TARP for Dummies

Quick post:
Very funny TARP for dummies from PEhub http://tinyurl.com/cj7rmv

IBM buying Sun - good or bad for business?

There is an interesting article in the WSJ about the potential acquisition of Sun Microsystems by IBM. There are a few issues that the WSJ did not address that are direct affects of this transaction to the venture capital and IT oriented private equity markets.

1) One less acquirer -

There is only a handful of large tech oriented companies in the world that are active acquirers of tech businesses and pure innovation. Sun Microsystems is one of them. They did more than 20 transactions in the 1990s and more than 20 in this decade. Sun has not been such an active acquirer of Israeli tech (like IBM), but they acquired Aduva and they have a nice sized R&D center in Herzeliya. The VC / PE model is based on M&A exits to provide financial returns. More than 80% of exits are M&A. The M&A market will shrink after this acquisition. This handful of companies in the world understand that in order to sustain market leadership and in order to grow shareholder value is through organic AND inorganic / strategic growth.

Parenthetically, most large Israeli companies do not realize that acquisitions are necessary for value creation. Case in point, lets quickly explore arguably the star of the Israeli tech scent - Check Point. They are the founder of firewalls. Great internal innovation. Selling software at close to 100% gross margins and 40%+ net margins consistently. Sitting on a huge bag of cash. And only making small or distressed acquisitions - not strategic acquisitions. Growth is hurting and shareholder value is relatively low, compared to other active acquirers in the security software space - companies with less cash and worse operating performance (see MFE, SYMC, etc). But value is forward thinking. Forward thinking = longer term and strategic thinking, not just tactical. Therefore, acqusitions are key for large tech companies to grow.

2) Sun has more than 30,000 employees

"Consolidation" and "efficiencies" are code words for firing and shutting down units. This has good and bad implications. Mostly good for our industry, since it forces good people to enter the work force - where many will enter in start up world. This generates the recycling model, allowing for sound investment opportunities. This is true for Israel as well, where IBM has been and will be an active acquirer of Israeli tech. They have subsequently created R&D divisions across the country - Jerusalem (iPhrase, Unicorn, etc), Haifa (historical applied research center), and Tel Aviv (XIV, Diligent, etc).

3) BPM

Lastly, a bit more closer to home, within some period of time after the acquisition, there will be one less BPM player competing in the market (disclosure: Goldrock Capital is an investor in PNMsoft). Sun acquired SeeBeyond and is now called Sun Java Composite Application Platform Suite. And IBM made BPM acquisitions with FileNet and ILOG. It will also take some integration time for IBM and Sun, and may set them back in the market a bit. We shall see!

No more need for leverage in the Private Equity business?

Is seems that for the past year, a trend has been developing in private equity. Non leveraged buyouts. deals are harder to find. credit is harder to secure. LPs are 'unsure' if they want funds to call capital. So the funds are getting creative to be able to continue to invest. The funds must pay much cheaper pricing and have a story that can convince LPs that the upside is huge. Risk, or course, is higher, since the funds have to deploy much more capital per investment, and the value of the asset must significantly increase to exit with a profit. In the old days, LBOs could make serious returns without creating too much value - since profitable businesses would be paying off the debt, paying less corporate tax and within a short period of time - paying off the debt while the fund owned the company. The funds could do 2-3x without creating any value!

Will LBOs continue to exist, or will only a handful of EBO value generators take over - leaving behind the days of financial engineering?

A few big LBOs have been seen trying to move to the EBO model - like Advent, Hellman & Friedman, and others.

Here, at Goldrock, we are pure equity players - and we strive to assist our companies to grow and create REAL shareholder value. Will see if the rest will follow...

The climate is Right for innovation

I would like to draw your attention to an interesting blog posted today by PNMsoft on innovation. I liked their realism, connected to a desire not to give up on innovation as a culture. Since I know the guys over there pretty well, you can assume that they have their feet on the ground and use innovation as a driver for furthering their business in a way to give benefit to their customers, rather than for its own sake. This helps them to keep the right balance and perspective during these uncertain times - happy reading!

