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Chapter 10: September 11, 2001 - The Half Life of Surprise - Episode 3
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In the south tower of the World Trade Center, Larry Lazard has just asked: "What share of the combined company are you crooks proposing to offer hackoff holders?"
"We would rather get to that after we go through the PowerPoint presentation," answers H. Fredrick. "We've done quite a bit of work of comparative valuations using different methods and we would like to build up to this and present it to you."
"I don't give a fuck about all that," says Larry. "It doesn't matter to me how you got to your number. It only matters what the number is."
"We'll get to that in due course, you have my word. But we would like to go through the Power—"
"I don't know if its worth my time to listen to the presentation unless I know what the number is. Tell me the fucking number and then we'll look at the slides."
"Could we huddle for a minute?" asks H. Fredrick.
Larry agrees and the bankers and antihack people get up to leave.
"Just a minute," says Larry. "We'll leave. You can stay here and talk. We'll be back in five minutes."
"Okay," says H. Fredrick. "Can I get you a breakout room?"
"We're fine in the hall," says Larry. "We have this thing about bugs."
"I assure you…" For the first time H. Fredrick looks somewhat offended.
"We're in the business of fighting hackers," says Donna. "It gives you a suspicious mind. We've learned to be very careful."
"No offense taken," says H. Fredrick. "I understand perfectly."
"No offense intended," says Donna. She smiles at H. Fredrick.
Larry glares at her.
"What the hell are you doing reducing the tension?" he asks once they're out in the hall. "I don't want them to be comfortable."
"For what it's worth, I don't think the room is bugged," says Dom.
Larry ignores him. Donna gives him a covert shrug.
"Look, Lar," says Donna. "You're not going to like the number they give you."
"No shit. In fact, I'm gonna hate it so much we'll probably walk out."
"Then what have we learned?" asks Donna. "We came here to learn something and we're not going to learn anything if we walk now. Moreover, we may let ourselves in for some legal trouble down the road."
"We'll learn that they made a low-ball offer. And since when are you a lawyer?"
"We already knew they'd make a low ball offer. We knew that before we came. The offer doesn't matter. The numbers'll change. I want to know ... WE NEED to know ... what they think their strengths and weakness are. They'll tell us that in the presentation. And we want to make damn sure we establish that, as officers of a public company, we listened carefully to anything that could remotely be in the interest of our shareholders, regardless of our own feelings. You don't have to be a lawyer to know that, Lar."
"Shit. Okay, we'll sit through the presentation. But I don't want to signal weakness by listening to a lower than whale shit number and sitting still."
"You sort of set us up for that, Lar," says Donna.
"No. I know how to handle it. It'll work out better. Just be sure you guys shut the fuck up when we go back in. I know what I'm doing."
Donna knocks, and they troop back into the room. Larry circles to the credenza and refills his coffee cup before sitting down.
"Well," says H. Fredrick, "we don't like to go out of order but we want to be as accommodating as we can so we've decided..."
"We don't want to hear your number," says Larry.
"Excuse me?" H. Fredrick is confused.
"You don't know a fucking thing about hackoff except what's public. You don't know what technology we have and haven't introduced yet. You don't know what we're doing with our customers. And you probably believe a lot of bullshit about what antihack is going to do and how it'll turn profitable soon when we all know that it won't; it's in a death spiral."
"Antihack has never been stronger," George Wrobly interrupts.
"Since you don't know anything about us and you probably don't know much about your clients, your number is meaningless. We'll listen to what you think. We might tell you where you're wrong, but we're sure as hell not going to tell you any secrets about hackoff. At the end you can give us a number or not give us a number, really doesn't matter because you don't know enough to come up with a number anyway. If you bankers don't have your heads too far up your asses, then we might talk to you about how to get a real number and what a hackoff takeover of antihack would look like."
"The numbers we have put together, while certainly not final, do represent what would be the beginning of a basis of a fairness opinion for antihack," says the second most senior banker. He put the numbers together. "Obviously, your bankers will have to provide a fairness opinion to hackoff share—"
"Yeah," interrupts Larry, "yeah, if there's a deal, bankers'll get millions of dollars for their ‘fairness opinions' as well as whatever fees you're charging antihack. And for those millions of dollars you'll decide that whatever deal you're getting a piece of is fair. That's why it's called a ‘fairness opinion'. And all those millions of dollars for bankers is just one more reason why there probably isn't going to be a deal as much as it makes sense for antihack to get taken over by hackoff and get bailed."
