Will new hedge funds lose their edge under Dodd-Frank?

Published by Reuters Complinet
June 1, 2011

The hedge fund industry is likely to lose some of the risk and entrepreneurial approach that has attracted investors with an appetite for high risk and reward scenarios as a result of new rules being formulated in the US and Europe.

The biggest impact of new rules under Dodd-Frank and the forthcoming Alternative Investment Fund Managers Directive (AIFMD) in Europe, AIFMD regulations will likely make it much more costly for new and smaller funds to operate because of the reporting and compliance infrastructure requirements.

There are also a number of concerns about conflicts between the two sets of rules when they come in to play, especially for offshore funds and those funds interested in marketing to investors in both Europe and the US. Continue reading “Will new hedge funds lose their edge under Dodd-Frank?”

Movin’ on Down: Firms Eye Alternative Listings

Published by Reuters Complinet
June 2009

General Motors did it. Air France expected to save $10 million by doing it. Many smaller firms have done it, too, citing cost savings averaging around $500,000 annually.

Since passage of the Sarbanes-Oxley Act in 2002, a number of companies have chosen to “de-register” and move their stocks to foreign or over-the-counter exchanges. While that number has tailed off over the past couple of years, a new rule scheduled to go into effect in December has companies increasing exploring options beyond SEC registration and the major U.S. trading exchanges.

Public companies with annual revenues of $75 million or more whose fiscal years end after Dec. 15 must become fully SOX-compliant. The deadline was pushed back from last year, but there have been no indications so far that there will not be another extension. The deadline is forcing a large number of firms to explore alternatives, experts say.

“When you amalgamate these costs – Sarbanes, litigation, D&O (directors and officers) insurance – you have to be a fairly sizable company from a market cap perspective to bear those costs,” notes Thomas C. Klein, an attorney with the Silicon Valley-based law firm GreenbergTraurig, where he represents public companies and specializes in venture capital deals, mergers and acquisitions and other transactions.

There have been a lot of recent conversations about alternatives to SEC registration with GreenbergTraurig clients, Klein said. “We’re reaching down into the 90 percent of the companies that are listed and applying the SOX 404 to them, and there’s a cost concern for those that are already public. As for those that are not yet public, every one of them now considers … listing on another exchange.” Continue reading “Movin’ on Down: Firms Eye Alternative Listings”

The 1-2-3s of ABCs


When the owners of family-run A. LoPresti & Sons Inc. decided they could no longer continue in business last year, they chose a less-common method to liquidate the business in place of a traditional bankruptcy. Turning its assets over to an independent trustee through an Assignment for the Benefit of Creditors, or ABC, enabled the century-old food and produce distribution company to cease operations without the legal hassles and high costs associated with the federal bankruptcy process. It most likely shortened the time required to complete the liquidation and may have recovered more funds for creditors.

Cleveland-based A. LoPresti & Sons fell victim to the economic downturn. Despite maintaining its market share, the firm with annual revenues of around $40 million, saw business plummet by 25% and two major customers go out of business, resulting in $500,000 in unrecoverable receivables, Patricia LoPresti, president and CEO, said in a statement.

Companies facing insolvency have a number of options to consider. But in recent years, with the rising costs and length of time it takes to complete a bankruptcy filing, ABCs – which have been around for years – have become increasingly popular. “We’re in a period where there is a favorable outlook on these types of proceedings and you’re seeing them more than Chapter 11,” said Anthony J. Pacchia, founding partner of Traxi LLC, a New York City special situations advisory firm. “It seems that nobody likes the process in Chapter 7 anymore.”

Bankruptcy is an adversarial process, with creditors and their attorneys on one side of the table, the debtor and his counsel on the other. Each significant event must be decided by a judge, often after reviewing multiple filings and hearing arguments, a process that lengthens the time it takes to complete a bankruptcy and adds to its cost. An ABC “is a more collegial process,” says Pacchia, who is an attorney.

“An ABC is a faster and more cost effective process that gets to the same end and a bankruptcy can be substantially more costly for all interested parties,” said Howard Samuels, owner of Rally LLC in Chicago. Rally specializes in distressed situations and Samuels estimates his firm has handled more than 1,000 assignments over the past 20 years.

Assignments are less public than bankruptcy. Unlike a bankruptcy, an ABC is conducted privately, in most cases administered by an assignee or trustee selected by the debtor.

“ABCs have become attractive in a number of situations where there’s cooperation with a senior lender, there is no senior lender, or the senior lender is the owner, a hedge fund type,” notes Steven A. San Filippo, managing director with Traxi, which also handles corporate restructuring, asset recovery, investment banking and other financial services.
The turnover of assets is governed by a trust agreement for the specific purpose of sale or liquidation, Samuels said. The debtor retains its liabilities. The transfer of assets must be made to an unrelated third party purchaser to avoid any potential liability. Creditors must deal with the trustee from that point forward.

An ABC “is a process or procedure of choice among bankruptcy or insolvency professionals in Illinois when you want to close a business or facilitate a transfer of assets to a purchaser,” Samuels said. He notes that “There are other alternatives – anything from just locking the doors in the middle of the night and walking away to filing bankruptcy.”
The size of the firm using an ABC doesn’t matter, experts say. It is easier, obviously, for a small, privately-owned firm with a simple structure to liquidate through an ABC. “The more complicated [the debtor firm is], the harder it is to do an assignment,” said Edward Hostmann of Edward Hostmann Inc. in Lake Oswego, OR.

No common rules
There is no common set of rules governing the use of ABCs across the country. Each state has its own rules. Forty-one states have specific laws governing the process; nine do not. In those states, the practice is governed largely by case law and custom, Samuels said.

The level of court involvement varies from state to state. In some jurisdictions, a state court must approve the trustee assignment; in others, an agreement between the creditor company and the trustee is all that is required.

Most tend to follow the same order for distribution of funds followed by federal bankruptcy rules. Secured creditors are first in line; government obligations, such as taxes, are next; employees come third; general and unsecured creditors are last. Final distributions are made when liquidation has been completed, and in some cases earlier, at the discretion of the trustee.

A sweet outcome
Cherrydale Manufacturing opted for an ABC rather than bankruptcy. The century-old Allentown, PA candy manufacturer assigned its assets to Traxi in April 2009. The company operated out of two buildings with a total 360,000 square feet of space. Cherrydale owned the Bartons trademark, a well-known chocolatier.

The candymaker essentially collapsed. A dozen lawsuits were pending. There was perishable inventory in a number of locations that needed to be dealt with. Deliveries in the months preceding the assignment had fallen behind.