Gartner's Kathy Harris is pushing the innovation agenda in her latest blog. "The climate is right for innovation and organizations that don’t change may lose their edge or even disappear. You can’t not innovate"

Kathy's innovation strategy is a bit ahead of its time.

Most companies are in the midst of the credit crunch. Their focus is on survival. Some will cut projects, some will cut staff. Long term planning usually gets chucked out the window in times like these. Innovation budgets are slashed. It takes real guts to be able to sit down calmly and think of innovation.

But when the panic dies down, and company execs realize that the new circumstances requires rethinking - they will find Kathy's strategy "spot-on". Companies will need to innovate in order to remain competitive. Most current business models are no longer sustainable.

"Innovation is the ability to see change as an opportunity - not a threat."

The current crisis (burning platform) is a great driver for innovation...

Click here to read more

Leadership as a Management Tool – or How to ask for a Cup of Tea

I have the great privilege of seeing many mangers at work (and some at play). In many cases our interaction with management is during a process by which we are checking their company out as a potential investment. This naturally means that they are in "sell" mode.

As a potential investor I have to try and find ways of getting behind this and discover what the manager is like in "real life" situations.

I have learnt that sometimes the really small things are the ones to watch for. How a CEO asks for a cup of tea from a secretary or colleague. How other employees talk to him during a tour of the office, or just as he is walking down the corridor. How management refers to one and other in meetings, and indeed what view they take of the contribution made by others in the organisation.

Why do I apply importance to these matters?

For me one of the most difficult intangibles when looking at a potential investment is the leadership skills or style of the management of the company. This typically starts at the top and is usually reflected all the way through the organisation.

In order for a small company to grow there needs to be strong leadership from the front. This leadership needs to encompass all of the employees and in many cases partners and shareholders of the company too.

Authoritarian style alone cannot achieve this, in order to the maximum from the company everyone must feel that they are making a contribution, and that this contribution is valued by the company's management. This in itself engenders out-performance by employees at every level as they strive to improve the company that they now identify with.

Managers can and must be pro-active in this area, and this style must be prevalent at all levels of the company:

• Lines of communication must be open and transparent: Employees, Management, Investors, Board, Partners etc
• No idea is a stupid idea
  
• Make sure that you interact with as many employees as possible on a regular basis
• Don't just talk about immediate goals
• Use the time to understand what employees and partners would do if they were CEO for the day
• Lead by example
• Be accessible
• Earn the respect of the company, don't demand it!
• Recognise the strengths and weaknesses of those around you

These are just a few ideas about how to lead the company that you are trying to grow, in adverse markets you need better than average performance from the entire company in order to continue to grow. It is your job as a manager to achieve this, and it can only be done if you succeed in inspiring rather than demanding.

Management who either have this or learn it will be the ones to come out of the downturn, not just in survival mode, but also stronger.

Good luck!

Is Mark-to-Market a Good or a Bad Rule?

For those of you who aren’t familiar with mark to market, the term refers to the present day value of an investment, regardless of how much was originally invested. It was put in place as a part of US GAAP in the early 1990s, and the use has increased steadily over the past decade, primarily in response to investor demand for relevant and timely financial statements that will aid in making better informed decisions (according to Wikipedia J).

A good example of mark-to-market is people’s homes. Let’s say you bought your 2 bedroom apartment in Miami Beach for $300k two years ago. Taking into account the current real estate market, if you were to mark-to-market the current value of the apartment it would probably be closer to $200k.

Companies like GE, Citigroup, Bank of America, Wells Fargo, and many other financial institutions would benefit greatly if mark to market accounting were suspended.