"We're not talking about hackoff taking over antihack," says Wrobly.
"Don't know what else we'd be talking about," says Larry. "George, you have to put your ego aside and consider the best interests of your shareholders. That's what we're doing; that's why we're spending this beautiful morning with you in this beautiful office instead of doing our regular jobs and burying you out in the marketplace." Larry leans across the table toward Wrobly. "Come, come, Georgie. You run a public company now and must act accordingly. Now let's see those slides."
The most junior of the bankers fiddles with a console at the end of the table. At first the lights go up brightly; finally he manages to dim them. A few more jabs at the console's touch-screen and a projection screen rolls itself down at the west end of the room. The blinds on the window rotate to cut off outside light. There is a message on the screen:
No Signal
As he repeatedly jabs the console, the lights go bright, dim and off again; the blinds rotate back and forth; the screen goes up and down; the message goes on and off; at one point, a dialtone is heard; at another, CNBC appears on the screen; but no slideshow.
"Function F3," says Dom.
"Excuse me?" says the flustered banker.
"Function F3. On your PC. It toggles to the alternate screen." He comes around the table and presses the correct keys. The title slide of the bankers' presentation appears on the screen. Dom sits back down.
The second most senior banker (or second most junior depending how you look at it) narrates the slides he has produced while the most junior banker clicks from slide to slide. Larry impatiently waves them past all the slides about their bank, the number of mergers and acquisitions they have been part of in the last year, the logos of the companies they have helped, the state of the e-commerce market in general, the presumed addressable market for e-commerce security, the relative market shares of hackoff and antihack, and the charted stock price performance of the two stocks.
The hackoff team leans forward intently at the next slide:
#
#
"This is our SWOT analysis of antihack: Strengths, Weaknesses, Opportunities and Threats," says the second most senior banker.
All three hackoff executives exclaim at once.
"Technology?" says Dom. "They ain't got shit."
"Management?" says Larry. "You mean Georgie?"
"Market leader?" says Donna. "Not according to any analyst report I've ever seen. You're damned right they're not perceived as the market leader; it's because they're NOT!"
"We believe that antihack technology is the best in the market," says George Wrobly. "Our customers have suffered very few successful intrusions. We were the first to block both the Andromeda One and KittyKat attacks."
"Our customers have NEVER been successfully attacked in a significant way when they followed our procedures," says Dom. "Never; count'em, not once. Your shield for Andromeda One was pathetic because you released too soon; we didn't put ours out until it was done. And your KittyKat shield was so slow it crippled your customers."
"As you'll see when we get to the next slide," interrupts the banker, "we rate the two companies evenly on technology. As far as market share is concerned, I agree with Ms. Langhorne that the analysts cite hackoff as the leader; that is why we have said that antihack is ‘not perceived' to be the leader. But we believe it is incorrect to count the ‘not for cash' sales that hackoff makes since they are not contributing to cash flow. So we have backed them out for all of our analyses. If you do that, then antihack is the leader. We think that the market actually does realize this to some extent and that's why the antihack equity is trading at about four-and-a-half times hackoff. However, these non-cash sales are a problem for antihack. They limit the size of antihack's addressable market. It is usually impossible for antihack to convince an e commerce site that's getting cashless protection from hackoff that they should start paying antihack for what they perceive to be the same protection."
Donna jumps in: "Antihack isn't having any luck taking cash paying customers away from hackoff either. They have to practically give their service away – in fact, I think they do give it away – in order to take one of our customers."
"And even then," says Dom, "if the customers aren't brain dead, they stay with hackoff because they want real protection, not the crap they get from antihack."
"In fact," says the banker, "we think the wins and losses are about even. Hackoff takes customers from antihack by giving them a cashless option…"
"Only if they have valuable equity in today's terms," says Larry.
"That's debatable," says Wrobly.
