Between the Lines
Don’t believe everything you read. That’s certainly one of the lessons from the August press release hoax that more than halved the price of Emulex Corp. stock in 59 minutes and resulted in the arrest of a 23-year-old who had netted nearly $250,000 on his positions. The price quickly recovered after trading was halted on Nasdaq, but the event left many pondering the market’s vulnerability to instant information.
It certainly was a wake-up call for the wire services, especially Internet Wire, where the suspect had worked. Says Michael Rockenbach, CFO of Emulex, a fiber-channel adapter maker based in Costa Mesa, Calif., “You don’t want to be the only one without the news, but you don’t want to be the only one out there with something like this,” which claimed the CEO had resigned and that the company was the target of an SEC probe.
The gullibility of small investors also came into play. Rockenbach notes that most of the frantic trading was done by individual investors, “who tend to trade on news and the direction of stocks and tend to be much more reactionary. The larger institutions were more skeptical.”
Running on Empty
It hasn’t been a good year for energy. California utilities struggled publicly all summer to avoid blackouts, and customers of San Diego Gas & Electric Co. saw their electric bills more than double, prompting $2.6 million in federal aid and an investigation by the Federal Energy Regulatory Commission. And the news promises to get worse.
The East Coast is expected to get a shock this winter, but not from electricity. Gas companies are warning of natural gas price increases ranging from 15 percent to 40 percent, say American Gas Association officials, and the Clinton Administration has been scrambling to boost low heating-oil supplies in the region. “Stocks are one-third of what they were last year at this time,” says analyst Randall Nottingham of Boston-based Yankee Group. “Heating oil will be in very short supply, and if we get even an average winter, you will see price spikes and shortages.”
Companies facing such spikes can lock in prices now with fixed contracts. But that’s no defense against physical shortages caused by Mother Nature. Space heating and cooling accounts for up to one-third of an office building’s energy costs, and a bitter cold snap or a heat wave can wreak havoc with an energy budget.
“We protect ourselves against warmer than normal winters by buying weather derivatives,” notes Paul Forrest, CFO of Heating Oil Partners LP, in Darien, Conn., which distributes heating oil throughout the Northeast. “CFOs who want protection against colder than normal winters can go into the same market.” As for the cost of heating oil this winter, says Forrest, “Companies can also fix their oil price with a cap and buy a put against it that compensates them if the price goes lower,” he says.
Most companies will sign contracts that leave such exotic hedges to their utility or energy service provider, says Yankee Group senior analyst Richard Baxter. But the deregulated energy market is forcing its way onto the finance radar screen. “The average facility manager does not have the sophistication to handle forwards, puts, and weather derivatives,” notes Forrest. “You need heavy financial analysis.”
Not Depreciated Enough
Congress has had a habit of tinkering with real estate depreciation schedules, and it may soon reexamine whether they match reality. A new study by Deloitte & Touche argues that the rate of real estate depreciation allowed under current tax law is too slow. The study concludes that the 39-year non-residential and 27.5-year residential schedules should be reduced to 20 years. The Real Estate Roundtable, a Washington, D.C.-based organization, commissioned the study to provide new data that could be used to demonstrate to Congress that current tax depreciation schedules are outdated.
“The tax system is supposed to reflect the actual economics of loss in value, but it does not provide depreciation quickly enough to match the actual loss in the value of buildings,” says Randall Weiss, director of tax economics for Deloitte & Touche in Washington, D.C., and the lead author of the study. While the changes would lower taxes on any existing real estate investment, Weiss speculates that faster depreciation would also provide more incentive to invest in real estate.
Depreciation for an office building at 39 years “is simply much slower than the real economic rate of depreciation for that asset,” says Stephen Renna, the Roundtable’s vice president and counsel. “If you didn’t make ordinary capital improvements to a building, it would have an economically useful life of 2025 years.”
According to Weiss, previous research understated the rate of economic depreciation and overstated the appropriate recovery periods because it neglected to account for the substantial expenditures for building improvements after original construction.
