As disasters go, the dot-com meltdown of 2001 vanished almost as quickly as it arrived. Not many netrepreneurs have offered an explanation of what happened. In the U.S., each month seems to bring a new book on the global dot-bomb, but no such outpouring has happened in Asia. CFOs with dot-com experience have moved on. No one wants to talk. No one, that is, except one young, bright, incredibly earnest man who, in one of the rashest decisions of his life, decided to become CFO of chinadotcom (CDC), one of Asia’s biggest dot-com flame-outs.
In some ways, it’s incredible that Daniel Widdicombe still has a job to talk about. Chinadotcom’s descent has been breathtaking. In its heyday, it raised more than a half-billion dollars in less than a year on the New York and Hong Kong markets. By the end of last year, CDC had lost US$181 million, fired hundreds of staff, watched its analyst coverage wither to the occasional research note, and accepted the resignations of two of its founders. Here’s how bad it is: CDC has a market cap of US$311 million versus a net cash position of US$387 million. Investors do not even think the company is worth what it holds in cash and equivalents.
But this is not just a story of another flaky dot-com bankrupting itself into lava-lamped, bean-bagged oblivion. Widdicombe, who joined in November 2000, knows that CDC’s history is far from conventional. But here’s the difference: An unconventional company, he believes, can become conventional. Yes, the company played fast and loose with some of its accounting practices (see “Finance in the Dot-Com Era: A Round-Trip Ticket,” at the end of this article). But it stayed on the right side of the law, moved out of the sillier side of the Internet business, and is turning respectable. This is the story of a company that just might be saved by its CFO.
Wild in Wan Chai
First, some history. The genesis of chinadotcom began in a dank, 500-square-foot office in Hong Kong’s low-rent Wan Chai district. There, Peter Hamilton, a Briton and former lawyer, and Ian Henry, an Australian with a background in marketing, started an Internet design shop called The Web Connection. The pair produced simple company Web sites but struggled with the huge ignorance at that time about the Internet. Hamilton recalls pitching his services to one executive who, at the end of the spiel, said: “The Internet thing is pretty interesting — how much is one?”
In March 1997, the pair teamed with Peter Yip, chief executive of privately held China Internet Corporation (CIC), which provided computer-based information services to mainland businesses. In January 1998, CIC bought a 51 percent stake in The Web Connection and, in February 1999 these various assets were transferred to a new entity: chinadotcom. Its stated mission was “build, sell, distribute”: Build Web sites, sell Internet advertising, and distribute content through its own portal network.
Nobody did a better job of catching the Asian Internet investing boom than the CDC founders and, for a while, the world was their ATM. CDC’s US$97 million Nasdaq IPO in July 1999 generated an extraordinary US$4 billion in demand. An exceptionally well-timed follow-on in January 2000 netted another US$398 million, US$94 million of which went directly into the pockets of the founders and strategic shareholders. And then, in March 2000, CDC raised another US$168.5 million with the sale of 18 percent of its consumer portal, hongkong.com, on Hong Kong’s second board, the Growth Enterprise Market.
In 2000, flush with capital and finding strong demand for its Web design services, CDC invested with a zest that only an absurdly rich dot-com could muster. It spent US$187.6 million on more than 50 acquisitions by year-end, including stakes in XT3, an Australia-based Internet integrator, and e2e Business Solutions, a Hong Kong-headquartered software and “solutions” outfit. With these acquisitions came staff — CDC’s payroll soared from 285 workers at IPO to 2,400 at its peak — and revenue, which jumped from US$20 million in 1999 to US$121 million in 2000.
Anyone who’s read a newspaper knows the next part. By mid-2000 the Internet investing boom collapsed and CDC’s core services of Web design and Internet ad sales shriveled. New, easy-to-use software tools lowered the barriers to starting up a Web-design business. CDC found itself competing against one-man studios equipped with little more than a Mac and some pirated Flash software. CDC began downsizing, beginning a process that would see hundreds of staff pared from the payroll.
Management also began leaving. The Web Connection founder Ian Henry resigned in October 2000. He would be followed by The Web Connection president Steve McKay, who left in early 2001, and Peter Hamilton, who announced his intention to resign as COO in October 2001.
Boarding a Sinking Ship
Widdicombe joined CDC in November 2000, possibly the company’s lowest point. For the nine months ending September 30, 2000, the company announced net profits of US$73.3 million and an eightfold revenue boost. But beneath these figures ticked an amortization time bomb in the form of 65 Internet investments, many of which were unreformable money-losers. Its balance sheet creaked with the weight of US$50 million in accounts receivable. The share price was down about 90 percent for the year.