“With food, and in the case of Cherrydale, we saw a lot of food products which have a shelf life and a lot of costs – cooled warehouses, inventory everywhere – and the need to move with some speed and knowledge of the space to get the maximum value in the shortest time,” San Filippo said.
To preserve the value of the assets, Traxi operated the company for a about 90 days, liquidating assets, obtaining appraisals and maximizing value.

Appraisals were obtained, assets were auctioned off, receivables were collected. The assignee chose lawyers to represent the company. Resolving claims “is a big part of the process,” San Filippo said.

The Bartons trademark, despite being “very distressed,” was sold for the value it was appraised at as a going concern.
A bit over a year later, the final distribution of funds was filed with the Chancery Court in Pennsylvania, and was awaiting court approval in mid-June.

“Sometimes it’s about returning assets to a productive use and getting on with life, closing out a failed venture,” Pacchia said.

Another candy company bought many of the Cherrydale assets, rehired a number of employees and took over one of the two buildings. The other building was turned back over to the landlord, so “Two landlords got their assets back efficiently,” Pacchia noted.

The Cherrydale ABC “was deemed a success because it would have been administratively insolvent and in bankruptcy and we did significantly better than that,” San Filippo said. “We estimated going in that we would recover $1 to $2 million on the inventory and assets that we had, less the costs.”

He estimates the final recovery at $1.1 to $1.2 million. “It was much worse than we thought going in,” San Filippo said.

Keys to ABC success
The Cherrydale Manufacturing example illustrates two key elements necessary to a successful ABC.
As soon as an assignment is made – in some states that requires approval by a court – the original owner is out of the picture. Assets are taken over by a separate trust to be liquidated by the assignee.

When a situation has deteriorated to the level where a restructuring or an orderly shutdown is required, there are often a lot of tensions, frayed nerves, anger and distrust between the debtor and its creditors and vendors. Often communications have broken down.

Turning the situation over to an independent third party gives everyone a fresh start.

“We were very communicative, and people might not have liked what they wound up with, but people understood [Cherrydale] would have been administratively insolvent,” San Filippo said.

“The way an ABC works best is through disclosure and communication; we don’t do magic,” Pacchia said. “We can’t return the losses people are going to suffer in these bad situations. But generally, we’ve found that people are realistic. Often the anger, the frustration, the litigation is a result of not getting answers to legitimate questions. Once you explain what’s really happening, what potential outcomes are going to be, you tend to spend less time in court.”

A trustee may also continue to operate a business to maintain its value as a going concern to prospective buyers or to complete work-in-progress inventory to an account receivable, or finish orders. To operate, an assignee or trustee must have a funding source as he is precluded from incurring fresh debt, said Samuels.

A bank that will work with the trustee can play an important role. Rally is operating one company in an ABC where the bank is essentially funding its ongoing operations, he said. If the bank has a solid first position – usually the case if it is a secured lender – it stands to recover more when the assignment results in a good outcome.

“So they want somebody in there who is independent, but who is a fiduciary for not just the bank, but all creditors. I’m not involved in the company other than to secure the highest and best return for the assets,” Samuels said.

PACA’s role in an ABC
Fresh produce suppliers have the same priority rights to payment in an Assignment for Benefit of Creditors under the Perishable Agricultural Commodities Act as they do in a bankruptcy, according to attorney Mark Amendola of Martyn and Associates in Cleveland. The law firm has practiced PACA Trust law exclusively since 1987.

PACA is a federal law that is designed to help unpaid suppliers of fresh produce get paid on a priority basis ahead of other creditors.

Produce suppliers would likely see the same benefits as other types of creditors from an ABC: more funds become available because the process is less costly and faster payouts because of the less formal structure, Amendola said.

Not one size fits all
While some very large companies have successfully liquidated through assignments, the experts agree that it is easier for smaller, less complicated private firms to accomplish.

One of the biggest benefits of the ABC process can also be its Achilles’ heel.

“In the pecking order of law in America, federal law trumps state law,” Pacchi points out. Even after an assignment is under way, “Three disgruntled creditors can always put your ABC into a federal bankruptcy.”

An assignment does not work well with service firms or those that require special licensing, such as a medical practice or a liquor store, according to Samuels.

It is also not a good idea when there are large, contentious issues to be sorted out. “Sometimes it’s just better to bite the bullet and be in bankruptcy because you’re going to wind up there anyway,” Pacchi said.

“If the situation has deteriorated past where you can effectively liquidate, you’ve got to be careful,” San Filippo adds.

An ABC liquidation is not the answer for every situation, but it can be a quick way for company facing financial difficulty to get out from under a bad situation and for creditors to get the most for their recovery efforts.

Drilling for Profits

Published in Buyside

March 2003

Analysts See Oil Industry as Safe Haven for Investments


Sales of gas-glugging SUVs outpace most other vehicles.  The eastern U.S. shivers in the grip of one of the coldest winters in recent memory. War with Iraq grows more likely every day.

These seemingly disparate facts of American daily life all have one thing in common: They are all positive signs for investors in the oil and natural gas industries. Experts say investors haven’t yet warmed to the notion of investing in the oil and gas sector, even though the outlook is encouraging.

Companies ranging from the international “super majors” whose operations cover the entire spectrum from searching for new oilfields to filling an automobile’s gas tank to the independent firms with specialty niches like seismic data analysis that are both profitable and undervalued — still a rare combination in today’s markets.
A Simple Case of Supply and Demand
A basic tenet of business is that when supply can’t keep up with demand, prices rise. Despite the recession, the U.S. is using more oil and natural gas than is being produced and imported.

Other short-term factors, such as the prospect of war in the Middle East, unusually cold weather and the recently resolved oil workers’ strike in Venezuela all tend to push prices temporarily higher than they would otherwise be. But the long-term trend suggests prices will continue to rise, at least for a while. These factors will influence the speed at which oil and gas prices rise, or the timing of the peaks and valleys, but the trend is still modestly upward.

U.S. oil inventories are about nine percent below what they were a year ago, and January oil inventories were the lowest in 25 years, analysts say.
And due to the harsh winter, inventories of U.S. natural gas have fallen below five-year average levels, according to the U.S. Energy Information Administration’s storage level survey. Natural gas appears to pose a widening gap between demand and supply.
Despite prices running 50% higher than last year, natural gas production in the U.S. has actually declined by five or six percent, says A.G. Edwards & Sons Oil and Gas Analyst Bruce Lanni.

Demand for oil increases by about 1.5% annually, says Tina Vital, energy analyst at Standard & Poor’s Equity Group in New York. “Demand for natural gas will rise about two percent from all end users, but supply should drop about 1.5%. So we’ve got 3.5% to make up, and we think that will drive prices up,” Vital says, quoting projections from Global Insights.

In spite of that shortfall, natural gas exploration and drilling in the U.S. is only just beginning to increase.