"In fact," says the banker smoothly, "this discussion reinforces our thesis. Customers don't perceive much difference in the services of the two companies. The addressable market is shrinking rather than growing; poorly funded companies continue to go belly up and the VCs won't fund any new companies in the field. Each quarter, both companies lose customers to bankruptcies and consolidations. Both companies need new customers just to stay even with the quarter before. So the only way either company can get new customers is by cutting price to take them away from the other. And this is a vicious downwards spiral. That is one reason we're suggesting a merger. Consolidation will obviously result in better market power."
"You mean we won't always be undercutting each other if we take over antihack," says Larry.
"We're not talking about a takeover of antihack," says Wrobly.
"We don't talk in those terms," says the banker. "This combination will, of course, have to undergo Hart-Scott-Rodino scrutiny by the Federal Trade Commission. Under penalty of criminal law, we will have to give them all documents — even scribbled notes — that talk about market share. Note that we are careful to talk about ‘market segment share' rather than just ‘market share' in our presentation. Similarly, we will have to give them all analyses of the relevant markets including this presentation.
"Frankly, because the two companies are quite powerful in the market segment, HSR review could be a problem. However, we believe that we have a way around that. We have listed HSR review as an open item later in the presentation but this is something we should talk through rather than make slides which could be misunderstood. So, if it's okay, I'll go on with the presentation."
No one says anything, so he continues. He points out that the high cost of sales could be reduced if antihack could find a more effective sales channel than just using its own inhouse sales force. However, obviously there would be synergies in sales costs if hackoff and antihack combined since their salespeople call on the same customers. It should be possible to reduce the combined number of salespeople by at least fifty percent. At least that is what they have assumed in modeling the possible combination.
Obviously, one opportunity for antihack to grow is by using its cash and relatively strong equity to acquire companies in the same or closely aligned fields. Even without an acquisition, the company could expand by marketing other services to its e-commerce customers. Or the company can expand by selling security services beyond the e-commerce market; for example, they could sell to Voice over IP (VoIP) companies. The retailers of VoIP are very small but growing rapidly. Although the bankers are not technical, they imagine that these companies will need security and antifraud help just as traditional telephone companies do, perhaps more so since they are on the Internet and so presumably more vulnerable.
"Yup," Dom says quietly.
The banker continues: "Besides the ‘cash-less' competition from hackoff, which we have already discussed, Microsoft and Oracle must always be considered as a threat to anyone in the software business. Simply put, either of them could decide to provide what you provide. Oracle could build hacker-proofing into its databases and/or Microsoft could build hackerproofing into Windows."
"If they could've they would've," says Dom.
"Of course, if either company decided to go into this business it could also provide a good exit strategy for the incumbents. If they perceive that it would give them a good enough head start, they could decide to buy rather than build."
"I'd love to have Microsoft come into our space," says Larry.
"Why is that?" asks H. Fredrick, who has been quiet for a quite a while.
"Because then we'd sue their ass off for violating our patents," says Larry. "You forgot to put on your SWOT slide that antihack's in violation of a bunch of hackoff patents. We haven't got around to suing them yet but we will sooner or later if they don't fold on their own before that. You need to factor that into your ‘valuation'. But Microsoft is certainly worth suing. Talk about deep pockets. And they're afraid of patent fights ever since ‘disk-doubler' or whatever that bullshit was beat them out of hundreds of millions in California because a jury off the street couldn't understand the difference between five-bit and seven-bit encryption."
"This is our S.W.O.T. for hackoff," the second most senior banker continues on a signal from H. Fredrick.
#
#
Again, the hackoff team reacts in unison.
"At least you put technology first," says Dom with some satisfaction.
"You forgot REAL management," Larry growls.
"No way we're going to run out of cash," says Donna. "We still have hundreds of millions of dollars worth of stock in our portfolio we can turn to cash whenever we need to. Antihack'll be long dead and gone before hackoff runs out of cash, and then we'll get all the benefits of a merger without having to suffer any dilution. If that's what you're basing a proposal or a valuation on, forget it."
"Whether it is a present danger or not," the banker continues in a somewhat conciliatory tone, "the Street THINKS it is and is valuing hackoff as a company in real danger of running out of cash. Moreover, as we point out, the Street is put off by the prospects of further write-offs in your dotcom portfolio. Your equity is weak and your cash position is, at least, not strong, so you can't pursue an acquisition strategy. In short, it appears that you don't have many alternatives going forward."