The Price Of Bad Advice
In August, Bear, Stearns & Co. paid $30 million to settle a lawsuit that claimed the securities firm gave bad advice to a software company involved in a merger. The case, involving the now-defunct Daisy Systems Corp., has put investment banks more carefully on guard when facilitating M&As.
Bear, Stearns settled as the case was headed to appellate court, but the real blow was struck in 1998 after a federal judge in California found against it, reports Stuart Buchalter, co-chair of the business practice group of Los Angelesbased law firm Buchalter, Nemer, Fields & Younger.
“Since the judge’s decision was rendered,” says Buchalter, “the investment banking houses substantially changed the form of their engagement letter to make it very clear that they were not being retained as an agent or a fiduciary of the client company.”
John P. Mello Jr.
Investors who participate in direct purchase plans tend to be long-term investors, which is attractive to companies, especially in these volatile market times, when long-term investment dollars are at a premium.
The problem with these plans is that they can be expensive to run. It costs a company an average of $15 a year to maintain each account in a plan, according to BuyandHold, an online brokerage firm, in New York, that caters to long-term investors.
“What BuyandHold has done is take all the good that exists in dividend reinvestment plans and stock direct purchase plans and moved it into this century,” observes Peter E. Breen, CEO and co-founder of the firm.
By steering investors to BuyandHold, which was launched last November, companies can remove the burden of administering their plans off their backs. Companies such as The Walt Disney Co. and Sallie Mae have created links from their Web sites to BuyandHold, where investors can open an account with a balance of as little as $20 and trade twice a day for $2.99 a transaction.
Better yet, because BuyandHold is a brokerage, investors can invest in companies without direct stock purchase plans as if they had them. “We walk and talk like a direct investment plan because we allow people to buy shares in dollars and on a periodic basis,” Breen explains. “But we also allow you to buy shares of a company like Cisco Systems Inc., which doesn’t have a direct stock purchase plan.”
Getting Current Online
With around $1.5 trillion swap-ping hands every day, the foreign exchange market is a natural to enter the online exchange arena. However, while banks are racing to form Internet currency trading ventures—most notably FX Alliance LLC, owned by 13 major international banks; and Atriax, owned by Citigroup Inc., Chase Manhattan Corp., and Deutsche Bank AG—none of the services is yet fully operational, leaving corporate users with few alternatives.
However, two third-party services aimed at fulfilling corporate users’ yen to trade online recently began offering spots, swaps, and forwards over the Internet. Both Currenex Inc., with 25 banks and 12 corporate clients, and CFOWeb .com, with 10 banks and 4,400 users as of early September, use a reverse auction method, by which registered corporate users choose the banks they want quotes from and enter a bid. While the banks know the trader’s identity, they get no information about their competitors or other bids. Within a minute, banks’ quotes will appear on the trader’s screen, with a few-second window for the trader to accept or reject them.
Although only about 12 percent of foreign exchange trading is now electronic, the volume could grow to 75 percent by 2002, estimates Robert Iati, senior analyst at Boston-based TowerGroup. One factor that has slowed growth so far, he says, is that CFOs often are afraid that broadcasting quotes to a number of banks might reveal their trading strategies and allow banks to raise rates accordingly.
Early adapters say the system has few drawbacks. Stephen Piccininni, vice president of treasury for MasterCard International, says the company has been trading the majority of its foreign currency through Currenex’s pre-Internet, modem-based system since it opened in 1996, and has yet to run into a problem. In fact, the company now deals only with banks that agree to join the system. “It’s not just getting the best price; there’s an operational efficiency,” Piccininni says, compared with having a single bank provider or deploying a large team of people to get telephone bids from multiple banks.
Currenex CEO Lori Mirek says the service is a good proving ground for how well a bank treats its corporate clients. “We don’t get in the way of your relationship with your bank,” she says, noting that many banks have seen the exchange as a way to net new customers for offline services. “If the bank has been taking good care of the customer, then it isn’t an issue.”