The “Super Majors” as Safe Havens
The wave of consolidation among international energy companies during the past decade has created a class of companies analysts refer to as “super majors” or “the large integrateds.”The nicknames are shorthand for those huge companies that are active in a broad spectrum of energy businesses. Think Exxon Mobil Corp. (XOM) or ConocoPhillips (COP).

These companies have become so broadly diversified that they are no longer as cyclical as smaller businesses whose fortunes rise and fall in tandem with the price of a barrel of crude oil.

“Over a 20- to 30-year period, their earnings have not been very cyclical.  They’ve risen at a nice, steady clip, a nice upward flow, regardless of what the economies have done, regardless of what oil and gas prices have done,” Vital says.
Operations in nearly all parts of the industry, spread out across the globe, help the major firms to mitigate political risk, economic concerns, or supply issues. “That indicates to me that they’re safe havens over the long term.”

And unlike their trendier technology stock counterparts, the big oil firms pay dividends, further improving returns for investors, Vital points out.

Often, investors view oil companies as risky, speculative investments. And to be sure, there are wildcat drillers and mom-and-pop operations whose entire fortunes rest on whether a single exploratory venture pays off.

But the major international firms are actually very conservative today. Following those big mergers, many have streamlined operations, become more efficient, and cleaned up their balance sheets. The super majors as a group have just 18% net debt to equity, according to Standard & Poor’s.

“While you may not see very high growth rates, you tend to see preservation of capital. It’s a nice cornerstone investment,” Vital says. “It may not be as exciting as some tech investments, but it’s steadily improving over time, and that’s something to be said in this environment.”

While the S&P 1500 declined 22% in 2002, the oil sector slipped just 14.5%. Victory Capital Management Oil and Gas Analyst Bill Chapman also likes the major oil firms, and views their diversification as a hedge against lower oil prices. “We’ve been building up our weight in some of the more diversified companies, when you see a drop in the price of oil, you’ll see some benefits on the other side through a better refining and marketing process,” he says.

Victory has a bit more of its $22 billion in equity investments than the S&P index’s roughly six percent. The company expects oil and natural gas prices to fall, so it has shifted its focus away from exploration and production companies, believing them to be more vulnerable to falling prices, according to Victory’s Portfolio Manager Neil Kilbane.
The big mergers have run their course, says A.G. Edward’s Lanni. He thinks the benefits of huge oil industry mergers diminish with each additional deal.

Where Gas and Oil Don’t Mix
While oil and natural gas are often viewed as disparate parts of the same industry, the relationship is changing. Oil is very much an international business; crude is extracted all over the world, then shipped to anywhere it commands the best price.

The logistics are not quite so simple for natural gas. Natural gas used in the U.S. must be produced in North America. With the technologies in place today, there is simply no cost-effective way to ship it half way around the world.  While demand has increased, and U.S. inventories are very low, drilling activity is only just starting to pick up. Most of the analysts Buyside interviewed think natural gas drilling activity will increase later in the year.

“The problem in the U.S. is that we have very old natural resources, and you can only squeeze so much juice out of an orange, so imports are becoming increasingly more important,” Lanni says. “Prices, as a result, will probably stay higher than they have historically.”

For years, a widely used formula suggested that natural gas prices were firmly linked to the price of a barrel of oil.“The price of natural gas vis-à-vis the price of oil is probably a little bit richer today than it has been historically, and I think there are reasons for that,” Chapman says. “We’re short in our ability to provide natural gas incrementally, so I think the price of natural gas is going to be better. But I think it’s still vulnerable to the downside when the price of oil falls.”

One reason investors like natural gas is that some 90% of new electricity generating capacity is fueled by natural gas, says Joe Dancy, manager of LSGI Fund Advisors. “It’s cleaner than coal and doesn’t have the same environmental issues as nuclear.”
That suggests demand is likely to continue. Natural gas prices, at around $5 per million BTUs (British Thermal Units), are 50% higher than they were a year ago. While that price will likely decline as the heating season ends, it is still high enough to justify drilling new wells, at least by smaller E&P firms.

Global Insight projects an average natural gas price of $4.42 this year, dropping to $3.50 next year. “We think people are going to have to start spending on drilling even if demand hasn’t picked up. Otherwise, we could be setting ourselves up for quite a good price spike in natural gas,” says Vital. “We think North American natural gas drilling activity will rise about 15% this year.”

The integrated oil firms are more focused on international gas reserves and “stranded” fields, which hold gas that has not been economically feasible to produce at lower gas levels.

As production in the U.S. and Canada declines, liquefied natural gas (LNG) imported from those locations will become a larger part of U.S. gas consumption.
Follow the Reserves
Analysts agree that a key factor in choosing a company to invest in is how successful it is at increasing its oil and natural gas reserves and growing production from year to year. Vital likes the French integrated firm TOTAL FINA ELF (TOT) because it has a very high reserve replacement rate, and has steadily grown its production. “TOTAL FINA ELF is a good buy because it’s a relative newcomer to the super major field,” she says.

“The stock trades at a discount to the other super majors, yet it offers a very high ROI and return on production growth.” Exxon Mobil has demonstrated a consistent production growth rate of two to three percent, and that’s why Vital is recommending it as well. “While you might see the market reward Exxon with a slightly higher premium in the market, they’re being rewarded for their earnings stability,” Vital says.

Victory Capital Management has increased its position in BP (BP) and ConocoPhillips. “They have the diversity of operations so if the price of oil and gas goes down, there’s a bit of a cushion in the refining and marketing areas,” says Chambers.“We also like those companies because they’re selling at relatively modest multiples to what they’ve sold at in the past.”

Ellen Hannan, oil and gas analyst at Bear, Stearns & Co., recommends watching the fundamentals. She likes to see good management and a strong balance sheet. She also watches free cash flow very carefully.

Modern Prospectors
Companies that search out and drill oil and natural gas wells are known as exploration and production (E&P) companies, and the experts see some attractive plays in this arena, too. Victory has positions in several E&P companies, according to Kilbane. The fund’s approach is to “buy good companies particularly if they are positioned for substantial success in their drilling programs,” Kilbane says. Here, too, a company’s ability to replace reserves and grow production is key.

Kilbane likes Kerr-McGee Corp. (KMG) and Unocal Corp. (UCL). Kerr-McGee is one of the largest leaseholders in the deep Gulf of Mexico.“They’ve got very active drilling programs, and we think the possibility of success is great relative to the [other E&P firms],” he says.

Chambers likes Unocal’s international operations.“They have some interesting discoveries and a lot of shelf positions where they can go down to the deep depth and look for incremental natural gas deposits that look interesting.

