Archived entries for Capital markets

2010.47 Inside Job screening and my review

What should have been an important movie is marred by a slanted and biased attack.

First, thank you to The Wrap for inviting me to a screening of Inside Job (click Inside Job for webpage) last night in Sherman Oaks. And thank you also to director Charles Ferguson for speaking about the film and answering questions after the screening.

I wasn’t able to articulate the question I would have liked answered last night but now can: Why lose such an important message in mean spirited and malicious attacks?

The movie starts with some quotes from finance professionals and commentators that set up the audience for the tone of the movie. I’m okay with that; the documentary needs a mission statement and this one’s is clear from the beginning.

And the first half or so of the movie is great. A lot of these questions should be asked and the answers exposed. Many Wall Street and other firms did a lot of questionable things during the time frame covered and the public deserves answers. Ferguson spares no administration from Clinton, to Bush, to Obama…which I admire. He treads softly around certain governmental participation in the factors leading to the bubble then skewers them in others. For example, when regulating derivatives was proposed, the poor lawyer who suggested it was attacked from industry and government both. Ferguson’s clips of executives from various firms evading questions, even very direct ones, while in front of various government panels is painful to watch. Sure, answering some questions honestly exposes your firm to potential liability but a certain level of ethics and acceptance of responsibility when presented with facts would have been reassuring. The lead up to the financial crisis is informative, concise and understandable.

The film’s photography and imagery are beautiful. Technically the film is lovely. It follows a coherent narrative flow and explains complex issues in a way understandable to many. I especially loved the sweeping aerial shots of Manhattan. Ferguson is a very skilled film maker.

Ferguson does get a few facts wrong – for example, while Wall Street CEOs earned high numbers, much of this compensation was in the form of stock, deferred comp and other illiquid (in the short term) payments…and in some cases was only paper money that melted away during the financial crisis. And he also makes a few puzzling arguments (the increasing distribution of wealth to the top 1% of the population may be relevant when analyzing the financial meltdown but he doesn’t explain the tie…which makes it puzzling). I can forgive him these points; he is clearly using facts selectively to support his mission statement. Ferguson doesn’t owe us a fair minded portrayal…he’s been clear from the start in defining his agenda.

But Inside Job veered off course completely when the personal attacks began; both in not substantiating them and in the mean spited way many interviewees were attacked after agreeing to speak (leading questions with no answer being shown on film, accusations, assumptions…). I was puzzled when he criticized professors who had advised and been in government for getting paid for their work and public speeches (and, in like spirit, is Ferguson getting paid for the documentary or any related paid speeches he is asked to do?). Economic theory is just that – theory. Only in actual application can we see if it will work. I don’t understand why academic economists shouldn’t do advisory work inside or outside government.

And having Elliot Spitzer as a moral high ground making indirect accusations/innuendos about prostitution and sex in the industry seems bizarre. First, I have my own issues with Spitzer as I believe his actions directly contributed to the financial meltdown. Next, his innuendos are tied in with direct (but unsubstantiated) accusations of rampant drug use and prostitutes as a part of Wall Street culture by a madam and psychologist with “Wall Street clients”. With no direct information just sweeping statements the tactic appears to be a trick meant to deflect from the real issues and just smear the industry.

Interestingly, Ferguson uses interview clips with Raghuram Rajan, who wrote Fault Lines and was at the IMF during the time in question and warned of the risks, to support his argument. Yet Rajan’s excellent book is more moderate and realistic and much more powerful than this biased movie.

The question and answer period after the film revolved around a wall street bashing free for all so Ferguson clearly found his audience last night. Too bad he didn’t aim for a serious discussion of the issues instead of sensationalism. I thought the first half of the movie was excellent and was disappointed with the ending. Perhaps that’s what it takes to get big studio support in this day and age. But, I wonder if, had his viewpoint not been pre-determined and antagonistic, he would have gotten access to a broader range of key potential interviewees and been able to provide a more rounded picture.

That movie is still waiting to be made.

2010:44 Due diligence; better to identify problems early on

People entering the panel room.

