Microforum Inc - Street Wire
Microforum, a sinking tale of a ship and its rodents
Microforum Inc MCF
Shares issued 36,586,754 2000-09-29 close $1.68
Monday Oct 2 2000 Street Wire
MACHIAVELLI, DRACON, OR THE THREE STOOGES
by Stockwatch Business Reporter
The Microforum meltdown, sparked by a loss warning and fanned by news that allegations against chief executive officer Howard Pearl are being investigated, raises questions that go far beyond either the loss or the allegations. Already well off its 52-week high of $15, the stock fell 55 per cent after the two pieces of bad news on Sept. 28, closing at a new 52-week low of $1.68 on Sept. 29. Whether Microforum will continue to slide lower or stage a recovery will depend largely on the answers to a growing number of questions.
The estimated $3-million to $5-million loss for the second quarter is serious and distressing, but a clearer understanding of that loss should be available when the company releases its financial statements on Oct. 16. Microforum has already indicated that the loss resulted from "unexpected costs to complete certain fixed-priced contracts" and that "internal policy changes with respect to expense control and approval procedures" have been implemented to reduce the likelihood of similar nasty surprises in the future. It remains to be seen whether those policy changes will do more than just eliminate the element of surprise with respect to possible future losses.
Once the second-quarter financials are available, perhaps some of the analysts who previously beat the drum so loudly for Microforum will sally forth again to offer their spin on the results. At the moment, however, most seem to be ducking for cover. Indeed, some turned their back on the stock long ago. Taurus Capital last issued a report on Microforum in December of 1999, according to Adam Adamou. Mr. Adamou, once among Microforum's biggest fans, said that Taurus did not believe it was necessary to go public with the news that they were no longer formally following the stock. Canaccord Capital was more open. Analyst Jim Zadra inherited Microforum from his predecessor David Wong, another leading Microforum enthusiast. Mr. Zadra did not like the stock, gave his reasons and dropped coverage a month ago. When Mr. Zadra dropped coverage, Paradigm Capital analyst Carol McGillivray rated the stock a buy and set a 12-month target of $12. What Ms. McGillivray thinks now is anyone's guess; the Paradigm oracle apparently reserves her public pronouncements for "live TV."
Taurus, Canaccord and Paradigm were all part of a financing syndicate that took down a bought deal special warrant financing at $10 per warrant, raising $43.3-million in February. That raises another set of questions regarding brokerages and their analysts. Of course, analysts argue that their research and commentary is intended for their clients and they have no obligation to offer their assessments to other investors or reporters. That is true. However, most analysts will happily set that convention aside and gush about a stock when it suits their purpose. Evidently that purpose would not be served by public comments about Microforum right now. At a time when the company is in desperate need of some support, analysts have gone mum, prompting thoughts of foundering ships and rodents.
Early in the afternoon on Sept. 28, Steve Hanson, president of the Investor Relations Group (IRG), told Stockwatch that there was "some positive commentary out there in terms of research." In spite of the fact that IRG no longer handles Microforum's investor relations, replaced by GPC Canada earlier this month, Mr. Hanson was very accommodating in providing the names and telephone numbers of several analysts who might offer some of that positive commentary. Any possibility of that apparently disappeared about an hour after speaking with Mr. Hanson, as Microforum delivered its second piece of devastating news after the markets closed. Allegations against Mr. Pearl, made by the company's former chief financial officer, Frank Iadipaolo, were being investigated. Analysts were suddenly unavailable for comment.
Those back-to-back bombshells might almost be interpreted as Machiavellian. Somewhat crudely paraphrased, Machiavelli's princely advice was that unpleasant actions should be undertaken at one fell swoop; to prolong them risked uncertainty and discontent. However, Microforum's actions lack any clear indication of the finality advocated by Machiavelli. There is undoubtedly more pain to come, much of it because so much uncertainty surrounds the allegations and to what extent, if any, they are related to the second-quarter loss.
Microforum has officially said very little about the allegations. Nonetheless, news has been leaking out in dribs and drabs, adding to the uncertainty. The Financial Post, citing "internal documents," reported on Sept. 29 that Mr. Iadipaolo's allegations "concern the possible mismanagement of between $100,000 and $200,000." Other allegations reportedly "centre on personal executive expenses and issues of CEO discretion."