Nabors Industries (NBR) reported a 10% increase in drilling activity in December, says Vital. S&P is recommending Nabors in this sector.

Hannan expects volatility to continue in the E&P sector, and she recommends looking for companies prepared to weather a volatile environment. Her top pick in the sector is Apache Corp. (APA), a choice echoed by others. Hannan likes Apache for its ability to make well-timed acquisitions of potentially profitable reserves. One of the largest E&P firms, Apache is drilling in Texas, Oklahoma, Canada, Australia and Egypt, where it recently announced its fourth consecutive discovery in deep offshore waters. Apache also recently acquired some promising leases in the Gulf of Mexico shelf region from BP.

Oilfield Services and Technology
One of the ways the super major oil firms cleaned up their balance sheets was to outsource some services to niche firms that specialize in them. Increased drilling activity and rebuilding efforts following and conflict that might occur could keep those firms busy. From companies that apply the latest technology to pinpointing pockets of oil and gas to those that deliver basic support services, there are attractive candidates here, the experts say.

Dancy points to a couple of firms that provide compressors — the electric motors used to keep drilling rigs and wells running — as good microcap candidates. In particular, he likes Natural Gas Services Group (NGS), a $20 million company that rents or sells compressors and posted a 23% increase in its business last year. Dancy picked it as his “2003 Investment Idea of the Year” by the Dick Davis Digest. Wellhead compressors help drillers get more gas out of their wells, Dancy says.

The Iraq Factor
Concerns about the impact of a war with Iraq may have driven some investors away from the oil and gas industry.

Predicting future oil prices is tricky business, the analysts agree, but there are a few models to consider. How long might a conflict last? Will neighboring oil-producing countries be affected? Will OPEC fill the gap caused by a loss in production? How long might it take for production to resume in Iraq? And what happens to Iraq’s oil fields once the conflict ends?

Some analysts think current oil and gas prices already reflect concerns about a war and Saddam Hussein’s threat to set fire to Iraq’s oil fields, as he did to Kuwait’s oil fields in 1995. Two situations — the Gulf War and the recent labor shutdown in Venezuela — may offer some hints as to the likely outcome.

Prior to the strike, Venezuela produced about 1.5 million barrels of oil per day (bpd) — roughly the same as Iraq’s production. OPEC agreed to increase production to cover some of that loss, and would likely do so if Iraqi production shuts down, as most expect it will if the U.S. attacks Iraq.

OPEC has said it could probably not replace the combined three million bpd of the two countries’ combined production, Vital says.

A further shortfall could, of course, lead to higher prices. “If Persian Gulf exports were disrupted, then I think that would send oil prices spiraling,” she says, adding that S&P does not expect that to happen. Even if Iraq’s oil fields are severely damaged, one expert says Kuwait’s wells were repaired and production resumed in just a few months after the Gulf War ended, far less than the years some thought it would take.

There are both positive and negative impacts once the conflict ends. Iraq’s drilling equipment and technology is outdated; getting its oilfields up and running again could be a boon for oilfield services companies experienced in such international operations, like Schlumberger (SLB), says Chambers. “The stock is selling at a really attractive price right now. When I look at price-to-cash flow, I see Schlumberger selling not much different than the [overall] market’s priceto-cash flow. I take that as a benchmark of when a stock is attractive.”

The potential longer-term downside is that once Iraq’s oil fields are repaired, production could be increased to help pay for the country’s reconstruction efforts, thus pushing oil prices down.

Even so, A.G. Edwards’ Lanni doesn’t think oil prices will fall as far as some have suggested. Even with Venezuela and Iraq producing oil at or near capacity, “Prices may come down, but not to that sub-$20 level that the bear community has been preaching,” Lanni says.“There’s nothing to suggest that they should even come close to that. We may even see prices fall back to the mid-$20s, that’s where we think there’s a comfortable price.”

A Good Time to Buy?
The lack of attention focused on the oil and gas industry and its subsectors could be good news for investors.

Even though the industry appears poised to do well over the next couple of years, stocks are trading at substantial discounts to historical averages.  The integrated oil companies are trading at prices that are “reflecting a $19 to $20 oil price and I think it should be $22, so they’re selling at roughly a 10% to 20% discount to the market, Lanni says.

There appear to be solid opportunities ranging from the largest international oil companies all the way to the niche suppliers of technology and support services.

As a group, analysts were most bullish on the large integrated firms, “We’ve got large market cap stocks, [with] high liquidity, high dividends, strong balance sheets, modest growth, clear earnings visibility — which you cannot say for a lot of sectors in the market today,” Lanni says, “the possibility of upward earnings revisions … and the strong generation of free cash flow which can be used to buy back stock, raise dividends or make acquisitions. Do I think that the integrated oil group is ripe for the picking? Absolutely!”

One-man nano investment bank plays matchmaker to firms, funders

Published in Small Business

March 2003

Here’s one more sign the nanotech industry is getting closer to maturity: A former Wall Street analyst is creating what he calls the first investment bank focused solely on the nano business.

NanoTech Financing Solutions LLC was formed late last year by R. Douglas Moffat, who wants to help startups with promising technologies navigate the treacherous waters of corporate finance. It’s a one-man firm right now, but eventually Moffat wants to branch out and launch a venture capital fund to invest in nanotech companies.

One of the most difficult challenges for any emerging technology is to bridge the gap between its beginnings in a research lab and creation of a company prepared to bring commercially viable products to market. Along the way, the company’s financial backing must evolve through several stages. Continue reading “One-man nano investment bank plays matchmaker to firms, funders”

New Corporate Governance Measures Lengthen Deal Cycle, But Ultimately Will Benefit Mergers & Acquisitions Volume

September 2002


New laws and regulations aimed at stemming the tide of corporate fraud will have a lasting impact on mergers and acquisitions. And while the short-term impact is slowing the already glacial pace of merger activity, in the long run, the new rules will help deals get done, experts say.

In late July, President George W. Bush signed the Sarbanes-Oxley act into law. Called the most sweeping reform of U.S. securities laws since the 1930s, Sarbanes-Oxley is part of an allfronts effort to restore faith in corporate leaders. The SEC has passed rules creating a new accounting oversight board and is beefing up its enforcement efforts.

And there is still more to come: the National Association of Securities Dealers (NASD) is considering new measures, SEC is currently considering new rules to oversee lawyers involved in securities work, and the Financial Accounting Standards Board (FASB) may also review some of its rules.

Distracted by new rules that require executives to sign off on their companies’ financial statements and facing stiffer jail terms for false statements, an extremely volatile stock market and suspicious investors, few companies have had the time – or the attention – to devote to buying or selling companies. Deal volume is now generally not expected to show any significant improvement until next year.