"We would rather get to that after we go through the PowerPoint presentation," answers H. Fredrick. "We've done quite a bit of work of comparative valuations using different methods and we would like to build up to this and present it to you."
"I don't give a fuck about all that," says Larry. "It doesn't matter to me how you got to your number. It only matters what the number is."
"We'll get to that in due course, you have my word. But we would like to go through the Power—"
"I don't know if its worth my time to listen to the presentation unless I know what the number is. Tell me the fucking number and then we'll look at the slides."
"Could we huddle for a minute?" asks H. Fredrick.
Larry agrees and the bankers and antihack people get up to leave.
"Just a minute," says Larry. "We'll leave. You can stay here and talk. We'll be back in five minutes."
"Okay," says H. Fredrick. "Can I get you a breakout room?"
"We're fine in the hall," says Larry. "We have this thing about bugs."
"I assure you…" For the first time H. Fredrick looks somewhat offended.
"We're in the business of fighting hackers," says Donna. "It gives you a suspicious mind. We've learned to be very careful."
"No offense taken," says H. Fredrick. "I understand perfectly."
"No offense intended," says Donna. She smiles at H. Fredrick.
Larry glares at her.
"What the hell are you doing reducing the tension?" he asks once they're out in the hall. "I don't want them to be comfortable."
"For what it's worth, I don't think the room is bugged," says Dom.
Larry ignores him. Donna gives him a covert shrug.
"Look, Lar," says Donna. "You're not going to like the number they give you."
"No shit. In fact, I'm gonna hate it so much we'll probably walk out."
"Then what have we learned?" asks Donna. "We came here to learn something and we're not going to learn anything if we walk now. Moreover, we may let ourselves in for some legal trouble down the road."
"We'll learn that they made a low-ball offer. And since when are you a lawyer?"
"We already knew they'd make a low ball offer. We knew that before we came. The offer doesn't matter. The numbers'll change. I want to know ... WE NEED to know ... what they think their strengths and weakness are. They'll tell us that in the presentation. And we want to make damn sure we establish that, as officers of a public company, we listened carefully to anything that could remotely be in the interest of our shareholders, regardless of our own feelings. You don't have to be a lawyer to know that, Lar."
"Shit. Okay, we'll sit through the presentation. But I don't want to signal weakness by listening to a lower than whale shit number and sitting still."
"You sort of set us up for that, Lar," says Donna.
"No. I know how to handle it. It'll work out better. Just be sure you guys shut the fuck up when we go back in. I know what I'm doing."
Donna knocks, and they troop back into the room. Larry circles to the credenza and refills his coffee cup before sitting down.
"Well," says H. Fredrick, "we don't like to go out of order but we want to be as accommodating as we can so we've decided..."
"We don't want to hear your number," says Larry.
"Excuse me?" H. Fredrick is confused.
"You don't know a fucking thing about hackoff except what's public. You don't know what technology we have and haven't introduced yet. You don't know what we're doing with our customers. And you probably believe a lot of bullshit about what antihack is going to do and how it'll turn profitable soon when we all know that it won't; it's in a death spiral."
"Antihack has never been stronger," George Wrobly interrupts.
"Since you don't know anything about us and you probably don't know much about your clients, your number is meaningless. We'll listen to what you think. We might tell you where you're wrong, but we're sure as hell not going to tell you any secrets about hackoff. At the end you can give us a number or not give us a number, really doesn't matter because you don't know enough to come up with a number anyway. If you bankers don't have your heads too far up your asses, then we might talk to you about how to get a real number and what a hackoff takeover of antihack would look like."
"The numbers we have put together, while certainly not final, do represent what would be the beginning of a basis of a fairness opinion for antihack," says the second most senior banker. He put the numbers together. "Obviously, your bankers will have to provide a fairness opinion to hackoff share—"
"Yeah," interrupts Larry, "yeah, if there's a deal, bankers'll get millions of dollars for their ‘fairness opinions' as well as whatever fees you're charging antihack. And for those millions of dollars you'll decide that whatever deal you're getting a piece of is fair. That's why it's called a ‘fairness opinion'. And all those millions of dollars for bankers is just one more reason why there probably isn't going to be a deal as much as it makes sense for antihack to get taken over by hackoff and get bailed."
