” —Tim Reason

New Chapter

Key business provisions of the Bankruptcy Act of 2005.

  • Debtor company’s exclusive right to submit reorganization plan limited to 18 months
  • Investment banks no longer precluded from advising former clients in Chapter 11
  • Management retention bonuses subject to higher scrutiny
  • Companies have 210 days maximum to assume or reject leases
  • International bankruptcy proceedings harmonized

Take My Job…Please!

Forget the seven-year itch. Most finance executives feel the urge to part ways with their employers before even three years are up. The average tenure of the CFO, according to executive-services firm Tatum Partners, hovers between 30 and 36 months.

The CFO seat is especially hot at large companies. A recent study by recruiting firm Russell Reynolds Associates says turnover among CFOs of Fortune 500 companies increased by 23 percent from 2003 to 2004.

But despite anecdotal evidence (see “Throwing in the Towel“) that CFOs are fleeing the burdens of Sarbanes-Oxley, the research suggests a more complex picture. The Russell Reynolds data, for instance, reveals that the number-one factor was promotion, at 29 percent, compared with 27 percent who left for promotions in 2003. Retirement was the second biggest reason for departure in 2004, although that’s a common euphemism for leaving under less-than-ideal circumstances.

True, resignations accounted for 22 percent of CFO departures in 2004, up from 18 percent in 2003. Clearly, increased regulation, longer hours, and greater scrutiny and liability are contributing to turnover, says Lorraine Hack, managing partner of the Financial Officers Practice at Russell Reynolds. Brian Anderson resigned as CFO of OfficeMax in January after just two months on the job, for example. On the day he left, the company announced an internal investigation into accounting practices.

“One thing we hear is that it’s not fun to be the CFO of a public company anymore,” says Hack. “A lot of CFOs really enjoyed the operational side of their jobs, and some of them are going back into that.”

High turnover isn’t limited to the top spot. The survey shows a 25 percent increase in controller turnover between 2003 and 2004, and an astounding 400 percent increase in resignations. Hack says that although many controllers resigned due to the increased pressure brought on by Sarbox, other controllers left for new positions at other companies, where their CPA credentials have never been more in demand. —Kris Frieswick

U.S. Treasury Going Long Again?

Thirty-year Treasury bonds could be making a comeback. That should be good news for corporate debt issuers, since their bonds generally compete with the Treasury Department’s 10-year notes, which would be used less frequently.

In May, Treasury announced that it is considering bringing back its 30-year bonds — the longest of the U.S. government’s IOUs — which were shelved in October 2001, the last year that the federal government ran a surplus. The bonds would be used to finance record budget deficits. The Bush Administration is projecting a shortfall of $427 billion for this year alone.

The rationale for bringing back the 30-year, says Ken Goldstein, an economist at The Conference Board, is to take some pressure off the 10-year Treasury notes. While the Federal Reserve has pushed interest rates up at the short end of the yield curve, high demand for the 10-year notes has kept rates at the long end steady. “The yield curve is a little flatter than it would be if they never got rid of the 30-year bonds,” he says. The move would spread the demand out a little and could align the yield curve more with the short end, says Goldstein.

For corporate debt issuers, the news shouldn’t have too much of an impact, but it could make borrowing slightly cheaper. David Wyss, chief economist at Standard & Poor’s, explains that companies that generally issue debt in the 3-to-10-year range might do a little better, “because the 30-year competes less with what companies are generally issuing.”

Corporate pension-fund managers should also be delighted. “Pension-fund managers love [30-year bonds] because they offer a guaranteed return that fits with their long time horizon,” says Wyss. “There is a huge demand for long-term assets.” It could also help pension funds, which were forced to benchmark pension obligations with the lower-yield 10-year notes after 30-year bond issues were halted, increasing funding shortfalls.

The final decision to bring back the bond will be announced on August 3. “We will examine if we have the flexibility to issue 30-year bonds while maintaining deep and liquid markets in our other securities,” says Timothy Bitsberger, Treasury’s assistant secretary for financial markets. If Treasury does bring back the 30-year, it will conduct auctions twice a year starting in February 2006. —J.McC.

Lawyers, Nuns, and Money

Companies have been besieged by shareholder activist campaigns that press businesses to be more transparent about their political contributions. The campaigns, which often put managers in an uncomfortable spotlight, are starting to have an effect.

In April, boards at both Schering-Plough Corp. and Johnson & Johnson reported that they intend to publicly post their companies’ political contributions, including monies given to political action committees (PACs).

The decision to divulge the sensitive information came after faith-based investor groups and union pension funds filed shareholder resolutions that would require the two businesses to account for their campaign contributions. “It’s very difficult to tell where the money is going and why,” says Daniel Rosan, director of health-care access at the Interfaith Center on Corporate Responsibility (ICCR), a shareholder advocacy group representing the filers. “Are they giving money that, in the long term, benefits shareholders?”

Other shareholders appear to have similar concerns. According to the Investor Responsibility Research Center, stockholders filed 37 resolutions this year asking corporations to go public with political contributions (up from just two campaign-related proposals in 2003). Margaret Weber, coordinator of corporate responsibility for the Adrian Dominican Sisters, the Michigan-based order that spearheaded the campaign at Schering-Plough, says the ICCR resolutions were spurred by the passage of the Medicare Prescription Drug Improvement and Modernization Act — and the influence drug companies purportedly exerted on legislators drafting the bill. The agreements with Schering-Plough and J&J, says Weber, are part of a push to shed light on “the very public and powerful role pharmaceuticals play in shaping health-care policy.”