Reform Vexes Microcaps
The ever- shrinking spreads and tougher listing requirements in the over-the-counter markets are welcome reforms for big companies and institutional investors. But the outlook is bleaker for the small-fry companies of the world that–often lingering in bulletin board hell–are finding the new rules working against them. Decimalization, for example, with its anticipated tiny bid-ask spreads, may chase away market makers that already find small issues with light trading volume hardly worth their while.
And it’s becoming harder to get a listing in the first place, says Kenneth Kamen, co-founder of Princeton Securities Corp. and chairman of the Regional Investment Bankers Association, a group whose niche is initial public offerings of $20 million or less. In the past five years, the number of its offerings under $20 million has shrunk by 90 percent, from $2.3 billion in 1994 to $228 million last year. “It’s cutting out the opportunity for small companies to become $400 million companies,” says Kamen. Not only are good, solid businesses being denied public capital, he says, but microcaps that have gone public are finding it increasingly hard to do follow-on offerings.
Although 6,600 companies trade on the bulletin board or pink sheets, Nasdaq has distanced itself with tougher listing requirements as it prepares to go public itself, says Kamen, and the trading technology has not reached the smallest of public companies. “Clearly, the smaller end of the market has to get a viable place where investors are not worried they’re making an investment in an inefficient marketplace,” says Kamen, who presented testimony to Congress on the subject in May. Regarding the president of a company on the bulletin board, Kamen says, “Instead of feeling proud that he’s public, he’s a leper. The bulletin board is the only incubator the nation has. It’s not the trash heap.”
A Costly Revolving Door
If your company’s employee turnover rate is soaring, you may just have to start answering to your shareholders about it. A new study claims that employee turnover replacement costs have had a dramatic impact on company stock price, especially in high-turnover industries such as specialty retail, call- center services, high-tech, and fast food.
Earnings and stock prices were depressed an average 38 percent as a result of turnover costs, according to the study by Sibson & Co., a consulting firm in Princeton, N.J. The expenses tallied to compute turnover costs included recruiting costs, advertising, headhunter costs, the cost of training a replacement, and the cost of processing out the departing employee.
The survey determined the effect on the stock by subtracting the industrywide turnover costs from earnings, then recomputing the industry’s market capitalization based on accepted multiples for that industry.
“Most companies don’t know or underestimate their turnover costs,” says Jim Kochanski, a principal at Sibson. He adds that many companies fail to target their turnover efforts toward employee groups that are expensive to replace–for instance, a high-tech or revenue-generating employee, such as a salesperson–and apply one-size-fits-all strategies to all employees.
A more specialized retention approach is being used at Booz, Allen & Hamilton Inc., a privately held management and technology consulting firm based in McLean, Va. Chief administrative officer Sam Strickland says the company currently has a turnover rate in the “mid-teens.” He’s not sure what turnover is costing his company, but intuitively, management is aware that it’s “a lot of money,” he says. After surveying employees, the firm quadrupled its training and development budget and created clear benchmark standards that, once achieved, automatically qualify nonmanagement personnel for promotion.
Feds Flounder in GAO Round- Up
In this heady age of budget surpluses, one shouldn’t become too complacent about the government’s capacity to count its own money. In its most recent audit, the General Accounting Office (GAO) gave the Internal Revenue Service one clean opinion, four disclaimers of opinion, and one qualified opinion, and chided the agency on the one clean opinion for relying on “aging financial management systems” and “costly, time-consuming processes” to gather the data necessary for the audit. For example, officials had to make tens of billions of dollars in adjustments to validate taxes- receivable figures.
The IRS is not alone in its accounting angst: 20 of the 24 major federal agencies failed to comply with the Financial Accounting Standards Board’s federal accounting standards issued last year, according to a roundup report the GAO issued in June. The agencies, which were audited by a number of private firms and government agencies last spring, were also cited for nonintegrated financial management systems or inadequate reconciliation procedures, and weak computer security. “We’re concerned that on a day-to-day basis, they don’t have reliable information on which to make management decisions,” says Gloria Jarmon, a GAO director.