I was a panelist at the recent Digital Hollywood conference. The topic was Venture Funding, Investment and Mergers. One question made me really think. In the context of a busted deal, we were asked how to head off surprise issues which can crater a potential company sale. The answer is to do your (generally extensive) due diligence both thoroughly and as quickly as possible.

But how exactly does company’s management go about doing that diligence?

Again, an easy answer does exist: hire the right investment bankers, lawyers and perhaps accountants. Sometimes a private investigator is also hired. But that answer only gets someone part way. Because ultimately management will live with the results of that diligence and therefore must stay involved, or appoint someone senior from the company to fill that role.

So what does doing your due diligence entail?

On a typical M&A transaction the bankers or lawyers representing the seller will put together a data room based on an extensive list of documents. We’ll then set up conference calls between the relevant parties to discuss questions that aren’t covered within the documents provided, or that stem from them.

Confidentiality of information is always an issue; even if an NDA is in place. Anything too proprietary must be kept confidential (and can be covered in any purchase or other agreement) and information is typically provided on a need to know basis. Sometimes it can also be disclosed to a company’s lawyers or accountants but not directly to management. Such sensitive information includes: technology, customer information, product sales mix and employee information. Indeed, some contracts may also limit what information can be shared with third parties.

On the disclosure side most bankers (and lawyers!) will encourage their clients to disclose any potential “smoking guns” upfront. If you have an issue which may scuttle the deal better to let the party know before you open the kimono, give them more information and ultimately waste everyone’s time. Either they can accept the information and move forward or not. And, nothing undermines credibility more than such an issue being discovered by the other party later in the process (which can scuttle the deal and possibility lead to a lawsuit).

Experts can also be brought in to do the diligence in niche, specialized areas like technology, industry or product.

What general topic areas are covered in the diligence process? Each list of items is customized for the respective company and its industry. Generally, the basics include: financials (audited, if possible) going back five years, customer and sales information, product information, facilities, legal information, general corporate information (such as articles of incorporation, board minutes, etc), marketing, employee information, retirement and health plans, environmental information, patents or other technology-related information and more.

Due diligence is a process that must be done thoroughly and with care. Missing something important can be a very costly mistake. In the long run, hiring experts when necessary is a wise financial decision.

2010:40 Exit strategies: practical realities for 2010

As I often say, I grew up in and out of Silicon Valley with a dad in high-tech. So, early on I knew what venture capital is (along with “chips”, “boxes”, “burn rate” and other valley lingo). The valley has changed; most of the orchards are gone and Tully Road is lined with company headquarters not the stables I visited in my teens.

Some things haven’t changed: Steve Jobs, Stanford University and the dead (cell) zone between Sand Hill and Page Mill Roads on 280.

But I’ve been surprised recently by the number of VCs saying – publicly and on panels – that any company looking for funding needs to have an exit strategy based around likely corporate buyers. Basically, a company sale instead of an IPO. The basis? The practical reality is that VC backed IPOs (no, wait, all IPOs) have gotten fewer and harder to complete.

According to PWC in a recent report, during Q2 2010 the number of IPOs filed tripled to 39 (raising $16.6 billion) from 12 (raising $5.1 billion) in 2009. But that number was down from the comparable period in 2007 during which 79 deals raised $21.1 billion. And the numbers being filed have been tapering each month. 15 IPOs were pulled or postponed in the latter two months of the quarter.

While the stats on VC-based M&A exits I’ve heard have ranged – the reality is that company sales are now the prevalent exit strategy for most VC funds. (And, to be fair, I think that any stats with respect to recent exits has to consider the impact of the bad economy over the past two years; the IPO market may not have been open but many companies were going belly up and not deprived of capital due to market issues – though those definitely existed as well – but rather operating ones).