The possible mismanagement of up to $200,000 is no trifling matter; nor is the possible padding of expense accounts, perhaps especially in a top-heavy company like Microforum, which boasts more than 15 vice-presidents as well as other exalted executive titles. Indeed, the company seems to dole out executive titles as readily as any local McDonald's franchise assigns manager titles. As for "issues of CEO discretion," little is known about exactly what that might entail.
Few would argue that these matters are of little interest and no concern. However, many might question the reaction of the board of directors. If the nub of this whole affair turns on the possible mismanagement of $200,000 and expense account padding, does it really warrant the striking of a special committee and the attendant publicity? Unless there is considerably more to all this, that reaction might seem somewhat Draconian to many investors; particularly following, as it did, the drubbing the stock took over the loss warning. In the span of two days, approximately $100-million evaporated from the market capitalization of the company, which was already in a prolonged slide.
To this point, the company's effort at damage control has been far from auspicious. Indeed, the philosophical underpinnings of that effort point less to either Machiavelli or Dracon than to the antics of Curly, Larry and Moe. Taking centre stage in that early fumbling, is Rick Segal, the recently appointed president and chief operating officer of Microforum.
Mr. Segal joined Microforum from Chapters Online on June 28. Chapters has been bleeding red ink, racking up a loss $36-million for the year ended April 1, 2000, and tallying a loss of more than $9.9-million in the first quarter of this year. It is not clear what Microforum expected from Mr. Segal in terms of its own bottom line and, in fairness, he has not been with the company long enough for any impact to be evident. As for Mr. Segal's expectations, it is not likely that they included any thought of being thrust into such a crisis. Unfortunately, he has not risen to the occasion as yet.
A hastily arranged conference call on Sept. 29 was anything but a triumph of public relations. Mr. Segal briefed analysts on his background, stressing that he had only been with the company for 40 days, returning to the point several times. Fair enough; point taken and duly reported in most accounts of the call. Moving gingerly toward the allegations, Mr. Segal remarked, "We unfortunately caution you that there is a tremendous amount of legal activity going on." Evidently that is true enough. According to a report in The Globe and Mail on Sept. 30, the special committee has independent counsel, the board of directors has independent counsel, and Mr. Pearl has also retained a lawyer. In any case, the point that Mr. Segal was trying to make was that there were legal restrictions on what he could say about the matter, arguably something he could have done by stating just that and foregoing the reference to "a tremendous amount of legal activity." He certainly did not expand upon what the tremendous amount of legal activity entailed, nor was he even clear on how many lawyers were involved.
Mr. Segal also stressed that no criminal charges had been laid, a point he made early in his spiel and then repeated, for no clear reason, at the end of a response to the only analyst to put a question to him. Why Mr. Segal felt compelled to serve up that piece of information early and late in the call is a mystery. Other gaffes, such as fumbling over the name of the third director on the special committee, which he had just lavishly praised as consisting of "experts that are doing the right thing," may well be put down to Mr. Segal's short time with Microforum. Mr. Segal managed to name Steven Small and Efrim Boritz but it took a whispered prompt from a colleague for him to recall Francois de Gaspe Beaubien. The same whisper provided him with other details possibly not yet familiar to Microforum's latest executive addition. Still, even though miracles were probably not expected from the new president after 40 days in the wilds of Microforum, many investors expected a more impressive performance. Their disappointment was amply demonstrated in the market.
Investors are not likely to be comforted by some of the other news that has been surfacing, particularly in the absence of any clear statement from the company that would put that news in context. For example, while Microforum has claimed that it is implementing internal policy changes with respect to expense control and approval procedures, it has yet to offer any specific details of those changes. The Globe and Mail article on Sept. 30, however, reports that Mr. Segal notes that correct procedures should require two signatures on corporate cheques. That weighty observation on such a rudimentary procedure invites speculation that there was little control over the corporate coffers, a rather unsettling thought under the circumstances.
It is not clear why Mr. Segal has not yet been more specific regarding the policy changes. As for the allegations, he claims that he cannot comment out of fairness to the participants involved, the company and shareholders. Meanwhile, Mr. Pearl is being pilloried on Internet chat sites and his criminal past is once again being trotted out for public viewing and comment. Mr. Iadipaolo is also the subject of a good deal of Internet allegations and rumour-mongering. The company's credibility is waning and, in spite of Mr. Segal's assurance of "business as usual," this will take a toll on employees. Shareholders are watching their investments evaporate. In the face of that kind of fairness, Machiavelli might well look benevolent.
