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Insiders got out { July 31 2002 } Original Source Link: (May no longer be active)
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Insiders who managed to get out just in time
By Caroline Daniel
Published: July 31 2002 18:27 | Last Updated: July 31 2002 18:27
Armed with baskets of petals, dried coconut and cloves, Umashankar Dixit, a Hindu priest, blessed Exodus, an unknown technology start-up in Santa Clara, Silicon Valley. With a series of chants Mr Dixit called for the company's prosperity and received hundreds of Exodus stock options in return for his services.
Within a few years of the Lakshmi Puja ceremony in 1994 the web-hosting company lived up to those prayers. Exodus, which had launched with the aid of credit card debt racked up by its founders, made it to the stock market in March 1998. Two years later it hit a valuation peak of $30bn but by last September it was bankrupt.
Mr Dixit sold his shares for more than $10,000, which he said he put towards building a temple in Bangalore. Others found their association with Exodus even more enriching. One person present at the blessing, co-founder K. B. Chandrasekhar, was to reap nearly $131m from share sales.
Though Exodus was by no means the most egregious example of wealth creation during the dotcom boom, many executives walked away from the bankrupt group with vast fortunes. The Financial Times has calculated that insiders raised more than $350m from share sales between 1999 and 2001 alone, including $41m of profits on options exercised in just one day of selling near the height of the market.
Baron's of bankruptcy
An FT investigation has found that the top management of the 25 biggest recent US corporate collapses amassed $3.3bn fortunes.
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Such sales have prompted regulators to consider restricting options. But one former Exodus director, Peter Howley, who amassed more than $30m, says: "I laugh at the stupidity and foolishness from Washington, DC. To say executives should not have the same incentives as shareholders makes no sense. The fact that insiders exercise options is made public. Most people know [that] if a manager sells it is never a good sign."
The rise of Exodus epitomised the pioneering culture of Silicon Valley, yet its founding idea was simple: enable internet companies to offer reliable websites by building vast data centres hooked up to speedy telecommunications networks. These were features customers such as Yahoo and eBay could not afford or maintain on their own. Exodus was the physical counterpoint to the virtual world of the internet. Yet its physical assets were to prove its weakness.
Its plan involved huge capital spending and making investment decisions in advance of demand. As internet start-ups exploded, Exodus was encouraged to take on huge debts. With the bust, revenue growth stopped dead and Exodus was left with excess capacity and too much debt.
Even before then, many employees had little confidence that Exodus's valuation was consistent with its negative cash flow.
Exodus was founded by two Indian entrepreneurs, Mr Chandrasekhar and B.V. Jagadeesh, in classic Silicon Valley style: touting for funds amid the gregarious, business-card swapping ambience of a networking event. An Indian investor decided to invest in 1995 and in doing so helped spawn the cult of "the curry network".
But Exodus's ambitions required access to the capital markets. Data centres were expensive, costing up to $50m (£32m) to install biometric security systems, the spaghetti of telecoms wiring and robust air-conditioning to control the heat of thousands of servers. Some were built to withstand a 10 megatonne nuclear bomb.
So in March 1998 Exodus headed for Nasdaq. Nine days before the listing, Ellen Hancock, 55, was appointed president to confer grey-haired management credibility on the youthful company. Her key inducement was stock options. On the first day's trading, when the shares soared 85 per cent, she had paper profits of $14m. Six months later she became chief executive.
It was an unusual choice, in spite of her blue-chip credentials. Even her friends said she was not a visionary - her only hint of recklessness was a penchant for Honda motorbikes. And her record was mixed. She had gained a reputation as straight-talking and hard-working, answering e-mails by 6.30am and working 80-hour weeks. But after 29 years at International Business Machines she was forced out after clashes with Lou Gerstner, the company's former chairman and chief executive, and a failure, as head of the networking division, to spot Cisco's threat.
A desultory period at Apple and National Semiconductor followed. Exodus was her way to redeem her reputation, said one director. "I believed it could become the EDS of websites," Ms Hancock said this week, adding that stock options had also been part of the attraction. "They were important. The salary I went in at from a cash point of view was conservative and I did indicate I was more interested in equity than cash. In one year I worked for a salary of $1 in return for increased share options."