So, anyone can quote numbers. What is the deeper analysis?
Key trends have changed:

1. Being a public company is much more expensive than it was ten years ago (I heard a quote from a lawyer yesterday saying that SOX compliance alone can cost $1 million per year these days).
2. Law suits, director liability, increased governmental encroachment into business affairs, complicated tax structures, uncertainty of future regulations and taxes…
3. I know my part of the world: smaller middle market or growth companies. Scale and deep pockets help in an economic downturn with more limited access to capital.
4. The larger companies are sitting on pools of cash (if lucky) and willing to buy growth.
5. The IPO market is still tough. VCs and their investors don’t always want to, or can’t, wait.
6. Even after a company completes an IPO, it often takes a year or two for the investors to get liquid on their stock – assuming it is still a decent valuation. A sale gets investors all/most of their liquidity at closing.
7. The role of the research analyst has changed (contact me offline on this point, if interested).
8. VC funds have had a bad ten year period overall (with the industry, though not all funds, being down for the period). They need to show some positive returns and M&A has been more closable than IPOs.

I’ll stop there because otherwise I’ll venture too far into opinion and politics.

But the practical lesson is that M&A is now – correctly or incorrectly – viewed as the probable exit strategy. You better know who might be a good potential buyer for your company when meeting with investors.

Saying that an M&A exit was the expected outcome used to be heresy. Now it’s the “new normal” (with a bow to PIMCO for the phrase).

Photo credit to Ana Berman

2010.47 Reprint of blog on VentureBeat

VentureBeat

Click above to see a re-print (slightly edited) of posting on how emerging companies become consolidating ones.

2010.41 LAVA Los Angeles Venture Capitalist Breakfast

Earlier today I was at the Skirball Center listening to a panel of (thankfully) outspoken and even blunt venture capitalists: Jim Andelman of Rincon Venture Partners; Kevin Jacques of Palomar Ventures; Klaus Koch of Vicente Capital Partners; Sumant Mandal of Clearstone Venture Partners; and Mark Suster of GRP Partners. Stephen Hughes of Silicon Valley Bank and Scott Alderton of Stubbs Alderton & Markiles moderated. I won’t attribute remarks to an individual unless it pertains to a difference in their fund or distinctive (and perhaps not universal) viewpoint.

Among the opening questions was one that got to the heart of the matter: are venture capitalists going away? No, but the industry has changed with many funds (and the industry overall) posting negative returns for the past ten years. There is less money going into venture capital, thus smaller funds and fewer VCs. The funds in northern California are often larger than those here in Los Angeles. Practically, this means that local VCs invest smaller totals into their portfolio companies. And, while venture investing amounts in Los Angeles are up over the past six months – especially relative to other parts of the country – deal numbers are up less dramatically. Additionally, many of the larger investments in southern California have not been made by local VCs (Demand Media and Gravity are two examples). The costs required to start an Internet based business have declined so much that some businesses in this sector are profitable after spending less than $100,000. Since one local pool of talent comes from the media world and often starts such Internet businesses, VCs can often see a working business – with a proven concept – before they need to invest.

Returns are an expected topic and really what enables VCs to raise subsequent funds. Typically, for an early stage investment the VCs agreed that they want a ten times return; which would make up for the inevitable lesser performers. A lower risk, lower return wasn’t of interest as it damped overall returns and the money couldn’t be deployed into potential home runs. For a late stage business (clear monetization and diverse customer base) a three times return was the minimum required and they expected most of these companies would continue their high growth (75 plus % surviving). Total invested over the life of the company ranged between $6 and $25 million.

The IPO market remains somewhat weak so most exits are currently company sales and the lower returns they entail. Hence, when characterizing who should take venture money one criteria stated is that your company should be the type that other companies are interested in buying. Lots of larger companies are looking to acquire (innovation). The company should also be quickly scalable and have a good use for the added resources.

One much discussed topic was how to approach VCs. Mark Suster made a strong point that in this day and age of social networking there is no excuse for any entrepreneur not to manage to find someone who could make an appropriate introduction: ideal is from an executive at a VC portfolio company, next another entrepreneur who knows the VC and third is from advisors who know the VC. Kevin Jacques clarified that an introduction was not the forwarding of a business plan from a random connection on LinkedIn but rather someone who knows the industry and had done work with your company to help guide or mentor you.

And, research (Crunchbase; SoCalTech; Internet) which VCs invest in your type of company, are actively still investing and are the right size/stage. Not doing the requisite work is proof that you aren’t a real entrepreneur.

Power point slides are easier to read than Word documents for someone buried in hundreds of business plans.

