The Directors Letter

Corporate Governance News Since 2006


Written by Executives, Read by Executives

January 6, 2018
In This Issue                                 
CEO Reference Checks
Corporate Debt in 2018
Uber, Tick, Tick, Tick
Risk Management Asking Tough Questions

Next week we will be sending to our viewers Part Two of our video series on Sexual Harassment.
"What senior management and the board should know?"
The New Tax Plan And Corporate Debt   One of our sponsors is KPMG, and we are neither qualified nor desirous of being your tax advisor. That said there are strategic issues in the tax bill that senior executives and members of the board should be discussing. Specifically, the deductibility of debt. The game has changed substantially. You should be advised of how much of your debt is no longer deductible and the potential impact on your bottom line. Second, if you are involved in or contemplating a merger or acquisition, which will be debt-financed the deal may no longer make sense. Third, if you are repatriating offshore profits and were thinking of stock buybacks or dividend payments, perhaps debt reduction might be a better use of funds.

Ed Note: On the positive side, the lower corporate tax rate might cancel out some of the negative impact of the loss of interest deductibility. Not the end of the world, but certainly something the audit and finance committee should be discussing with management and your tax advisors.

Venezuela on the Edge   The New York Times recently reported that Venezuela is in such dire economic straits, that children are dying of malnutrition at numerous hospitals in the country.

Ed Note: If you can put aside the humanitarian impact, for a moment, consider the geopolitical impact as well as the broader economic impact on South America. Despite their massive oil reserves current production in Venezuela is not a significant factor. The action of entities and countries holding sovereign and corporate debt should be of interest. This definitely applies to Russia, which has recently extended their loan payment terms. What does this say about the long term future? To what extent will these events impact your South American business plan?

Great Recruiting Ad    We are certainly not Madison Avenue qualified, but thought this ad was terrific: "America's Best First Job," McDonald's

The IPO Versus Direct Listing   Startup Spotify AB (music streaming) is waiting for approval from the SEC to list its shares directly on the New York Stock Exchange. The first step is for the NYSE to request from the SEC a change in listing procedures. The SEC in any direct listing situation is concerned about the quality of financials presented by any company. Therefore, they can require an independent third-party valuation. The current valuation of the company is based on aggressive previous rounds of financing, which may not stand up to independent valuations.  The SEC has until mid-February to approve or not approve the request.

In a direct listing, a company transfers its shares to the exchange without raising money as in a typical IPO. One risk is that the price of the shares drops because they are not supported by the marketing effort of the underwriters. On the flipside, there are no underwriting fees and few if any restrictions on when insiders (employees and early on investors) can sell shares.

Ed Note: This is a new endeavor for the NYSE, and the NASDAQ has only done a handful over the last 10 years. If your company is thinking of an IPO, and is concerned about the cost and the role of an investment banker then this is a possible option. Keep in mind that most ongoing filings and compliance requirements for the company would not change because of a direct listing.

You Should Know  

A recent WSJ/NBC poll showed women with four year college degrees would prefer that the Democrats run Congress by a margin of 32 points. This was versus a 12 point margin for a democratic congress from women without college degrees. In 2016, women with college degrees made up almost 15% of the US population.  Midterm elections are just 10 months away and specific candidates could change these numbers. Regardless, Congress should take note.

Retailers, what is your return policy for online purchases? Returns are becoming more expensive with 40 to 60% ending up in the hands of consolidators. Are you shipping back to headquarters, a local store pickup, or third-party pick up lockers? Just as critical, "Who pays for the return?" How do you separate the usable return from the trash? Check out the competition.

Tesla's Musk tweets that he will challenge the Ford 150 pickup truck possibly as early as 2019. In the meantime, Tesla still struggles with ramping up production on its medium priced Model 3 along with its Model Y SUV. At Tesla, talk is cheap but it does get media coverage.

General Mills CEO Jeff Harmening said in a recent interview that he believes 30% of cereal in theUS is eaten as a snack rather than a meal. This is up from 10% a decade ago. Let's hear it for Chocolate Peanut Butter Cheerios, up 7% this year.

Sixteen companies from China have gone public in 2017 on either the NYSE or NASDAQ according to Dealogic. Ten of the newly issued stocks are trading below their IPO prices. Several of the companies were in the financial technology (lending) area. The median P/E ratio was 50 for those with positive earnings. Cited reasons for the drop in share price were, inadequate risk disclosure beforehand and overenthusiastic investors. Buyers beware.

Sexual Harassment and Sexual Assault
In the Workplace 
Part 1
This is  Part One  of our three-part series discussing  Sexual Harassment and Sexual Assault  in the workplace. We are joined by Jennifer Fay from the Boston office of Goodwin. She is a litigation partner focusing on employment law. This is a candid interview on an important subject 
which should be viewed by every executive and board member.

Please wait for video to load.


KPMG logo       
No Distractions, Focus and Focus  might be the appropriate battle cry for Uber.  Didi Chuxing Technology, the Chinese company to whom Uber sold its Chinese operation, just announced it has received $4 billion in new private funding. This brings its valuation close to Uber's $68 billion. The new investors have deep pockets, specifically the Softbank Group and an Abu Dhabi state investment fund. Now, Didi has $12 billion in cash on hand, marking a record of venture money raised. While DiDi has expanded elsewhere in Southeast Asi, its primary customer focus has been on the Chinese domestic market. Going forward, Didi states that it is preparing to invest significantly in autonomous/self driving vehicles and has opened an R&D lab in Silicon Valley to enhance this effort.