The gamble initially paid off. In 1999 the shares rose 985 per cent. Revenues also rose, from $12.4m in 1997 to $73m for the six months to June 30 1999 and $314m for the same period in 2000.
Exodus had bought the prevailing dogma that market share mattered more than profits. It made bigger and bigger bets. Between 1995 and March 2000 it accumulated losses of $287m. A year later that hit $1.1bn. To fund growth required more cash than could be raised from equity markets. At the end of 1999 Exodus announced a $900m debt package, followed in June 2000 by a hefty $1.2bn deal.
The mounting debt worried at least one former executive. "We needed to invest more and more in new markets, where there was competition and where the time lag to see revenue from that investment was at least a year. When you started to see numbers that big, there was concern."
As investors were pouring money in during 2000, insiders were taking money out. Mr Howley, who left the board that June, says he continued to sell shares. "It was the prudent thing to do. I had people call me up, laughing at me because the shares went on to double. Yet I would laugh back and say: 'Well, you call me and tell me when the shares have hit the peak and I will sell then.' The thing is, you just don't know when the peak is."
Those remaining at the company also sold. At the end of August a lock-up expired on stock options. In a one-day blitz, six executives and one director netted $41m of profits from options. The day turned out to be the second highest peak of the year.
That day, Ms Hancock also sold $4.4m of shares. Two months later she made the biggest donation in the history of Marist College, New York, offering $5m to build the Hancock Centre, devoted to technology.
She was by no means the biggest beneficiary of share sales. Records show that Sam Mohamad, head of global sales, amassed about $30m and Richard Stoltz, finance director, more than $40m.
In retrospect, Ms Hancock says: "Some of them were perhaps more correct in terms of reaping the rewards of the hard work we did." She adds: "I have to say I have mixed emotions about whether I should have sold more, but at the time I was very sensitive to the fact that I was chief executive of the company and I should follow a process [of selling] in a consistent fashion."
Aft er the August blitz, the window for selling closed, as Exodus negotiated a $6.5bn deal to buy GlobalCenter from Global Crossing. It made Exodus king of the web-hosting market. But some analysts jibbed at the price. And it added to concerns that Exodus was too dependent on low-margin revenues from renting bandwidth and space rather than upmarket services.
Exodus was also overexposed to weak dotcom customers. A crucial warning sign was that sequential revenue growth had slowed from 59 per cent in the third quarter of 1999, to 28 per cent a year later.
By April 2001, the chief operating officer, marketing officer and finance director were gone; but insider selling continued. In May, three executives, including Ms Hancock, sold a combined $4m of shares. Within weeks Exodus had announced a profit warning. The shares fell 30 per cent in one day and the trades prompted a class action lawsuit. In their defence, Exodus lawyers say that the sale represented just 2.7 per cent of Ms Hancock's holding.
They were to be the last shares Ms Hancock sold as chief executive. By September, L. William Krause, an old Silicon Valley hand, took her place. This time the inducement into the chief executive's job was hard cash rather than shares: he was offered a $600,000 initial bonus and another $1m if he could sell or reorganise Exodus.
The end was swift. Weeks later, unable to meet interest payments on its more than $3bn of debt, the company once seen as a critical part of America's infrastructure filed for bankruptcy. It was sold to Cable & Wireless for a fraction of its peak value.
Directors dumped millions of shares at five cents apiece. Mr Howley says he sold his final 312,000 shares for peanuts. Leo Hindery, chief executive of GlobalCenter, who had been granted a 5.5 per cent stake in the company - once worth $250m - fared worse, being unable to sell any shares before they became worthless.
Reputations were also damaged, including that of Ms Hancock. Nevertheless, she says she hopes to return to the tech industry. Mr Chandrasekhar has already bounced back, with a new venture, aptly named Jamcracker.
As for Mr Howley, his feeling about Exodus is one of regret. "I'm 62 years old and bragging rights are just as important as financial returns. I still brag about Exodus - but then I have to put a footnote at the end of it, which says, 'but unfortunately they ended up in bankruptcy'."
The last part in this three-part series will appear on Thursday
Additional details of the FT investigation are available at www.ft.com/barons
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