The largest example is probably AIG. Currently, AIG is a $1b company, give or take. The stock is teetering at around 50 cents! Compare that to Bank Hapoalim – Israel’s largest bank – which has a $2.2b market cap – with a tenth of the assets! AIG became insolvent and was subsequently bailed out by the US TARP, due to mark-to-market accounting standards. Without mark-to-market, it would have survived. But would this been a good thing, or a perpetuation of the financial facade?

But more importantly – to save the global economy - the question is would suspending mark-to-market be a good idea or a bad idea to stimulate or save the economic meltdown? Two options:

1) Bad: Suspending mark-to-market accounting could completely destroy the financial system, since banks would be able restore assets to their original value and investors would have a much tougher time understanding the true value of these companies.
2) Good: On the other hand, on paper the banks would look more attractive and the investment dollars would return to these institutions. Subsequently, lending / borrowing would be restored quickly, and perhaps the underlying values would slowly catch up to the paper value.

I am not an economist, so thoughts?

Sport and Politics

Sadly over the last few couple of weeks we have been witness to several occurences where sport has been badly overshadowed by politics or terrorism.

As a lover of sport I have always found it remarkable that it is often used to as a way of creating leverage through the influence politics has on these situations.

The three most recent incidents are:

• the visa row in Dubai, when two Israeli tennis players were denied entry because of where they came from. In this case, due to some fairly heavy international pressure and fairly obvious financial threatening, the Dubai authorities relented allowing the second of the two banned players to enter.
• The second tennis incident is the David Cup match in Malmo that was played behind closed doors,without any spectators from either side (Sweden or Israel), under the guise of security considerations. In the background to this decision there seems to have been some political influence, rather than pure security based concerns. In this case it does not seem to have worked out for the Swedes as they lost the tie.
• Finally and far more seriously was the terrorist attack in Pakistan on the Sri Lankan cricket team. This is an outrageous crime, which will create potential long term damage to cricket in general and Pakistan in particular.

We are living in very unstable times, and there is increasing tension around the globe as uncertainty on both political and economic problems blend to form a potentially toxic blend of unrest.

Perhaps it is naive to believe that we can keep sport and international politics separate, but we must hope that this remains the case. otherwise it will be a signal that there is very little left in our lives not tainted by the wider political environment.

Be Smart not Right!!

Sometimes the best option is to be smart not right.

I note in the press that Sage (~15,000 employees and over $1.8bn in revenues worldwide) is having a spat with Kashflow, a tiny company in the UK.

The reason for the spat is that Kashflow, which offers a SaaS based accounting offering to UK SME's has made some allegedly disparaging remarks about Sage. The facts of the complaint will undoubtedly be reviewed by the Trading Standards Authority and if necessary they will oblige Kashflow to retract or change the information.

I can't help feeling that the only beneficiary of this now public row is Kashflow, who seems to be receiving disproportionate coverage for the size of company. Sage has unwittingly given this minnow an equal platform and in so doing has vastly increased the market's awareness of their existence. PR like this they could not have dreamed of.

If I were a psychologist I might analyse the situation by surmising that Sage is feeling a little raw that their SaaS has been withdrawn and that Kashflow seems to have got it right - perhaps a case of wounded pride from the clear market leader.

Dealing with competition and upstarts sometimes requires muscle, but occasionally patience and the ability to ignore can be just as relevant as a strategy.

Sage – please take note!

Humility - The Lesson for 2008 (and 2009?)

I have been thinking about the real message of the financial and economic meltdown. There are some obvious ones:

• The management of risk
• Use of historic models to predict economic and financial outcomes
• Level of ethical behavior within international financial institutions
• Level of trust we give to commercial and financial counterparties

I could of course go on, the list is long, and there will be many books published and academic courses written relating to these and other results of the financial meltdown we have experienced, and the uncertainty we are likely to have to suffer.

My bottom line is somewhat simpler, and can be applied across the board by almost anyone in business, and many of those who are not.

Humility as a business tool sounds somewhat counter-intuitive, at least it does to me. When we think of Gordon Gekko from the film "Wall Street" that is not the first characteristic that springs to mind. In fact, that is also the case when I think about most characterisations that we are familiar with in modern culture in relation to business and financial leaders.

