Thursday, March 23, 2006

Project Velocity

resist the need for speed At some point as discussions with a prospective target advance, us buyout firms want to lock the seller into advanced discussions that exclude other competing firms.  After a certain point this only makes sense.  We, the buyout firm, are about to spend a pile of money on lawyers, consultants and our own time and travel to assess the business more completely.  We're not going to spend that sort of money so some other firm can come and snatch it up at the last minute.  Typically this is after the seller has gotten an offer from us (that is contingent on our doing due diligence) and likes it better than what they already have on the table.

Shifting into "exclusive due diligence" is usually the next step.  For some period (60 days perhaps) the seller is prohibited from talking to other potential buyers.  The buyer feels safe, therefore, that the deal is their's to lose and they can commence more intense (and expensive) due diligence.  This can lead to abuse, as we run into occasionally including just this week on "Project Velocity."

If a seller is foolish enough to be obvious about the time pressure attached to a deal it is pretty easy for a private equity firm to construct an exclusive diligence schedule that makes it impossible for the seller to keep a firm timetable if negotiations break down.  Of course, many firms abuse this by putting high bids in their letters of intent and then working down the price aggressively on the excuse that substantial "problems" or "risks" were discovered during the diligence process.

By the time these revelations are uncovered, the opportunity for a competitive auction is limited at best.  The seller is stuck.  Some sellers are wary of this nuance.  Others are not.

Project Velocity involves a wholly owned subsidiary of a massive high tech firm (Velocity) you would surely recognize the name of.  It used to produce a key product for the market which was, within 2 years of being the singularly most revolutionary development in its category, another runner in a large pack.  In the last 3 years it has become entirely obsolete.  Fairly typical for tech firms with steep research and development curves that don't know how to manage their development properly.  More on this later.

Velocity, however, is bound to several long-term support contracts to maintain the product.  They need to continue to produce it and provide replacements.  Of course, back "in the day" it was common for large tech firms to sign up massive multi-year maintenance contracts (and book much of the revenue up front in some instances) figuring, in their arrogance, that they were certain to be the chief supplier for 7 years.  So now Velocity has a problem.  They have to honor these contracts, but they have long since left the manufacturing business and, instead, have "transformed ourselves into a service company."  Or so their latest public filings say.  Did I mention yet that Velocity pissed in excess of $500 million in IPO money away in under 5 years?

From my perspective, Velocity's problems started with their product being too good.  Yes, too good.  Riddle me this:  If you developed and patented an aircraft and air transportation system infrastructure system that reduced the price per mile of flying, price per pound of lifting goods and increased the lifetime between service of aircraft all by an order of magnitude, would you immediately set up transportation to all corners of the globe with this new system?  I would suggest that the answer here is "no."  Particularly if you were in the business of selling and operating such systems.

Rather than blowing away the market, you would improve things in increments, each time beating your competition's latest cost structure by about 10%.  Constantly one-upping them every time they improve and meanwhile causing them to tear out their hair in clumps wondering how the hell you were doing it and waiting for you to bankrupt yourself in a price war of their making (which you can never lose).  You would avoid the "single blip" approach because you would destroy all competition (and have the Justice Department all over you).  Also because you would leave significant revenue on the table.  You'd also destroy your own market.  The fleet you put in the field today would not need replacing for 200 years.  You'd never sell another aircraft.  This is a crude and heavily disguised example of what Velocity did to itself.  They commoditized their own market.  So severely, in fact, that being in the business has become a chore.  Innovation that went too fast.  Too much Velocity.  Sound Machiavellian?  Well, that's my job.

So now they want someone to take over the business.  It's "non-core."  We were the only ones talking to them until a pair of other firms got involved.  One firm, we happen to know from experience, is notorious for using the due diligence gambit to squeeze firms. Velocity wants to get something done before they have an earnings call for the first half.  They are playing right into the hands of our little diligence predator who is promising them the world, but requiring 90 days of exclusive diligence.  What can we do but warn them that their near-term and unintellectual greed (which ironically got them in trouble in the first place) is about to end poorly for them?  Nothing.

To paraphrase Gekko: Intelligent greed works.  Blind greed (ahem, quarterly earnings guidance) is counterproductive.  That is, of course, unless you are a consumer.  But why should we care about consumers?  No one else does.  Consumers were commoditized long ago.

Tuesday, April 04, 2006

Speed Bump

ga-thunk Closing Project Velocity has taken a turn for the worse.  Or, I should say, the larger issues that have always been contained within Project Velocity have begun to emerge.

From the beginning we suspected that the involvement of other private equity firms would either price Velocity beyond the scope of reason, or make the process too prolonged and difficult to manage.  Both are now true.

Velocity's management has responded to our letter of interest, and more particularly to the pricing range we offered, with the mergers and acquisitions equivalent of a Walther Mathaeuesque grumpy frown, a long whiny letter.  It is three pages but boils down to "We think it's worth more," and is highlighted by this absolute gem of business literature:

"In our conservative estimation the cash portion of remuneration contemplated by your letter of [Date] may be in need of some adjustment."

No wonder this company pissed away so much money.  They must a committee of seven attorneys writing letters by committee or something.  What I wouldn't give one day to get a letter more like this:

April 3, 2006

Equity Private
Vice President
Sub Rosa, LLC

Re: Valuation of Velocity, Inc.

Dear Equity Private,

Too low.

Best Regards,

Velocity, Inc.

Of course, I know exactly which firm it is that's pushed Velocity's expectations into high Earth orbit.  I suspect it is pointless to pen a letter back pointing out that the cash in our offer is unlikely to shift downward much, while others are.  I'm not even really supposed to know who else is interested, but I do.  Since it's been a bit slow, I am going to write the letter anyhow.

Tuesday, May 02, 2006

Melting Offers

i am melting! Oddly, Project Velocity has not died of its own accord.  Perhaps, though I am not certain on this point, through our dire prediction, that the other interested parties were merely leading Velocity down the primrose path and that when the trap of time sprung, offers would melt under the onslaught of nickel and dime objections until a fraction of the original offer was still on the table.  I do not know for certain that this has happened, but I strongly suspect it.

Late last week one of our contacts at Velocity called up and asked after our interest in supporting a management buyout (MBO).  This puts us in something of a quandary and our first reaction was to carefully cull the non-disclosure agreement we had inked with Velocity to make sure that our discussing an MBO with a member of the management team was kosher.  It seems to be, even according to the grumpiest of our attorneys.

I can only guess at what happened, but I think I am probably close with this scenario:

Lured into the honey trap of diligence with our rivals, hopes were drawn up, but time began to wind down, assisted, no doubt, by the slow pace of progress cultivated by the interested firms.

Annoyed by senior management's blindness (how do you think they lost all their IPO money in the first place) and totally unwilling to do business with the sharks now circling, senior-middle management looks around for white knights and we are the closest approximation.

This is interesting because, depending how valued senior-middle management is to the division, the sharks might be scared off by the potential "People Pill" defense, the mass defection or non-cooperation of critical managers familiar with the product, production and etc.  If this is so then an MBO, with us as sponsors, could be the only alternative left to the parent.  Although, shut-down is always an option. 

The big question now is how badly senior-middle management, and Sub Rosa, have alienated senior management at Velocity.  Part of this depends on how much of an "us and them" dynamic exists.  Time will tell.

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