“A few weeks after I arrived we announced our fourth-quarter 2000 results and I think we lost US$130 million. There had no been no cleanup of the balance sheet at that date, and we had to make significant write-downs for impairment on some of our investments,” says Widdicombe. “So really, from day one it was firefighting,” he says. Widdicombe knew what he was getting into. He had been involved in the firm’s Nasdaq IPO in a former role as head of Internet and telecoms research at Bear, Stearns. Widdicombe also knew Peter Hamilton — CDC’s interim CFO, whom Widdicombe replaced — through his previous job as CFO at I-Quest, a broadband access provider. Hamilton served as a board member at I-Quest. The CFO rolled up his sleeves and got to work. The company would report US$137 million in write-downs in CDC’s 2000 annual report, and this cleanup would continue through 2001. Last year, he stripped the books of US$52 million in goodwill and questionable investments. Today, everything in the US GAAP-compliant accounts suggests frugality and conservatism.
Widdicombe’s efforts have resulted in a 62 percent decline in accounts receivable and cash due from related companies. Operating costs came down by a third in last year’s fourth quarter alone. Staff, including senior management, took pay cuts. He also oversaw the implementation of a rigorous job reporting system that tracks employee billable hours and “value added.”
While the company is still making losses, it has shed unprofitable businesses and keeps a keen eye on margins. Whereas, in 2000 CDC was closely identified with the china.com portal or The Web Connection, now the company is more inclined to talk about e2e, an Oracle reseller, or Ion Global, the name of its Web consultancy.
Churn, Baby, Churn
While Widdicombe oversaw the company’s move into more profitable, stable businesses, he has also weaned the company off much of its “connected” party transactions. The practice, known as churning, involves passing money from one subsidiary or invested company to another. In one sense, this is all normal and prudent. Companies that belong to the same group or which share investments would naturally be inclined to pass business between themselves. But the sheer complexity of CDC’s past intergroup transactions raised questions.
For example, most of the income declared by subsidiary hongkong.com, a consumer portal operation, in 2000 came via these “connected” transactions. It reported a HK$4.4 million (US$565,000) profit in 2000 on HK$79 million (US$10 million) in turnover. But, as the company details in notes in its 2000 annual report, HK$45 million (US$5.8 million) of that income came from CDC-related parties. For example, hongkong.com reports that it had an agreement with CDC subsidiaries 24/7 Media Asia and The Web Connection by which each would pay US$100,000 a quarter to hongkong.com. What did they get for their money? Their logo and a hyperlink on the hongkong.com portal.
Spending US$400,000 a year for the privilege of linking to an affiliate’s site might seem excessive, but the spending had no effect on CDC’s bottom line. As 81 percent owner of hongkong.com, all hongkong.com revenue is consolidated onto the CDC accounts.
Most of hongkong.com’s “connected transactions” in 2000 were with China Internet Corporation, CDC’s former parent. CIC had a licensing agreement with AOL in which it would sell ISP services under the AOL brand. Hongkong.com reported HK$31.5 million (US$4 million) in income from CIC in 2000, in return for services it provided in the running of AOL Hong Kong. Widdicombe says CDC received, in total, US$21 million from CIC for the provision of AOL support services in 2000, which includes hongkong.com’s US$4 million. There is nothing apparently wrong about that. Most of the abuse of public companies involves a flow of money in the other direction — from publicly listed entity to private concern. However, Widdicombe acknowledges that CDC made a loss on the provision of services to CIC. In other words, it received US$21 million from CIC, but spent more than that providing the services for CIC. Widdicombe won’t disclose how much it spent on CIC-related services in 2000 but admits: “It was a negative return for the company.”
Three of CDC’s board members serve as directors at CIC, including CDC CEO Peter Yip who also holds “significant” equity in both companies. Widdicombe assures that all transactions between CIC and CDC companies followed the best corporate practice, and denies that the relationship has even the appearance of a conflict of interest.
Nevertheless, Widdicombe says CDC exited from its loss-making joint venture with CIC in 2001 — an extraction he says CDC needed to “treat carefully.” There is generally less connected revenue coursing through the company’s intergroup accounts. For example, hongkong.com only derived 1 percent of its turnover via connected transactions in 2001, compared with 57 percent in 2000. Widdicombe says that 98 to 99 percent of CDC revenue nowadays is derived from large blue-chips. Real money for real services.
Today, Widdicombe describes himself on the china.com Web site as being on a “mission to break even.” In addition to the divestment and write-down of most of CDC’s dot-com stakes, he has helped the company move into the broader and more profitable business of Internet consulting and systems. Instead of talking about portals, Widdicombe likes to steer the conversation toward Ion Global, the name of its Web consultancy. Ion Global builds and designs Web sites, and advises companies on Internet strategies (for example, how to craft an identity for the Internet or how to find and target customers via the Net). Ion Global has offices throughout Asia Pacific, and its most promising market is China: it retains as clients mainland blue-chips such as Tsingtao Breweries, Beijing Telecom, China Southern and China Eastern Airlines.
Widdicombe also oversaw a steady reduction in operating costs, such that they fell by half on an annualized basis in the most recent quarter. A lot of the reductions have been in salaries. Some employees took pay cuts while others were laid off and then rehired as consultants. Some were put on sabbaticals so that they will be available when business improves.