The IRS’s problems, however, are among the most severe. Plus, “it’s a credibility issue with the IRS,” says Gregory D. Kutz, the GAO director who headed the IRS audit team, “and I think that’s why they’re working so hard to resolve them. How can they expect taxpayers to keep good records when they can’t do it themselves?”
William Phillips, a partner in PricewaterhouseCoopers’s government consulting practice, is working with some federal- agency CFOs. “We shouldn’t take all the shock out of it, because it’s not a pretty picture,” he says of the GAO report. He also points out, however, that federal agencies started their CFO compliancy from scratch only six years ago, in accordance with 1994 legislation.
Bond Auctions Go Live
The dog days of summer saw the debut of a new treasury trick, as a trio of borrowers turned to the Internet to auction their latest debt offerings. Bear, Stearns & Co. was first out of the gate on August 10 with $600 million in global notes; however, Deutsche Bank AG and The Dow Chemical Co. were close behind with smaller issues over the next three business days.
Earlier this year, DaimlerChrysler and Ford Motor Co. peddled their bonds on the Internet, but these latest transactions mark the first time a real-time online auction process was utilized. Using a proprietary system to conduct its Dutch auction, in which qualifying bidders paid the lowest price in a range of accepted bids, Bear, Stearns allocated the 7.8 percent, seven-year notes to 57 investors, pricing the transaction at a spread of 182 basis points over the relevant treasury benchmark.
Although similar in approach, Dow used an online system developed by W.R. Hambrecht & Co. that gave investors two hours to electronically submit bids, which they could withdraw or change. Bidders watched a split screen, half devoted to their own accounts while the other half showed other orders coming in without identifying the other participants.
“You can watch the deal unfold minute by minute, second by second,” says Mitchell Stapley, who added Dow’s notes to the $3.5 billion he oversees as chief fixed-income officer at Lyon Street Asset Management Co., in Grand Rapids, Mich. “The technology will change the face of how bonds are distributed.”
Just how quickly remains uncertain. “Lining up buyers is not as hard as getting share-of-mind on the issuer side,” says J.D. Delafield, a senior managing director at W.R. Hambrecht, who helped conduct the Dow sale.
Count Dow treasurer Geoffery E. Merszei as one who is steadfast in his embrace of the Web. “Providing investors with the ability to directly establish the market clearing price is a stair-step improvement in transparency, which benefits both investors and the issuer,” he says.
In all, 57 investors were awarded a portion of the $300 million, five-year issue, with a clearing yield of 7.108 percent. Typically, Merszei notes, 15 to 20 investors would have ended up with paper. The fees Dow paid to Hambrecht and three other syndicate members were about 50 percent below those of an offline offering, in part because the transaction was one of the first of its kind, and because it was not fully underwritten.
Will Temps Get Organized?
A National Labor Relations Board decision in late August makes it somewhat easier for the nation’s 3.1 million temporary employees to join the unions of their permanent co-workers. But don’t expect to see masses of temps rushing to the picket lines.
The decision allows temporary employees to join combined bargaining units with the permanent employees at their workplace without the consent of either the temporary staffing firm or the employer. However, unions must still prove that the temporary employees share a “substantial community of interest” with the permanent workers, including that they are on the job long enough to benefit from union activity, and that the placement agency and its client are “joint employers,” meaning that they co-determine employment terms.
According to Edward Lenz, general counsel for the American Staffing Association, “There is less to the ruling than meets the eye,” because temporary workers and contractors make up a small fraction (about 1.5 percent) of the total workforce. Only about 25 percent of these workers stay on the job for more than a year. However, some see the ruling as one of the first victories in a larger movement to improve working conditions for long- term temporary workers, says Barrie Peterson, associate director of the Institute on Work at Seton Hall University. The decision should be a “wake-up call” for employers to evaluate their use of temporary workers, he says.