The newly released information from Schering-Plough hints at that role. According to company data, the distributor of Cipro and Levitra gave more than $800,000 to politicians and PACs in 2004, with the lion’s share going to Republican candidates and organizations. Two of the company’s biggest donations went to PACs run by senators Bill Frist (R­Tenn.) and Richard Shelby (R­Ala.), legislators not known for their hostility to big pharma. All told, health-care PACs doled out more than $32 million in 2003 and 2004.

Although other shareholder resolutions targeting campaign contributions failed to garner much support (a proposal filed at Eli Lilly and Co. by the Sisters of Mercy got a 6.5 percent yes vote), Schering-Plough and J&J avoided a showdown. Schering-Plough spokesperson Rosemarie Yancosek says the company plans to update the information twice a year. Meanwhile, J&J will begin posting its political contributions in 2006. “We believe this is an appropriate level of transparency,” explains Jeffrey Leebaw, a spokesman for the New Brunswick, N.J.-based company.

Of course, activists are successfully pushing companies to come clean on more than just political contributions. In April, the Rainforest Action Network partnered with shareholders to get investment bank JP Morgan to adopt a “green” lending policy. And after years of pressure from activists, Nike produced a report detailing its difficulties in improving labor conditions in Third World factories.

With directors monitoring company expenses more closely — and plenty of closely contested congressional races expected next year — it’s possible that political contributions could be a very hot topic in 2006. At the very least, some companies can expect to hear from Sister Margaret again. “Our job is to be well in front of the curve,” she explains. “We were way ahead on climate change, too, and now, many companies see it as a legitimate business concern.” —John Goff

New Theory, Same Practice

When the U.S. Supreme Court ruled in March that disparate-impact theory applies to cases of age discrimination, it made it easier for older workers to file claims against employers. Such workers no longer need to prove that their companies intended to discriminate. Now, they simply need to show that the policies in question caused them to suffer a disparate — or different — impact compared with other employees.

The ruling would seem to add fuel to an already roiling fire. According to a report from New York-based insurer Marsh Inc., age-discrimination charges jumped by nearly 20 percent from 2000 to 2003.

Yet employment-law experts say the Court’s decision won’t change much, mainly because of the way the theory will be applied. “Obviously, it would have been preferable for the Court to have ruled that disparate impact does not apply to age,” says Rosemary Alito, a partner at law firm Kirkpatrick & Lockhart Nicholson Graham LLP. “But [at least] the ruling applies it in a less onerous way than in cases of race and sex.” The difference is subtle, but significant: in other discrimination cases, companies must prove there is a business necessity for their policy and no other method by which to achieve their goal; in age claims, companies have to show only that there is a reasonable basis — other than age — for their policies.

Still, the ruling could lead to a slight increase in age-discrimination cases. “In the short term, we could see more cases filed, but going forward [the real impact of the ruling] will depend on how the courts react,” says Kyle Brown, retirement counsel at human-capital consulting firm Watson Wyatt. “If they embrace the reasonable-factor defense, we’ll see equilibrium return.” Judith A. Malone, a partner at law firm Palmer & Dodge LLP, agrees that the ruling won’t have a major effect. At best, “it will cause companies to look more closely at their policies,” she says, particularly when it comes to workforce reduction, salary, and promotions. But that in itself shouldn’t be a big issue, since most companies are already cautious when putting in place policies that affect older workers. —Deana Colucci

America’s Next Top Model

Now that expensing stock options is inevitable, companies are getting to work on valuing them. But choosing the right valuation model can be tricky.

The Securities and Exchange Commission’s April postponement of its compliance deadline for FAS 123R, which mandates expensing of employee stock options, has served to prolong debates about the pros and cons of the different methods that have proliferated in recent months. Companies now have until the first-quarter report of their next fiscal year that starts after June 15, 2005, to make the change.

Sun Microsystems, which has opposed expensing, is taking a tack that many companies are considering: accelerating the vesting of stock options. Sun will avoid pretax charges of about $400 million over the course of the original vesting period. For remaining options the company still has to expense, CFO Steve McGowan says it is still deciding between Black-Scholes and binomial models. “We’re busy loading information into the two different models,” he says.

Many companies will follow that approach, trying different models and using the one that creates the most favorable outcome. FAS 123R allows the choice between the Black-Scholes formula and binomial lattice models that meet the Financial Accounting Standards Board’s fair-value principles. But that hasn’t stopped others from working on variations of those models.

Glenn Bowen of Milliman, a Seattle-based actuarial firm, helped create a binomial lattice-based model that incorporates assumptions based on historical company and industry data to predict the probable future behavior of option holders. Bowen says that models like his “will, all else being equal, probably produce a slightly lower present value.”

Academia is also getting into the act. Stephen Penman, a professor of accounting at Columbia Business School, has co-authored a model that uses what he calls shareholder-value accounting. His method would allow for a “settling up” when the option is either exercised or expires. “If in fact the option is never exercised, you’ve got to actually adjust,” he maintains.

Mark Link, chief accounting officer at Hopkinton, Mass.-based EMC Corp., says his company found little difference in the results produced by the different methods. He says his first financial report in 2006 will use Black-Scholes. “It’s easier,” he says. —Ed Zwirn

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