From Cnet.com:
news.cnet.com
The tech lender of last resort?
By Larry Dignan
Special to CNET News.com
August 14, 2001, 4:00 a.m. PT
If you ask his critics, Promethean Asset Management
CEO James F. O'Brien Jr. is a loan shark for technology
companies, a purveyor of "toxic loans," or a man who
profits from the misfortune of others.
But maybe he, and his firm, are misunderstood.
O'Brien runs a hedge fund that frequently helps fund
cash-strapped technology companies with private convertible
bond deals. He cringes at Promethean's lender-of-last-resort
reputation. "We don't view our companies as distressed at the time of investment," he
said.
In June, Promethean helped Excite@Home raise $100 million in funding. Under the terms
of the deal, Excite@Home can pay off Promethean with stock or cash. The bonds convert
to stock at $4.38 and above. Convertible bonds, which have attracted a lot of tech
companies lately, are hybrid securities that companies sell to investors, who can convert
them into shares of stock at a future date under certain conditions.
If all goes according to Excite@Home's plans, its stock will rise and the company will turn
its business around and pay off Promethean for a cheap loan. For Excite@Home--which
can't issue more stock because of a weak stock market and because it would face high
interest rates from traditional lenders--the deal with Promethean could be bargain.
Excite@Home's problem? Its shares hover around $1 after the company's latest earnings.
Excite@Home declined to comment about its deal with Promethean beyond what can be
found in regulatory filings.
Wall Street analysts, most of whom don't want to be identified on the record, argue that
Promethean shorts the stocks of the companies it deals with, spreads misinformation and
then profits. Short selling is a technique in which investors profit by betting a stock will
decline.
These analysts note that Promethean has a history investing in companies that eventually
see their shares plunge. Indeed, Promethean earlier this year restructured a deal with
MicroStrategy that would have led to a lot of stock dilution for existing shareholders.
MicroStrategy even sent a letter to shareholders asking them to battle short sellers.
O'Brien says the argument that he wants to run
companies out of business and cash in on the way down
is fatally flawed. Although he shorts stocks, he says, "it's
illogical to think that we'd benefit from the stock falling."
Promethean does hedge its bets to minimize its risks,
O'Brien said. And the company does take on a lot of
risks. For example, Promethean had to "eat some paper,"
or lose money, on its June 2000 investment in the
now-defunct eToys.
O'Brien sees his firm as the halfway point of a venture capitalist and a traditional
investment bank. And it's a hot niche right now. Courtesy of the go-go days of the stock
market, many immature companies are now public and in need of Promethean's custom
"creative financing."
CNET News.com recently caught up with O'Brien in Promethean's New York office.
Q: You've been investing in a lot of tech companies, including MicroStrategy,
Excite@Home and eToys. How do you find them? Do they come to you? Do you
go to them? And what kind of due diligence is involved?
Each of our investments in these companies develops in their own unique way. We have a
lot of investment bankers bring in a lot of companies to solicit our interest. If there are
companies we like, we approach them. We don't have a preference for one route or the
other, but most of our investments that we have made have generally been the result of
our contacting the companies directly. That was the case with eToys, MicroStrategy and
Excite@Home as well.
What do you look for in a potential investment?
We're looking for situations where we perceive that we are going to add value. (One
example is) if a company is in a situation where we think (it needs) a relatively significant
amount of capital and (it) has characteristics where a shot of capital can be very helpful to
the issuer's business plan. However, there may be some impediments to that issuer
receiving capital or capital cheaper than we can provide. Then that will go on our watch
list.
A lot of companies we're investing with, sometimes we know only a couple months, but a
lot of them we've known for two years, sometimes more. It really depends on the situation.
There are some companies we really like that we follow that don't need capital now, but
we see with their growth pattern there may be an opportunity for us in the future. There are
other situations like MicroStrategy that came up to us internally when one of our guys
owned the stock when it was way, way up and they had their accounting issues.
Goldman was on a road show for a $1 billion common (stock) deal, and understandably
Goldman had to walk away from the deal as the stock corrected. There was a lot of
uncertainty (over accounting issues), but this person (an employee) that owned the stock
liked MicroStrategy and suggested they (were) going to raise money and the public
markets (weren't) open to them. Over two or three months, they got to know us and we
got to talk about terms.
A lot of analysts and observers have referred to your company as the "toxic loan"
guys, lenders of last resort and loan sharks. How do you respond?