But there is a silver lining amid the storm of scandals and restatements. Ben Boissevain, Managing Partner at middle-market investment bank Agile Equity, believes the new rules will be beneficial. “It will help increase corporate confidence, which I think is critical,” he said. “M&A is a function of corporate confidence.” After all, if you’re uncertain of the numbers, how can you do a deal?

While all the attention has been focused on large deals involving public companies on both sides of the table, some 90 percent of all deals that are getting done involve private companies. The median deal size recently has been around $25 million, notes Dan Donoghue, managing director of middle-market M&A for USBancorp Piper-Jaffray [NYSE:USB]. In the current environment, only the best quality deals are getting done, he said.

Do private companies need more regulatory oversight? Donoghue doesn’t think so. After all, the SEC’s role is to make sure the investing public gets a fair shake from large, faceless corporations where they have little or no influence. In a privately held company, the largest shareholders also operate the company.

Longer Deal Cycles

The new rules clearly mean it’s going to take longer to get deals done. There is almost unanimous agreement among the advisors we’ve talked to in recent months that buyers – and in some cases sellers, too – are taking a closer look, spending more time on due diligence.

“Any CEO who is going to personally certify the financial statements, you can bet he’s going to increase the amount of resources that are dedicated to the preparation and the verification of those statements,” Donoghue believes. “I’m sure the accounting costs are increasing substantially.”

“There’s more seller due diligence when it’s a private seller – public company transaction,” Boissevain said. “Typically before, you looked at the SEC documents, you looked at the financials they reported, and that was pretty much the extent of the due diligence. Now, the sellers, even if they are private, are requesting more on the due diligence side, a little more coverage in the ‘reps and warranties,’ and this makes sense.” Private sellers are especially wary of any deal that involves public company stock as part of the purchase price, Boissevain said. “More deals are being done with shares in proportion to cash — you’re not going to get 100 percent cash these days. The value of those shares is critical. And given the volatility in the tech sector, you don’t want to sell to a potential future Worldcom and then see the value of your shares decrease to zero.”

“They’ll still do the deals, it’s not going to stop them from happening,” Donoghue said. “But it’s definitely going to cause the process to be slower and be more expensive.”

Unexpected Impacts

As sometimes happens when new laws are rushed through the process, there are some unintended consequences. The experts we talked to see at least two such cases. Cross-border deals have accounted for slightly more than half of all transactions involving U.S. companies over the past year or so. So it’s no small matter when foreign buyers or sellers are worried about the new laws. In particular, multinational firms with stock market listings in more than one country are concerned about how the rules might affect them. Will prosecutors go after executives of companies based outside the U.S. in their zeal to halt fraud? The head of Germany’s industrial federation, the British trade minister and at least one European Union trade official have all expressed their concerns to U.S. regulators. The German official has voiced concerns that attempts to impose the rules on dual-listed firms would have to be challenged in court, according to The Financial Times. Some 24 German companies have dual stock listings there and on the NYSE.

“We constantly encounter the negative perception that our clients have regarding the U.S. judicial system and the potential legal liabilities associated with doing business here,” said Robert Gibbons, president of Kaupthing New York, an Icelandic investment bank with corporate clients throughout Scandinavia. The bank takes pains to advise its clients about the risks of doing business here, often engaging advisors to quantify the legal risks. Once they are fully informed, “We have been able to minimize any disruption to the business,” he said.

Going Private

The increased regulatory burden – and the costs that go with it – could be the final straw for many small public companies, Donoghue believes. He thinks one impact of the new regulations could spark a number of deals as some companies decide they’re better off in private hands or as units of much larger public entities.

Mid-size public firms – those with annual revenues below $250 million or so – that are not involved in the “hot” industries that investors are drawn to, see few benefits and lots of added costs associated with being public, Donoghue said. They find it difficult to attract analyst coverage, and thus get little attention from big institutional investors, so their stock prices suffer. Many of these firms “are pretty well run, but they just are too small to be a public company in a world where being public carries such high regulatory and corporate governance burdens.” A decade ago, the target size for a company to go public was $100 million, Donoghue said. Today, the figure is closer to $700 million.

With all of that comes the added costs of finding and keeping independent directors. Not only has the cost of liability insurance for directors skyrocketed, but board members are increasingly targeted in shareholder lawsuits. “I think we’re starting to see more trepidation on the part of directors about serving on these boards,” Donoghue said. “It isn’t all that financially lucrative to serve on the board of a small-cap public company. So attracting directors is probably going to mean increasing the financial incentives” they receive.

“The small public companies are going to realize that the costs of being public are too high, and I think we’re going to see a lot of consolidation of public companies,” he said.

On the private side, Boissevain sees venture capitalists thinking twice about the number of seats they hold on the boards of portfolio companies. With the added costs, and the perception that VC firms have deep pockets making them attractive targets for litigation, “There are cases where board members have resigned because of the increased liability exposure,” he said, and there could be a negative impact on mergers when that happens. “VCs on the board have portfolio companies typically in the same space, and deals get done by a VC calling on portfolio companies as well as other VCs. So if there are less VCs at the board level, that will certainly affect M&A.”

Long-term Benefits

Ultimately, the experts say, the new rules will have a positive impact on M&A volume. Financial statements personally guaranteed by CEOs – some of whom are, in turn, requiring department heads to sign off on their numbers – should increase confidence in the validity of a buyer or seller’s numbers. “They have to make sure that their house is in order, that it’s clean, that their financials are signed off on, that there’s no undue exposure.”

There may be some pent-up demand for acquisitions as companies have focused on their internal issues over the past year or so, Boissevain said. Eventually, they’ll be looking for ways to speed up growth and get ahead of the competition.

The investment banker sees the volume of technology deals increasing in the months ahead. While large corporations have been focused on their accounting woes, the pace of technological innovation and R&D has continued at small firms. Boissevain predicts the cycle is about to come around again. Companies that have cut back on technology expenditures over the past couple of years will find they don’t have time to catch up by building those new technologies, so they’ll acquire the companies that already have them, he said.

And Donoghue sees more strategic takeovers as small companies decide it isn’t worth it to go it alone as a public company. “Public-to-private sounds interesting, but it usually requires such a high level of debt financing and offers shareholders such a low premium that most small and middle-market companies end up finding better transactions and end up selling to larger strategic acquirers,” he said.

For the foreseeable future, strategic divestitures of noncore businesses and acquisitions of companies that complement core strategies will be fertile ground for M&A practitioners.

A Former Reporter Describes Simple Steps to Working with the Media

Building a successful relationship with the press in your target industry is a frequently misunderstood process.

Treat the media the way you treat your customers. Why are the best companies successful? More than pitching their products, they listen. They ask questions to determine the customer’s needs, then try to fill that need. When your client complains he or she doesn’t understand the media, use this sales analogy. It’s a context they recognize.