The B round was referred to as a “sucker’s round” with fewer VCs willing to do a B round, especially if A round investors weren’t continuing to fund the company. During the 2008 crash VCs were too busy with existing portfolio companies (figuring out who to continue funding and who to let die) to take on anyone else’s mess – the B round. Angels likewise pulled back in 2008 as they worried about their own cross-platform investments. Slowly the angels are coming back but the B round investors aren’t.

So think clearly about which VC money you take (they should be the type who sticks by their portfolio companies for that B round; for the C round your concept is either working or not and funding will depend on that factor). It’s easier to get a divorce than exit this type of partnership, said Jim Andelman. Look at the investment as the beginning of a partnership and not just funding.

Eventual percentage ownership they’d like at a liquidity event ranged from about 25% to 50%; but really varied based on the stage they had invested and whether other investors were involved.

Overall, they were very upbeat about innovation in Los Angeles today. While the talent pool may not equal Silicon Valley’s in some ways other attribute of our local community and talent pool make up much of the difference.

For details on their varying investment types, the industries they favor, fund size and background please do the research. That is what a real entrepreneur would do.

And email me for more details on the panelist’s comment; I took many notes but aim to keep these postings short.

2010.40 Stress in Hollywood and recent media services developments

As you know, Megan and I are focused on the media services sector: the software, system, application, service and equipment rental companies that support the content ecosystem.  We often refer to this universe of companies as “first derivative plays” on the media/content business.

Megan’s post Thursday on Technicolor’s divestiture of its Grass Valley Broadcast business to Francisco Partners covered an important transaction in the broadcast equipment business.  I want to go further and connect a few recent data points:

  • Data point number one, April.  Eastman Kodak sells its post-production service business Laser-Pacific to an affiliate of H.I.G. Capital portfolio company Telecorps.  Telecorps had previously acquired Wexler Video, Coffey Sound, PostWorks New York, Orbit Digital and Hulu Post since 2007.  Terms were not disclosed, but word on the street is that Kodak received modest consideration for Laser after having acquired the business for over $30 million in 2004 (FULL DISCLOSURE: Hadley Partners owns an immaterial interest in Telecorps).
  • Data point number two, July.  Technicolor sells its Grass Valley Broadcast business to Francisco Partners.  As recounted in Megan’s post, GV lost 52 million Euros in the broadcast business last year, and Technicolor is selling GV to Francisco for no cash consideration – just a note and an earn-out.  In fact, Technicolor is contributing 20 million Euros to the company at closing.
  • Data point number three, July.  As covered in the Wall Street Journal Thursday (subscription required), Eastman Kodak’s movie film business is shrinking faster than previously expected due both to less film production generally and the transition of theatrical exhibitors from film to digital distribution.  Kodak’s “entertainment imaging” revenue fell 18% in the June quarter vs. the prior-year period.
  • Data point number four, ongoing.  We have heard from several sources that Ascent Media is soliciting bids for all or part of the Company.

I could go on, but you get the point.  Technicolor, Grass Valley, Eastman Kodak, Ascent Media – these companies are all leading vendors into the film/TV entertainment industry.  There is dramatic stress throughout this food chain.  The stress is due partly to financial factors (movie making is one of the last great capital-intensive businesses, and you might have noticed that the cost of capital has risen in the last three years).  It is also indicative of the fundamental shift from analog to digital throughout the video workflow cycle (from capture to display).  The gale-force winds of Moore’s Law will dramatically improve price/performance for customers in this sector as it goes digital, but it is not at all clear that volume will rise enough to support the business models of many vendors.

I’ll end with an advertisement for HPi.  If you an owner, investor, executive, entrepreneur or director in the media services industry, you need to understand the very powerful forces that are squeezing many of the leaders.  And you need a financial advisor who understands these currents and has significant transactional experience navigating in all business environments.  Call us if it is time to talk.

2010.38 Carl Icahn Sues Lions Gate and Rechesky over Debt to Equity Deal: Why Good Advisors Matter When Contemplating M&A

The ten-day truce between Carl Icahn and Lions Gate management is very clearly over.

Icahn has let it be known that he doesn’t support the merger discussions between Lions Gate and MGM.