We believe those comments--we have yet to see those comments attributed to any
individuals, which we find interesting--come from one of two areas: There's either lack of
familiarity and/or those that have a competitive axe to grind. Sometimes it's both.
We have seen several of the banks expressing interest on actually being active in
borrowing elements of the structures we've been using for years. That's only going to
continue to increase in frequency.
A lot of the bankers, as we are, are products of the bull market, where creativity wasn't at
a premium. Institutional investors would buy whatever the banks were selling. And anyone
could raise money, and it was cheap. In these markets, where investors are beginning to
recognize the risk element of risk/reward equation, I think bankers are seeing the need to
understand this space.
You mention "creativity." Is that just a nice way of saying the companies you work
with couldn't get money in the traditional markets? What's creative?
Each one of these investments is unique in how it's structured. It's tailored to the
issuer--to their risk and their goals. Most of our issuers actually dictate the structure we
utilize. We come up with a structure that will fall in line with what they hope and fear in
their business plans.
For an issuer that's going to be cash-flow negative for the foreseeable future, it doesn't
make sense for them to issue debt. We're in a situation where we're familiar with both
structuring it and putting our money to work to get them the cash. That's why you're
seeing a lot more hedge funds become increasingly active.
Would you say you specialize in companies that are distressed?
No, certainly not at the time that we make an
investment. There's no company we'd label internally
as distressed at the time we're investing. These are
companies that generally have cost of capital at least
in the teens. If a company can borrow money at 8
percent we probably don't have any business to do
with them.
Some may be turnaround situations. Several years
ago we stepped in a situation like that with Borland. At
that point they had just cleaned house and brought in
a new management team from Apple. And we were
there to fund and begin a turnaround. That's one of our
proudest investments.
Other companies may have challenges pretty high, such as eToys, but we felt (we could
provide them their capital and have an acceptable risk/reward profile).
What would you tell analysts who say you short the stocks on the way down to get
more stock when companies have to pay up?
We'd encourage them to get a better understanding. Depending on the structure and the
risk we perceive in the investment, an investment may or may not be hedged. We're not
shy about the fact--and that it's important that people do understand--that we frequently do
hedge our investments. Hedging our investments is to protect against the possibility that
stock is going to decline, not to hope the stock is going to decline.
Without question, 100 percent of the time we want the companies to do well from a
fundamental and stock price standpoint. But we are also cognizant of the fact there's risk
in these investments; and it is not the U.S. government guaranteeing we will be repaid if
the stock doesn't perform and (when) our convertibles come due.
When you say hedge, does that include shorting a stock?
It definitely can. It can also include credit-default swaps, interest-rate swaps, and can--and
often does--include shorting stocks. The fact of the matter is 70 percent to 80 percent of
the convert market, public or private, uses short selling and other hedging techniques
every day to manage that risk.
Is the reputation for "toxic loans" misplaced since hedging is commonplace in
convertibles?
If they were to call any of the investments we make toxic they would have to call all
convertibles toxic. We don't consider all convertibles toxic, but the fact of the matter is
that if a stock improves over time it becomes equity, and if the stock falls, those
convertibles will need to be repaid and act as debt. That's part of the attraction for us as
buyers. Theoretically, you are protected on the downside because there's at least a stated
requirement that the company will pay you back, but we also know that sometimes that's
not guaranteed.
What are situations where you didn't get paid back?
eToys is one. We haven't had a lot of companies fail on us. We recently did a check. Out
of 100 investments we only had five or six names where a company failed on us.
If everything works out according to your plan, would you rather have stock or
cash? Is it ideal to get paid in stock after a run?
That is the dream scenario--where the stock really improves and we get heavy
participation. On the downside, it works out OK for us if a stock doesn't do well and the
company pays us. The nightmare is when the company comes to pay us back and
doesn't have the money.
If it weren't for the Internet boom would you be working with all these tech
companies?
There are more companies now finding themselves underserviced by Wall Street. The
market conditions have changed. A lot of these companies have waited, and continue to
wait, hoping the market will turn around and more or less gambling their business on
wanting to do financing on a higher level.
A higher level would be like a Goldman Sachs-quality deal?
Yeah. Or just hoping that even if it's not with a Goldman they can go to a hedge fund for
an investment. They're hoping that if the stock is $5 today and they are projected to run
out of cash six months from now that maybe the stock will double before then.
Regrettably, we're seeing way too many of those situations. |