Too often, communications between public relations professionals and media is all one-way. You’ve got a product to promote, so you bombard the press with releases, whether or not they are timely or relevant.

Know the media you target. Be sure what you’re sending is appropriate. I once edited a magazine for paneling manufacturers. We wanted articles about new technology and manufacturing techniques. But most of the inquiries and unsolicited articles I received were along the lines of “How I paneled my basement.” Read the publication; visit its Web site; check the editorial calendar. Get a copy of the media kit.

Understanding your target media is the first step toward building a lasting relationship. Make initial communications short and to the point. If the subject line reads “Widget Corp. Press Release,” the editor may file it away to read (much) later or not at all. “ACME Acquires Largest Widget Maker” is much more likely to get an editor’s attention.

Use the press release sparingly. Many editors allow only one or two chances to show that you have something newsworthy. After they see two or three releases that offer nothing newsworthy, subsequent company releases will likely be tossed unread.

Don’t be a pest. Don’t call to verify that your release arrived; make sure you have the right address first. If you have good reason to call, do it after deadline. Don’t spam every editor and reporter in the newsroom with your press releases. Find out who the appropriate contact person is, direct it there, and learn how they prefer to receive information; don’t send it by e-mail, fax AND snail mail.

Is that harsh? Sure. Is it fair? No, but it is reality. Reporters and editors too often are unreceptive, even rude. Their skepticism is usually based on prior experiences. The editor agreed to look at a story, but it was all sales pitch and no substance. Or a promised interview failed to materialize. Make it easy for the press to work with you, and you’ll stand a better chance of getting in on the really meaty stories.

One of the most effective ways to get press coverage – in breaking news and feature stories, not in the “people” or “new products” departments – is to make spokespersons available for interviews on current issues. Alert them that you have an expert who is available. Make sure the interviewee is available that day and will return calls before deadline. Provide direct contact information, in addition to your own. Include qualifications and relevance to the issue. You may also send a prepared quote. Include contact and background information. Some will use it, but most want their own quotes, or will do a follow-up interview.

In your press kits, note who is available for interview, their accessibility, and topics they can address. Make sure they are comfortable interviewees. Be sure they can speak for the company. A helpful interview can lead to a long-term, beneficial working relationship.

Reporters on deadline don’t have time to be bounced around. They’re under pressure to make productive contacts and write quickly. Make their jobs easier, and they’ll turn to you as a valued resource.

Quality Companies Move to the Pink Sheets

For most public companies, being “in the pinks” has been a stigma to be avoided at all costs. Savvy investors viewed these stocks as a “pink flag” signifying that the company was in trouble. And for years, the pink sheets were inhabited primarily by over-hyped and often worthless penny stocks foisted off on unwitting investors looking for that one cheap investment that was going to make them wealthy. Others were troubled companies that were just passing through on their way to oblivion.

But a change is taking place. In recent months, trading volume in pink sheet stocks has increased dramatically, surpassing volume on the soon-to-be-disbanded OTC Bulletin Board. While still nowhere near the tremendous trading volumes of the NYSE or Nasdaq, trading in pink sheet stocks has approached 300 million shares a day. It’s important to keep that figure in perspective; on a recent day in late May, the value of all those trades was slightly more than $100 million, or about 33 cents per share. In contrast, volume on New York’s Big Board recently has averaged more than 1.4 billion shares daily.

“When the bulletin board is gone, many small companies will have no place to go but the pinks,” says Andrew Berger, editor of Walker’s Manual of Unlisted Stocks, which claims to be the only definitive guide to quality pink sheet companies. Walker’s book delivers detailed research on what he believes are the 500 best companies listed.

Analysts with Walker’s Manual comb company Web sites, look for news and annual reports, and talk to company officials. Even so, there is often relatively little information available. These are very small companies, typically between $5 million and $50 million in revenues, emphasizes Berger.

The public U.S. markets are becoming a far less hospitable place for these small companies than they were just a few years ago. The many new regulatory, auditing and board requirements imposed by Sarbanes-Oxley add tens if not hundreds of thousands of dollars to the cost of being an SEC-regulated public company. Not to mention the foreboding requirement that a CEO must personally guarantee his company’s financial statements, and is subject to large fines and even imprisonment if someone fudges the sales figures.

Then too, the scandals on Wall Street have forced significant cutbacks in analyst coverage. Always an issue for smaller companies, there is now even less coverage than before, unless companies choose to buy it themselves. More and more, executives of small companies, already hammered by a weak economy, find themselves asking whether it is worth it to continue to be publicly traded. Increasingly, they are deciding that it is not. Every week, it seems quality companies announce their decision to de-list and become pink sheet stocks.


And today, Enron (ENRNQ.PK), WorldCom (WCPMQ.PK) and Global Crossing (GBLXQ.PK) are among the denizens of the pink sheets, too. Part of the pink sheets’ image problem is that it remains the last stop for de-listed, usually financially destitute companies on their way to liquidation. In fact, there are seven classes of Enron stock listed there.

Technology companies no longer able to meet Nasdaq listing requirements — especially the $1 minimum price, although the market has waived that standard in recent months — have found themselves in the pink sheets in the past couple of years. But Berger is skeptical, warning that for most, “it’s just a stop on the way to the bottom.” Experts warn that there are lots of troubled companies in the pink sheets, and while there may be opportunities there, it’s a highly specialized area.


Experts agree one more force is likely to drive even more companies to pink sheet status. Nasdaq is working on a plan to phase out the Over-the-Counter Bulletin Board market, currently populated by several thousand small companies, in favor of a new “Bulletin Board Exchange,” or BBX. The BBX is currently scheduled to launch next year.

The popular OTC Bulletin Board is an electronic trading service operated by Nasdaq. It began requiring companies traded over the service to file regular financial reports in January, 1999; before that, many “non-reporting” companies populated its rolls. Many of the higher-quality stocks to be found there issue annual reports, quarterly financial statements and press releases announcing material events that may impact their prices, even though they are not required to do so, and even maintain investor-friendly investor relations departments.


But now, Nasdaq is preparing to up the ante. In an effort to remain solvent, the Nasdaq market plans to charge an annual fee of $5,000 for listings on the new BBX exchange. In addition, companies that choose to be included on the new exchange must meet a new, tougher series of regulatory requirements that are very similar to those imposed by Sarbanes-Oxley on SEC-listed companies. National market listing fees are expected to triple.

All that paperwork can be very expensive — as much as $150,000 to $300,000 a year, according to Greg Ballard, chief operating officer of Knobias Holdings, which provides detailed financial data on some 13,000 U.S. companies to both professional and retail investors. Knobias started out offering hard-to-find data on bulletin board and pink sheet companies, and later expanded its service to include companies traded on the major exchanges, too.