On July 20, Icahn also launched a new takeover offer for Lions Gate common stock at $6.50 per share, lower than his previous $7.00 offer. The offer is contingent on management not entering into a major transaction outside the normal course of business. The tender offer will expire August 25; Icahn will then nominate a slate of directors to replace Lions Gate’s current board. The election will occur at the company’s annual board meeting; most likely in October.

Lions Gate, in an effort to reduce debt, issued common shares at $6.20 per share to retire $100 million in convertible debt, the stock price represented a 2.8% premium to Monday’s share price. Icahn’s holdings were reduced to about 33.5% from 37.9%. The move doesn’t only dilute Icahn; it dilutes all existing shareholders. The 16.2 million new shares went to Mark Rachesky (MHR Fund Management), who already held almost 20% of the company’s common shares; his percentage is now 29%. The debt, due in 2026 and 2027, was acquired from Kornitzer Capital. Kornitzer also owns a small number of Lions Gate shares which he hasn’t tendered to Icahn.

Icahn must now acquire almost another 17% of shares to accomplish his takeover goal – assuming that management doesn’t convert more debt to equity.

This morning Icahn filed a law suit in New York state court against Lions Gate and Mark Rachesky seeking damages, an injunction rescinding the debt-to-equity swap and the prohibition of the defendants from voting their shares in a vote to elect directors. Icahn also filed a petition to the Supreme Court of British Columbia – a hearing to be held on Wednesday – regarding whether to grant orders against Lions Gate and Rachesky. Both sides are engaging in some general public mud slinging; the specifics of their accusations won’t be covered herein.

The battle continues. Lions Gate stock closed at $6.90 today, July 26.

The fight over Lions Gate reflects the importance of good advisors. Both sides are now exploring creative transactions and strategies to ensure that the outcome of this M&A battle is in their favor. Clearly the bankers and lawyers involved are working hard on behalf of their respective clients.

2010.36 RealD IPO prices at $16, stock closes Friday at $19.50

Following up on our two prior posts on this subject (April 20 and June 30), we now report on the consummation of RealD’s IPO.  Highlights as follows:

  • Offering size increased from 10.75 million to 12.5 million shares.  All the incremental shares come from shareholders, so the company sold 6 million shares as previously planned and shareholders sold 6.5 million shares.
  • Share price increased.  On June 30, RealD had gone on the road with an estimated price range of $13 – 15 per share.  The IPO priced at $16.  This cannot be considered a shocker, given that the NASDAQ had traded up over 6% month-to-date through Thursday’s close.
  • Total offering generated gross proceeds of $200 million, and the company received net proceeds of $82.6 million.  That ought to finance a few more deployments…
  • Timing is everything.  Not only did RealD likely benefit from the good performance of the equity market in July, but they priced their offering just before a 261 point decline in the Dow on Friday.
  • Strong aftermarket performance.  After pricing at $16 Thursday night, the stock traded as high as $21 in early trading Friday morning before closing at $19.50 per share (up 21.9%).  Aftermarket performance for IPO’s in 2010 has not been generally strong, so this definitely counts as a successful start to RealD’s tenure as a public company.
  • Valuation update.  At the mid-point of the June 30 range ($14/share), RealD’s implied valuation was $725 million.  At the actual pricing of $16, the valuation was $828 million.  At the Friday closing price of $19.50, the valuation is a cool $1 billion.
  • “Greenshoe” from the shareholders, not the company.  As is typical for an equity offering, the underwriters have received a 30-day option to buy another 15% of the deal – in this case, 1.875 million shares – at the same price per share.  In this offering, the additional shares would come from existing shareholders, not the company.  With the stock price well above $16, it currently looks like a safe bet that the greenshoe will be exercised.
  • 3D validated by the public market as a significant growth opportunity, and RealD established as the leading pure-play company in the space.

On behalf of Hadley Partners, congratulations to the founders, management, employees and investors in RealD!  We look forward to continuing to follow the company as friends, bloggers and investment bankers.  One of my friends and former co-workers at BT Alex Brown, Andy Howard, has represented Shamrock Capital on the board of RealD since Shamrock’s investment in the company, so my particular congratulations to Andy.

Have a great weekend, everybody!



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