"We're not talking about hackoff taking over antihack," says Wrobly.
"Don't know what else we'd be talking about," says Larry. "George, you have to put your ego aside and consider the best interests of your shareholders. That's what we're doing; that's why we're spending this beautiful morning with you in this beautiful office instead of doing our regular jobs and burying you out in the marketplace." Larry leans across the table toward Wrobly. "Come, come, Georgie. You run a public company now and must act accordingly. Now let's see those slides."
The most junior of the bankers fiddles with a console at the end of the table. At first the lights go up brightly; finally he manages to dim them. A few more jabs at the console's touch-screen and a projection screen rolls itself down at the west end of the room. The blinds on the window rotate to cut off outside light. There is a message on the screen:
No Signal
As he repeatedly jabs the console, the lights go bright, dim and off again; the blinds rotate back and forth; the screen goes up and down; the message goes on and off; at one point, a dialtone is heard; at another, CNBC appears on the screen; but no slideshow.
"Function F3," says Dom.
"Excuse me?" says the flustered banker.
"Function F3. On your PC. It toggles to the alternate screen." He comes around the table and presses the correct keys. The title slide of the bankers' presentation appears on the screen. Dom sits back down.
The second most senior banker (or second most junior depending how you look at it) narrates the slides he has produced while the most junior banker clicks from slide to slide. Larry impatiently waves them past all the slides about their bank, the number of mergers and acquisitions they have been part of in the last year, the logos of the companies they have helped, the state of the e-commerce market in general, the presumed addressable market for e-commerce security, the relative market shares of hackoff and antihack, and the charted stock price performance of the two stocks.
The hackoff team leans forward intently at the next slide:
#
#
"This is our SWOT analysis of antihack: Strengths, Weaknesses, Opportunities and Threats," says the second most senior banker.
All three hackoff executives exclaim at once.
"Technology?" says Dom. "They ain't got shit."
"Management?" says Larry. "You mean Georgie?"
"Market leader?" says Donna. "Not according to any analyst report I've ever seen. You're damned right they're not perceived as the market leader; it's because they're NOT!"
"We believe that antihack technology is the best in the market," says George Wrobly. "Our customers have suffered very few successful intrusions. We were the first to block both the Andromeda One and KittyKat attacks."
"Our customers have NEVER been successfully attacked in a significant way when they followed our procedures," says Dom. "Never; count'em, not once. Your shield for Andromeda One was pathetic because you released too soon; we didn't put ours out until it was done. And your KittyKat shield was so slow it crippled your customers."
"As you'll see when we get to the next slide," interrupts the banker, "we rate the two companies evenly on technology. As far as market share is concerned, I agree with Ms. Langhorne that the analysts cite hackoff as the leader; that is why we have said that antihack is ‘not perceived' to be the leader. But we believe it is incorrect to count the ‘not for cash' sales that hackoff makes since they are not contributing to cash flow. So we have backed them out for all of our analyses. If you do that, then antihack is the leader. We think that the market actually does realize this to some extent and that's why the antihack equity is trading at about four-and-a-half times hackoff. However, these non-cash sales are a problem for antihack. They limit the size of antihack's addressable market. It is usually impossible for antihack to convince an e commerce site that's getting cashless protection from hackoff that they should start paying antihack for what they perceive to be the same protection."
Donna jumps in: "Antihack isn't having any luck taking cash paying customers away from hackoff either. They have to practically give their service away – in fact, I think they do give it away – in order to take one of our customers."
"And even then," says Dom, "if the customers aren't brain dead, they stay with hackoff because they want real protection, not the crap they get from antihack."
"In fact," says the banker, "we think the wins and losses are about even. Hackoff takes customers from antihack by giving them a cashless option…"
"Only if they have valuable equity in today's terms," says Larry.
"That's debatable," says Wrobly.