“The companies are like, ‘Whoa, wait a minute, why would we do this?’” Berger says. And they’re moving on down. As of June 4, some 3,949 companies were listed exclusively in the pink sheets (a figure that increased by more than 100 in two weeks), and just 437 on the bulletin board. Another 3,092 were quoted on both, according to statistics posted at www.pinksheets.com.

Ballard finds the turnaround to be somewhat ironic; Knobias added coverage of the NYSE- and Nasdaq-listed companies when interest in smaller firms waned during the Internet boom. Today, he says, there’s a great deal of increased interest because his firm is one of a select few that offer data on pink sheet firms.

Small company executives will have to choose between the unregulated, relatively inexpensive pink sheet lists, and the more onerous requirements of the new BBX exchange. Those who see few benefits associated with the cost and regulatory burdens of the public exchanges are likely to migrate to the pink sheets, experts say.


As with all fringe marketplaces, there are notable exceptions to the “typical” pink sheet company. These include the occasional quality company working its way toward a listing on one of the respected exchanges, or a thinly-traded firm owned mostly by family or employees that saw no reason to pursue the status, headaches and costs that come with being a public company. Companies with fewer than 500 shareholders, for example, are not required to file financial reports with the SEC.

Too often, companies listed on the pink sheets are tainted with what Coulson calls “guilt by association.” Is there more quality in pink sheet companies today than there was a few years ago? “I think quality is down across the board,” Coulson says.

For example, there are many community banks listed in the pink sheets. For these companies, the lack of SEC regulation is not so significant an issue as it might be with others. Everything banks do is already tightly regulated by the U.S. Comptroller of the Currency, providing a level of regulatory oversight that is far more exacting than that imposed by the SEC.

Then too, there are American Depositary Receipts (ADRs), the instrument used to trade shares of foreign companies that choose not to list their stocks on U.S. exchanges. Swiss chocolate-maker Nestlé is one of the best-known foreign companies that trades in the pink sheets.

A third category that some believe is worth exploring are preferred stocks of some major public companies that trade in the pink sheets. Tootsie Roll Industries (NYSE:TR) has a preferred class B stock (TROLB.PK) that trades only in the pink sheets.


In 1904, the National Quotation Board (www.nqb.com) was founded to create a system for trading the stocks of small companies. Brokers listed the stocks they had to offer and their bid and ask prices on yellow and pink paper — and the market has been known ever since as the pink sheets. That tradition has only recently begun to fade into an electric pink glow. Pink Sheets LLC acquired the exchange several years ago, and in 2000 introduced an online service where pink sheet stocks can be traded electronically.

Now, as the OTC Bulletin Board fades into history, Pink Sheets Chairman and COO Cromwell Coulson hopes his exchange will replace it, becoming the preferred method of trading for companies that choose to opt-out of the more regulation-laden BBX Exchange.

“It’s going to become a more important part of the marketplace,” Coulson says. “The pink sheets will provide a better forum with more liquidity and more stocks. We now provide a better platform than the bulletin board does today, anyway.”


The pink sheets’ checkered reputation can work to the advantage of careful investors, say market makers. Joseph Reilly is the resident pink sheet expert at Robotti & Co., a New York brokerage that makes a market in a number of pink sheet firms.

The very act of de-listing and moving to the pinks can cost a stock as much as half its value, according to Berger. But in the case of a solid company, often nothing has changed materially to justify that drop. And just as the stock may dive on its way into the pinks, a move out — to full listing, or through an acquisition, for example — can provide a similar bump.

Reilly grew up with pink sheets. His father was one of the founders of Tweedy Browne Co., one of the first brokerage firms to specialize in little-known value stocks found in the pink sheets. Today, Reilly is one of the few analysts who focus on the unlisted marketplace, although that could change if the pink sheets grow as expected.

Reilly likes Burnham Holdings (BURCA.PK), a Lancaster, Penn. maker of boilers and heating and air conditioning system components. The company has long been a pink-sheet favorite, and for good reason: “They pay a dividend, and they always make money,” Reilly says. The company reports its financials regularly, and has seen its stock rise dramatically this year.

He also recommends liquor distributor American Mart Corp. (AMRT.PK) for its steady growth. But here’s a company that might scare off anyone concerned about liquidity issues. As of June 1, American Mart’s stock had last traded for $299.50 per share — on Oct. 8, 2002.

 Another pink sheet market maker, Jeff Herr, senior vice president of Chicago’s Howe Barnes Investments, likes Limoneira Co. (LMNR.PK), a 110-year-old grower of citrus fruit and avocados in California’s San Joaquin Valley, for its steady growth and large share of the avocado market.


The good news is that “pink sheet companies are below everyone’s radar,” says Jay Suskind, director of trading at Ryan Beck & Co., a Florida-based, mid-size brokerage that makes a market in a number of community banks and thrifts that trade in the pink sheets. Investors aren’t competing with the interests of large institutions or mutual funds. For the most part, those groups are prohibited by their charters from trading in pink sheet stocks.

While those institutions are generally sound, Suskind offers the warning any investor considering pink sheets needs to be aware of: These are thinly traded, illiquid stocks. That may work for buy-and-hold investors, but it’s tough for those who want to be able to get in and out quickly. It’s not unusual for some pink sheet stocks to go without a single trade for weeks at a time.

Another pink sheet market maker, Tom Walker of Pennaluna, notes that trading in pinks is not for the casual investor. He believes it is better suited for fund managers and professional investors. Based in Colorado, Pennaluna specializes in mining stocks — long a staple of the pink sheet realm, and one where some of the market’s most dubious players can be found.

Another area Pennaluna specializes in, and one where there has been a lot of interest recently, is Canadian stocks. Many Canadian firms — legitimately listed and traded regularly on exchanges north of the border — use pink-sheet status to attract U.S. investors while avoiding the regulatory morass that comes with listing on the major markets here, Walker says.

“There are hidden gems there that people often overlook,” Reilly says. “But you can’t make a living trading them.” With those warnings in mind, “there are lots of jewels in the pink sheets,” Suskind says.

Prospective Buyers Approach Dot-com Deals with Caution

Published byTurnaround Management


The dot-com phenomenon is streaking back toward Earth in a fiery display even more spectacular than its meteoric rise just a couple of years ago. In the rush to capitalize on readily available venture capital and the promise of huge payoffs through initial public offerings, thousands upon thousands of companies were created in just a few short years. Some recognized the Internet’s potential as perhaps the most pervasive and flexible media to come along so far and developed truly unique business models, created innovative new tools or simply muscled their way to powerful first-mover advantage in their respective markets. But for every company with a product people will actually pay for and a truly promising revenue model, thousands were just along for the ride.