While the financial statements are scheduled to be released on Oct. 16, there has been no indication of just when the special committee will conclude its examination of the allegations or when its findings will be made public. Given the number of lawyers involved, doing things "in an expeditious manner" may be easier said than done. Moreover, whatever findings eventually make their way into the public domain will be well-lawyered, not that much comfort should necessarily be taken from that.
Some investors may also find scant comfort in the board of directors praised by Mr. Segal, particularly if they happen to review David Peterson's past associations, including a stint as a director of YBM Magnex. According to The Financial Post, the former Ontario premier and chairman of Microforum's board of directors was the one who suggested striking a special committee to investigate the allegations against Mr. Pearl. Mr. Peterson has some experience with investigations, gained during the course of a long probe of YBM by the Ontario Securities Commission (OSC) and law enforcement agencies, including the FBI.
In 1994, YBM was a near-worthless shell listed on the Alberta Stock Exchange; four years later it traded as high as $20 on the Toronto Stock Exchange, giving it a market capitalization of almost $900-million. YBM drew investors and analysts like a magnet. Indeed, the company's business turned on magnets, or so it claimed. However, YBM's claims about its magnet business and the reality of its business were poles apart. As it turned out, YBM was a money-laundering operation tied to the Russian mafia. It came to a crashing halt on May 13, 1998, when FBI agents raided the company's headquarters in Newtown, Penn., along with agents from U.S. Immigration, U.S. Customs Service and the Internal Revenue Service.
In some ways, Microforum bears more than a passing resemblance to YBM. Like Microforum, YBM experienced a meteoric rise, becoming the darling of many analysts, including Mike Middleton, who is now with Taurus Capital and listed on Microforum's Web site as an analyst covering the company. When the wheels fell off the YBM promotion, most of those analysts quickly headed for cover, though a few did pause for a parting shot at Canada Stockwatch. Evidently some of the former touts of YBM felt that Stockwatch had been unfairly critical of the magnetic company and bore considerable responsibility for the mess that it turned out to be. "Boy, you guys have been butchering it!" First Marathon analyst Steve Laciak exclaimed to a Stockwatch reporter in May of 1998. Wayne Deans of Deans Knight Capital fell back on a hackneyed analyst response. "We don't make comments to the public on anything we hold," he said, evidently forgetting his public support for Bre-X. At least he did not claim an exception for live television appearances.
YBM is something that many analysts and others, like Microforum's chairman Mr. Peterson, would probably like to forget. Given the class-action lawsuits and other legal entanglements, some of them engendered by Mr. Peterson, YBM is unlikely to pass from memory any time soon. In one of the latest twists, Mr. Peterson has filed a third-party suit against the OSC, arguing that if he is to blame for investor losses in YBM, then so is the OSC. The OSC, he claims, should share in any possible damage awards arising from class-action lawsuits. For its part, the OSC has scheduled a full YBM hearing, expected to last four months, for May, 2001. Thanks largely to delaying tactics by lawyers, including Mr. Peterson's counsel, that will be three years after the OSC first issued a cease trading order against YBM. Evidently a gaggle of lawyers can stymie attempts at handling things in "an expeditious manner."
Microforum shareholders must surely hope that anything more than a passing resemblance to YBM does not evolve into a growing resemblance. Beyond that, they probably also hope that the kitsch-Machiavellianism has come to an end; that the special committee struck to investigate the allegations against Mr. Pearl turns out to be an unwarranted Draconian reaction; and that future public relations efforts are not reminiscent of the three stooges.
(More information regarding Microforum is available in Canada Stockwatch articles on April 7, 9, 19, and 29, 1999; Jan. 24, 2000; and Sept. 29, 2000. Extensive coverage of the YBM debacle is available in Canada Stockwatch articles on March 10 and 16, 1998; May 13, 14, 15, and 26, 1998; June 4, 1998; Nov. 4 and 29, 1999; Dec. 12 and 22, 1999; Jan 6, 26 and 28, 2000; Feb. 4 and 16, 2000; March 20 and 28, 2000; and April 5, 2000.)
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