"In fact," says the banker smoothly, "this discussion reinforces our thesis. Customers don't perceive much difference in the services of the two companies. The addressable market is shrinking rather than growing; poorly funded companies continue to go belly up and the VCs won't fund any new companies in the field. Each quarter, both companies lose customers to bankruptcies and consolidations. Both companies need new customers just to stay even with the quarter before. So the only way either company can get new customers is by cutting price to take them away from the other. And this is a vicious downwards spiral. That is one reason we're suggesting a merger. Consolidation will obviously result in better market power."
"You mean we won't always be undercutting each other if we take over antihack," says Larry.
"We're not talking about a takeover of antihack," says Wrobly.
"We don't talk in those terms," says the banker. "This combination will, of course, have to undergo Hart-Scott-Rodino scrutiny by the Federal Trade Commission. Under penalty of criminal law, we will have to give them all documents — even scribbled notes — that talk about market share. Note that we are careful to talk about ‘market segment share' rather than just ‘market share' in our presentation. Similarly, we will have to give them all analyses of the relevant markets including this presentation.
"Frankly, because the two companies are quite powerful in the market segment, HSR review could be a problem. However, we believe that we have a way around that. We have listed HSR review as an open item later in the presentation but this is something we should talk through rather than make slides which could be misunderstood. So, if it's okay, I'll go on with the presentation."
No one says anything, so he continues. He points out that the high cost of sales could be reduced if antihack could find a more effective sales channel than just using its own inhouse sales force. However, obviously there would be synergies in sales costs if hackoff and antihack combined since their salespeople call on the same customers. It should be possible to reduce the combined number of salespeople by at least fifty percent. At least that is what they have assumed in modeling the possible combination.
Obviously, one opportunity for antihack to grow is by using its cash and relatively strong equity to acquire companies in the same or closely aligned fields. Even without an acquisition, the company could expand by marketing other services to its e-commerce customers. Or the company can expand by selling security services beyond the e-commerce market; for example, they could sell to Voice over IP (VoIP) companies. The retailers of VoIP are very small but growing rapidly. Although the bankers are not technical, they imagine that these companies will need security and antifraud help just as traditional telephone companies do, perhaps more so since they are on the Internet and so presumably more vulnerable.
"Yup," Dom says quietly.
The banker continues: "Besides the ‘cash-less' competition from hackoff, which we have already discussed, Microsoft and Oracle must always be considered as a threat to anyone in the software business. Simply put, either of them could decide to provide what you provide. Oracle could build hacker-proofing into its databases and/or Microsoft could build hackerproofing into Windows."
"If they could've they would've," says Dom.
"Of course, if either company decided to go into this business it could also provide a good exit strategy for the incumbents. If they perceive that it would give them a good enough head start, they could decide to buy rather than build."
"I'd love to have Microsoft come into our space," says Larry.
"Why is that?" asks H. Fredrick, who has been quiet for a quite a while.
"Because then we'd sue their ass off for violating our patents," says Larry. "You forgot to put on your SWOT slide that antihack's in violation of a bunch of hackoff patents. We haven't got around to suing them yet but we will sooner or later if they don't fold on their own before that. You need to factor that into your ‘valuation'. But Microsoft is certainly worth suing. Talk about deep pockets. And they're afraid of patent fights ever since ‘disk-doubler' or whatever that bullshit was beat them out of hundreds of millions in California because a jury off the street couldn't understand the difference between five-bit and seven-bit encryption."
"This is our S.W.O.T. for hackoff," the second most senior banker continues on a signal from H. Fredrick.
#
#
Again, the hackoff team reacts in unison.
"At least you put technology first," says Dom with some satisfaction.
"You forgot REAL management," Larry growls.
"No way we're going to run out of cash," says Donna. "We still have hundreds of millions of dollars worth of stock in our portfolio we can turn to cash whenever we need to. Antihack'll be long dead and gone before hackoff runs out of cash, and then we'll get all the benefits of a merger without having to suffer any dilution. If that's what you're basing a proposal or a valuation on, forget it."
"Whether it is a present danger or not," the banker continues in a somewhat conciliatory tone, "the Street THINKS it is and is valuing hackoff as a company in real danger of running out of cash. Moreover, as we point out, the Street is put off by the prospects of further write-offs in your dotcom portfolio. Your equity is weak and your cash position is, at least, not strong, so you can't pursue an acquisition strategy. In short, it appears that you don't have many alternatives going forward."
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