Widdicombe makes wide use of a job reporting system, which asks employees to clock in and book their billable hours. This was very unpopular at implementation as many at CDC felt that Internet companies demanded a different kind of workplace — non-hierarchical, non-authoritative, and non-rule-bound. “The first challenge was to get people to actually log in their hours,” says Widdicombe. “We started to say, if you don’t keep your time sheet you’re not likely to get all your pay this month. We took a hard line,” he says.
Some of the cost-cutting was painful. For example, the company ended its Internet incubator business, called Jump Start, in early 2001. By pulling the plug, CDC cut support to about 15 Internet companies in which were distilled the hopes, dreams and life savings of the founders. Not surprisingly, some of these are bitter about the experience. “I don’t think I would use the word ‘positive’,” says Patricia Tung, cofounder of cwow.com, when describing her time in Jump Start. Adds looks.com founder Ian Smith: “It was a very difficult experience.”
A New Company
The upshot of all this is improved margins. Stripping out one-time items, CDC lost less than US$3 million in the last quarter. “We expect our first-quarter net loss will be single digits (of US$millions) for the first time in the company’s history,” says Widdicombe.
Widdicombe’s background may be pure dot-com, but his sensibility is entirely CFO. He believes in balanced, credible books and he believes in transparency. He was fully cooperative in the reporting of this story, giving hours of interview time and offering direct, meaningful answers to all questions. He wants to explain his company. And, in fairness, this has always been a strength of CDC. The company has excellent disclosure on its Web site. Its annual report is a rigorous, comprehensive document. And, like Widdicombe, CDC management is typically accessible to investors and media, talking straight with a minimum of spin.
But is that enough to secure the company’s future? Despite having lost so much money on its investments in 2000, the company is still talking about acquisitions — a fact Goldman Sachs analyst Rajeev Gupta calls “worrying.” There is also the issue of hongkong.com. The company listed to much excitement with an “E-tail” business plan. Specifically, it was going to offer the Hong Kong shopping experience over the Internet to consumers around the world. But since listing, hongkong.com has mostly sat on its money. About three-quarters of its earnings in 2001 were in the form of interest earned from cash and securities.
But in all other ways, CDC looks more solid and mature. Its share price is ticking up. It has absorbed the worst of its write-downs, and it looks on the verge of profitability. And Gupta says Widdicombe can be credited for much of this good news. “Dan gives it to you how it is,” says Gupta. “He’ll admit that they had operating expense issues all along, and now they are under control. I think he deserves kudos for what they have achieved,” he says.
Chinadotcom, welcome to the grown-ups’ table.
Jasper Moiseiwitsch is a freelance writer for CFO Asia based in Hong Kong.
Finance in the Dot-com Era: A Round-Trip Ticket
At the height of the dot-com mania, Internet companies pulled all kinds of accounting tricks to improve their revenue and profit figures. Analysts and bankers winked at these numbers. It was all part of the effort to take these companies to IPO. But, as the Enron scandal has illustrated, reported figures have to be meaningful — not just US GAAP-compliant. The dot-coms’ balance sheet acrobatics of two years ago would not be tolerated today.
One of those maneuvers was a practice known colorfully in the industry as “round-tripping.” This involved investing in a start-up company with the understanding that it, in turn, would use part of the money to buy goods or services from the investing company.
Chinadotcom (CDC) provides a fine example of how this worked. In 1999, CDC began investing in looks.com, ultimately investing about US$1 million in the duty-free cosmetics retail site. An early participant in CDC’s Jump Start incubation program, looks.com was also a client of CDC subsidiaries The Web Connection and 24/7 Media Asia. Looks.com founder Ian Smith guesses he returned about 40 percent of the invested money to CDC in the form of billable services, and he believes most of those incubated in Jump Start were obliged to buy services from CDC. Cwow.com co-founder and Jump Start client Patricia Tung, for one, confirms that CDC specified the purchase of their services in the contract terms sheet.
Round-tripping is controversial because it was the source of so much accounting waffle in the frontier days of dot-com investing. Connected parties would pass revenue back and forth between each other, with the result that everyone’s numbers looked better. Chinadotcom CFO Daniel Widdicombe openly acknowledges that CDC was involved in the practice, but says investee dot-coms only fed about US$2.5 million back to it in 2000, that the income was fully GAAP-compliant, and that it was used in the purchase of valid services. “Entirely legitimate, not material,” summarizes Widdicombe.
But Smith of looks.com questions the validity of at least one transaction. Hongkong.com declared in its 2000 annual report that it took HK$538,000 (US$69,000) from CDC for “reimbursement of [hongkong.com] costs incurred in establishing and maintaining co-branded Web pages.” The co-branded Web pages refer to an agreement between CDC and looks.com, by which looks.com would pay for the development of Web sites that would market and sell looks.com products. Smith says he never saw any of these Web pages and that he never paid for services related to development of those pages.
The looks.com contract with CDC stated delivery of services in 1999, or about a year before Widdicombe became the chinadotcom CFO. Nevertheless, he addresses the issue. He agrees that Smith never paid for the co-branded pages but says the services were produced — chinadotcom just took the write-off. “I talked to hongkong.com executives, and they confirmed for me that these pages were produced. Absolutely,” says Widdicombe. And around it goes. … —JM