PeopleSoft May Repurchase Spinoff to Avoid Royalties (Update4)
By Ashley Gross bloomberg.com
Pleasanton, California, Dec. 31 (Bloomberg) -- PeopleSoft Inc. may reacquire Momentum Business Applications Inc. to avoid paying software royalties and ease investor concerns that the companies' relationship obscures PeopleSoft's expenses.
Chief Financial Officer Kevin Parker said PeopleSoft will decide by early next year whether to exercise an option to buy Momentum. PeopleSoft spun off Momentum in 1999 to boost profit by shifting some software development costs, an accounting arrangement that rulemakers have since banned.
PeopleSoft must buy back Momentum or pay a 10 percent royalty for 10 years on software developed by Momentum, which is running out of cash. A repurchase would help ease some investors' concerns that PeopleSoft's operating income is inflated.
``The point was to try to hide the expenses,'' said Ray Chan, an analyst at Franklin Templeton Investments, which manages $252 billion and owns PeopleSoft shares. ``The sooner they get this behind them, the fewer questions they'll get about it.''
In the wake of the collapse of Enron Corp., which filed for bankruptcy earlier this month after revealing previously undisclosed partnerships that kept debt off its balance sheet, investors are increasingly scrutinizing companies' accounting.
Momentum, which had a profit of $503,000 in its first four months of operation because of interest on funds from PeopleSoft, has had losses ever since. PeopleSoft would have had a loss last year if the costs were on its books, said Aziz Hamzaogullari, a senior technology analyst at Evergreen Investments, which manages $179 billion and owns PeopleSoft shares in indexed funds.
Reduced Expenses
PeopleSoft gave Momentum, whose one employee is a former PeopleSoft chief financial officer, $250 million when it was spun off as a research entity.
Instead of hiring its own programmers, Momentum paid PeopleSoft to write new programs. Those fees were listed on PeopleSoft's books as revenue. PeopleSoft then paid Momentum a royalty to license those products. On PeopleSoft's income statements, the development revenue offset the royalty payments and a portion of PeopleSoft's development expenses.
The arrangement helped PeopleSoft invest enough money to create its Web-based software package, PeopleSoft 8, without slipping into the red, said David Sankaran, PeopleSoft's director of investor relations. Pleasanton, California-based PeopleSoft competes with Oracle Corp., SAP AG and Siebel Systems Inc.
``The reason we did it was to build more products than we otherwise would have been able to,'' Sankaran said. ``That's a good thing for shareholders because you have a whole lot more products to sell.''
PeopleSoft asked for permission from the U.S. Securities and Exchange Commission before creating Momentum, PeopleSoft CFO Parker said. There's no comparison with Enron because Momentum was fully disclosed, he said.
``The two could not be further apart,'' Parker said.
`Loophole'
Still, the arrangement, which PeopleSoft modeled after drug company spinoffs, has drawn criticism from accounting experts.
``Every company would love a loophole that would allow them to remove expenses from their (income statement) for two and a half years,'' said Craig Sheets, an analyst with the Center for Financial Research and Analysis, an independent research company.
Companies are no longer allowed to create separate units like Momentum to fund research and development, a Financial Accounting Standards Board task force decided in May 2000.
A company can't unload development expenses on a research spinoff if the parent provides all the funding and that money comes back to the parent as revenue, said Stephen Young, a FASB practice fellow. PeopleSoft's accounting meets generally accepted accounting principles because Momentum was created before May 2000, he said.
Repurchase Option
PeopleSoft has an option to buy Momentum for about $90 million. The royalties PeopleSoft would have to pay if it doesn't buy Momentum could exceed $90 million, Sankaran said.
PeopleSoft shareholders in 1999 got one Momentum Class A share for every 50 PeopleSoft shares they owned. PeopleSoft shares fell $2 to $40.20 today and have risen 76 percent since the spinoff. Momentum shares, which closed at $18 on the first day of trading, fell 10 cents to $19.90.
``They'll buy it back by Feb. 15, in my opinion,'' said Bruce Newberg, whose Newberg Family Trust is the third-biggest shareholder with about 10 percent of Momentum's Class A shares outstanding. After Feb. 15, the minimum price increases to as much as $92.5 million, according to the companies' agreement.
Weaning
PeopleSoft has tried to wean itself off of revenue from Momentum. It peaked at $37 million, or 8.3 percent of PeopleSoft's total sales, in the third quarter of 2000 and will be about $15 million this quarter, $10 million in the first quarter and zero in
the second, Sankaran said. PeopleSoft plans to make up for that lost revenue by selling more software, he said.
PeopleSoft's goal is to spend 15 percent of sales on research and development by late next year, Sankaran said. In the third quarter, Momentum projects and PeopleSoft's other research and development costs made up 18 percent of sales.
Some investors said they doubt PeopleSoft will be able to make up for the lost revenue in the midst of a recession.
``I don't necessarily believe that they'll grow at a fast enough rate to overcome the profitability drag that Momentum going away will create,'' said Bruce Lupatkin, a portfolio manager at the hedge fund North Bay Technology Partners LLC.
Combined Results
Last year, PeopleSoft would have lost 1 cent a share if the two companies' statements were combined, instead of the 31 cents in profit that PeopleSoft reported, which excluded an investment gain, estimated Evergreen analyst Hamzaogullari.
This year, he estimates PeopleSoft would earn 35 cents a share if the results were consolidated. PeopleSoft is expected to earn 57 cents, the average estimate of analysts surveyed by Thomson Financial/First Call. Next year Momentum will contribute about 1 to 2 cents a share to PeopleSoft's earnings, Hamzaogullari estimated.
PeopleSoft CFO Parker said Hamzaogullari's calculations are ``arithmetically correct,'' though he argued that combining the statements is inappropriate.
``It's a bit of a what-if scenario,'' Parker said. ``We probably wouldn't have spent that money -- we wouldn't have wanted to suffer the financial consequences.'' |
