Painful Lessons Gleaned From High-Tech Wrecks
By: Duncan Stewart
17-Jul-2001
There will probably be another six months of failures
July 17, 2001
With the Nasdaq hovering around 2000 again, things are looking pretty bleak for investors in the e-world. How bleak?
Recently, my associate asked me the difference between bankrupt and defunct. The only thing more depressing than investing in technology these days would be listening to Mahler while reading the collected
works of S-ren Kierkegaard.
We are in the middle of a nuclear attack on tech companies. Remembering back to 1950s filmstrips on the "duck and cover" drill, investors are preparing to put their head between their knees and kiss their assets goodbye. Instead of contemplating 1000% returns from IPOs, they are wondering how you get your money out of a bankrupt technology company.
When a steel company goes under there are hard assets like blast furnaces, ingots and season's tickets to the Ti-Cats. High- tech wrecks leave nothing but worthless options, angry shareholders and a vast midden of empty Jolt Cola cans and Doritos wrappers -- of interest only to future archaeologists who will specialize in the ancient Geeks rather than Ancient Greeks.
While the tangible assets of tech companies might not measure up to most Old Economy bankruptcies, there are still some useful lessons from the pain we have endured so far, and the pain that is still to come.
Many of the "assets" of these companies are either worthless or
dwindling. During the bull market companies were being valued on how many visitors to a site they had, or a catchy Web domain name or being first to market. Revenue derived from Web traffic has been minimal, nobody pays for neat-o Web addresses, and having 80% market share of a tiny, unprofitable and shrinking market doesn't attract a lot of takeover bids.
But cash is king. Unless, of course, you are looking at a company with $20-million in cash, that is losing $5-million a month. The cost structures of these businesses are usually inflexible, and while cash does matter, burn rates matter more. The only method of reducing burn rate is to let people go, which incurs short-term severance costs and cripples the company going forward. In this market it is very dangerous to buy companies just because they are trading at less than cash.
Many software companies have minimal assets other than employees and
brand name. Their offices are usually leased and the corporate art gallery is thumbtacked Dilbert strips.
But enterprises like JDS or Intel do have extensive hard assets. Neither company is about to go under, but if they did the assets would be worth perhaps only 10¢ to 20¢ on the dollar. While they cost billions to build, the facilities are highly customized and there are few buyers.
Banks don't usually lend money to tech companies. Lenders like companies with strong assets that can be liquidated in the event that things don't work out.
What happened this cycle was unique. Banks looked at builders of fibre-optic networks and thought they looked like roads or pipelines. The purchasers of radio spectrum said that it was just like buying real estate, only on the airwaves, and the banks believed them and lent them money for the land rush.
Spectrum allocation and unlit, unneeded fibre were never tangible
assets, but lenders thought they were. And the holders of that corporate debt are going to be lucky if they get 10¢ on the dollar. There will be many sellers of fibre, and few liquid purchasers. The money the governments thought they were going to get for airwave auctions will never be collected.
The bankruptcy process is only just starting. There will probably be another six months of failures, with some take-unders and asset sales. The usual tests of solvency should be pulled off of dusty shelves. Do not buy companies because a broker says they look cheap -- ratio analysis is necessary. If your broker doesn't know about coverage ratios, leverage ratios, liquidity ratios, profitability ratios and cash flow to debt ratio, find one who does.
Because the difference between bankrupt and defunct is as follows: We are positive a defunct company is worth nothing, we are only pretty sure that a bankrupt company is worth nothing. |