As investors in growth companies we expect our founders/managers to have confidence, not to say exuberance about their capabilities and the heights to which they can lift their companies. We would probably not invest in them if they did not possess these qualities.

The problem seems to be that this confidence and optimism has been replaced by a pervasive hubris leading to a feeling that we are untouchable and basically financial and business geniuses.

This was true at least until the last year or so. For me the world is now splitting into two categories of managers:

• great managers, but have realised that they are not "Kings of the Universe"
• the rest!!

The ability to be at least a little humble should not in any way decrease one's abilities to build companies or create shareholder value. It can however lead to a situation whereby you do not believe you have a monopoly on wisdom or all the answers. Other people inside your company and without may have a real contribution to make, with ideas that you had not thought of etc.

One way to detect humble behaviour is shown by a person's ability to admit mistakes. A great example of this appeared at the weekend with the publication of Warren Buffett's annual letter to Berkshire Hathaway's shareholders. On several occasions Buffett not only admitted his investing mistakes for 2008, but also castigated himself for making them, taking personal responsibility for these acts. Let us remember that Buffett's not the CEO of a failed or nationalised financial institution; it is still the most liquid of all the financial or investment companies, and will be so for some time to come. (By the way the letter is highly recommended reading - make sure to do so each year).

I had the enormous privilege of having a Father who possessed great skills in business, but also never over estimated his own personal abilities, allowing him to enjoy the contribution of others in the creation and building of Sage.

I hope that I am able to take this lesson for myself this year, and that you have the confidence to think about this, without worrying that it may diminish your business success!

Common Sense - The Module not Taught at Harvard

It goes without saying that the current climate is creating great difficulties for companies trying to grow. It is hard enough just to survive! Most sources of capital have dried up, leaving managers and company board's scratching their heads about how to navigate the uncertain period.

For what it's worth, we are globally pessimistic with respect to 2009, and somewhat unsure about the prospects for 2010. If I had to guess I would suggest that when economic growth does return it will not be stellar, and will be accompanied by inflation as the money printing eventually take its toll.

As most other active fund mangers have done we remain in close contact with our portfolio companies at this time, in an effort to help them amend business plans to bring them in line with reality. We have seen some funds send out very radical presentations, which have inevitably been sent across the entire web, more or less prophesying melt down and advocating slash and burn tactics to stay in business. Perhaps the most famous of these is the now infamous Sequoia Good Times RIP presentation.

Whilst it is true that trimming the expenses has to be part of the survival strategy we do not think that is should be the only tool, and in fact each company has to look at its own unique situation before making possibly fateful decisions, with medium and sometimes long term consequences.

Common sense as a business tool is somewhat under rated, and to the best of my knowledge is not "taught" as a separate module in the great business schools of the world. Nevertheless at times like this (and probably even in the good times) it is helpful to remember how this "business philosophy" can illuminate the economic darkness in these trying times. A couple of common sense examples for us might be:

• Looking closely at what is really core to the business:
  • This does not mean only core revenue streams, or profit centres; but which people or products could I not do without in the running and future of my business.
• Is my sales messaging or branding suited to the current environment
  • Business savings and efficiencies, as opposed to faster go to market
• How can I shorten sales cycles or delivery lead times:
  • Emphasis on existing customers, or market niches where I have proven success
  • Pricing strategy or financing terms
    

Obviously these are specific examples, based on our own companies and experiences, probably different to the companies relevant to your universe. I would like to draw your attention to a great article published over the weekend in the Jewish Chronicle of London, based on an interview with Dan Schwarzmann, the PWC appointed administrator for Lehman Bros – what a headache that must be! I am grateful to one of our LP's who brought this to our attention and I think that it gives some really sensible guidelines applicable to almost all companies during the current crisis.

Enjoy the article and I hope that it helps you to navigate the stormy waters that we can expect for some time to come.