In just over a year, the market for dot-com companies has become a very different place. Burned by promises of profits that have yet to materialize, the investing public lost its appetite for the stocks of high-flying Internet IPOs and began to severely punish those who turned in quarter after quarter of lackluster performance. In the first quarter of 2000, 128 companies went public. In that same period this year, less than 20 braved those now shark-infested waters. Today, venture capitalists are more circumspect about the deals they will fund. Second-round funding is harder to get and is being doled out in smaller pieces.

Declining valuations for those that have managed to go public are causing follow-on funding problems for many firms, too. Dozens of dot-coms have been delisted by NASDAQ with many more teetering on the brink. Delisting can be the beginning of a slide down a very slippery slope. Most institutional investors and mutual fund managers won’t touch a stock that has been relegated to “pink sheet” status. Dire predictions abound about the eventual fate of some 400 public dot-coms and an estimated universe of as many as 10,000 companies.

Disappearing Equity Deals

Those sinking valuations have changed the mergers and acquisitions landscape in another fundamental way. High-flying stock valuations enabled buyers to use those shares as currency to acquire other firms. In the late 1990s most of those huge acquisitions were stock-for-stock transactions. Today, “There are no equity deals. People don’t want stock,” notes Robert Boehm, an attorney with Akerman Senterfitt and Eidson in Miami, who specializes in middle-market mergers and securities transactions.

That leaves many fledgling Internet companies with limited options. One of the few remaining opportunities to create a “liquidity event” is to merge or be acquired. That option, too, is neither as easy nor as attractive as it was just 18 months ago.

In today’s volatile marketplace, acquiring companies have grown cautious. Deals are being made, but not for the sky-high valuations that were typical just a few years earlier. The attitude of buyers has changed from what was perceived as a pressing need to establish a foothold in the Internet space at any cost, to one where there is little pressure to buy. Today’s buyers are biding their time, waiting for the best deal at the right price. They’re less interested in funding ongoing operations, the experts say. Companies with a hefty burn rate and no clear path to profitability will find deals elusive. Those with promising business models, technology that sets them apart from the crowd and real revenue streams are the most likely acquisition candidates.

Down, But not Out

Just as the promise of the dot-com company’s potential was over-hyped on the way up, rumors of the sector’s wholesale demise are greatly exaggerated. More than twice as many dot-com companies were acquired than closed their doors in the first quarter of 2001, according to Webmergers.com, a consulting firm that tracks merger and acquisition activity among what it calls “significant” Internet firms  those that have received at least one round of funding from venture capitalists, angels or other external sources.

Buyers spent $13 billion to acquire 380 Internet companies during the first three months of the year, Webmergers reports. In that same period, 147 companies closed their doors, compared to just five in the same period a year earlier.

While comparable data for the entire dot-com industry is not available, the San Francisco-based research firm offers an eye-opening look at one sector: destination web sites. Buyers spent about $2.2 billion to buy 132 Internet destinations in the first quarter of 2001, a significant decline in both valuation and number of deals from the same period a year earlier. Then, a whopping $52 billion was spent to acquire 231 destination companies, and that figure does not reflect the blockbuster acquisition of Time Warner by America Online for $157 billion. In the first quarter of 2001, only five deals were valued at more than $500 million, half as many as in the same period last year.

The Webmergers data shatters yet another myth of the Internet world. “The revenge of the bricks’ never happened” company President Tim Miller said recently. While a chart of the largest deals of the first quarter shows almost exclusively broader technology firms acquiring dot-coms, the vast majority of deals are Internet companies acquiring other Internet companies. Sadly, this strategy has not always panned out. Case in point: last year’s acquisition of Petsstore.com by Pets.com. Only a few months later, the sock puppet itself landed on the discard heap. Last fall Pets.com approached 50 prospective buyers and backers to no avail, according to published reports.

Yet one more example that shows the new reality in stark contrast to the Internet’s heyday: In the spring of 1999, fledgling e-tailer eToys merged with BabyCenter in a stock-for-stock transaction that gave BabyCenter roughly 15 percent of eToys. Two months later, when the much-anticipated eToys IPO closed its first day of trading at $77 per share, BabyCenter’s value on that ephemeral paper, at least was worth well north of $1 billion. In March of this year, Johnson & Johnson acquired BabyCenter from the now-defunct toy seller for $10 million.

Investment banker Phil Harris, managing director of New York’s Alterity Partners, thinks the acquisition amounts to little more than an inexpensive way for Johnson & Johnson to acquire customers.”If they had a million customers, it’s worth it at $10 per consumer, when you compare that to traditional media and what they’d have to spend to develop that relationship,” Harris said. That’s the kind of hard-nosed evaluation of a dot-com’s assets that buyers are making today, he notes.

Cash Rules Once More

Cash is king, Harris points out, and in an uncertain economy, prospective buyers are watching their cash very carefully. There’s a lot of tire-kicking, a lot of companies are looking, but few companies outside the Internet sector are stepping up to the plate, Miller agrees.

No one wants to take on a company with an unproven business model and a hefty burn rate, Harris said. “At the end of the day, even larger companies do not want to take on a money-losing operation–¦they’re just going to cherry-pick the best assets.”

An issue that slows the prospects for getting some deals made is that seller expectations have not yet adjusted to the new reality of the marketplace, Boehm said. Many are still pinning their hopes on a stellar IPO. “You have to drag the sellers, kicking and screaming, into it,” he commented.

One more difficulty faced by Internet firms seeking a buyer is that they often don’t start the process early enough. In a recent report, Webmergers.com’s Miller relates the story of Evite Inc., which announced last fall that it was seeking a buyer or strategic partner while the company still had $17 million in its coffers. Ticketmaster topped several other bidders and acquired Evite in March. All too often, Miller wrote, dot-com firms recognize the need to begin restructuring and seek a partner when it’s too late for the process to have much hope of succeeding. He recommends that firms begin their turnaround efforts, including looking for a partner or buyer, six to nine months before the cash will run out and suggests restructuring to pare operating costs and focus on the company’s core capabilities.

Caveat Emptor

Buyers are being more careful with their due diligence and that can mean a lengthier process. When external financing is involved, banks are more cautious, willing to lend against lower multiples than those offered just a few years ago. And that, of course, assumes there are any revenues on which to base the traditional EBITDA analysis. Trendy Internet measures of worth such as page views and cost per customer carry far less weight with buyers today.

The lesson, experts say, is that executives of troubled dot-coms need to recognize the need for assistance as early as possible, understand what they really have to sell and be realistic about the price it will bring. With those goals realized, the groundwork for creating successful transactions will be in place.