SoftBank and Uber    Making things more interesting, SoftBank looks like it has also completed the deal to buy approximately 20% of Uber from early on investors and employees under a tender offer. The price for the shares values Uber at $48 billion representing a 30% discount from the most recent valuation of $68 billion. This higher valuation was based on the last round of private financing. Simultaneously, SoftBank stated that they will invest a separate $1.25 billion in Uber at the previous valuation of $68 billion. Let's look at the good news and bad news in this deal.

The good news is that it provides shareholder liquidity for some early on Uber investors but more important some employees. It also is a real cash infusion of $1.2 billion which may be useful in the future. The deal expands the board by six directors, two from SoftBank, and it expands the voting rights of all investors.

The bad news is that the deal states very publicly that a big investor (SoftBank) doesn't really think the company justifies a $68 billion valuation. This could negatively impact an upcoming IPO. Two of the new directors will be directly tied to SoftBank, which is not unreasonable. Yes, SoftBank is also a significant investor in two Uber competitors, Didi in China and ANI Technologies in India. Will these companies compete globally or perhaps collaborate on R&D?

Ed Note: Perhaps one of the most significant and strategic positives of the deal is that the new CEO Dara Khosrowshahi can now focus on operations and deal with the myriad of challenges he inherited from the founder. These would include: a sexist employee environment, executive turnover, the future impact of self-driving cars, operating restrictions in London and trade secret lawsuits. Plus two quarters of losses totaling $2.52 billion. Without question a full plate in a very competitive global environment.

Reference Checks on the New CEO   With all of the media coverage revealing misbehaving executives, this will eventually be a discussion at the board level relative to vetting a new CEO, especially an outsider. The utilization of private investigators, the academic validation, and even personality profile tests have some value. Talking on the phone to specific references can be valuable, but they are much better done in person. Remember, few people like to deliver bad news and the clues indicating concern may be subtle and non-verbal.

Ed Note: We have been doing this type of interviewing and reference checking for decades in both the public and private sector.  We have one suggestion:  Get the meanest toughest member of the board, male or female, to have dinner with the final candidates (not more than three). Have one drink, maybe two; ask the usual questions, weak points, strong points, why do you want this job? Don't listen so much to the actual answers, but observe how the individual answers the question. Too much thought, not enough thought, too much eye contact, too little eye contact. Does the process so far, make you more or less comfortable with the candidate?

Close with the big question.  "Forgive my directness (locking eyeball to eyeball) but is there anything, and I do mean anything, in your background that could potentially be a negative to our company." "By that I mean, liquor, drugs, gambling, illegal activities or sexual misbehavior?"  Maintain the eye contact. Don't you move a muscle and don't speak another word. Just watch every facial muscle. You will learn a lot!  Your company will appreciate it. The candidate probably will not!

Return of the Super VC Fund   Venture fund Sequoia Capital is in the process of raising $5 billion for its third global growth fund. Their previous global growth fund was $2 billion, and was started in 2015. This would make Sequoia's new fund the largest raised by a US firm. New Enterprise Associates previously held the record at $3.3 billion. Both are established and quality venture firms. Internationally, Japan's Softbank Group recently joined the venture capital sector with its Vision Fund, a $98 billion tech focused fund.

Ed Note: Although the numbers were relatively smaller, this trend somewhat resembles the late 90s. Basically, too much money chasing too few quality deals. The question is how many startups need more than $10 or $20 million, let alone $50 million to open their doors?  If you are the entrepreneur, you certainly want an investor with deep pockets that can grow with you. You also would like an investor with some gray hair and combat experience who will answer your phone call. This is a challenging job description when the investor has to place $100 to $200 million annually.

What does all this mean to the entrepreneur? Possibly, your business plan never gets read because you don't need enough money fast enough to justify the investor's time. Perhaps, you get the junior varsity team, light on experience. Instead, you can go with a smaller venture fund and worry about who will price your third round of financing or the big mezzanine round.

Why does this happen? There are multiple reasons. Companies are remaining private, and avoiding IPOs. At the top end, some venture funds are getting to look like hedge funds, private equity firms, and institutional investors. The management fees for babysitting these funds are quite significant even without a liquidation event. It appears that the current tax changes will not impact the tax rate on the questionable carried interest (capital gains versus current income). The result is that, the deal with three guys/gals in the garage building the next widget will have to dig a little deeper to find the right investor for their business plan.


The Return of  Theranos   This is not a medieval monster story, but an update on the embattled Silicon Valley blood testing company. Several years ago, the WSJ discovered that Theranos was more sizzle than steak despite having raised a total of $900 million. The board was composed of marquee names, but they had little experience in startups or the life-sciences area. The original product really didn't work, much to the dismay of partner Walgreens and a series of investors. The Centers for Medicare and Medicaid Services subsequently banned the founder and CEO Elizabeth Holmes from operating a clinical laboratory for two years. While several law suits, but not all, from investors and former partners have been settled, the San Francisco US attorney and the SEC continue investigations. A former executive from Abbott Diagnostics was recently hired to direct product development, but resigned after six months adding to a string of senior-level defections.

Ed Note: CEO Holmes recently announced that they had secured a $100 million loan from the Fortress Investment Group (not a small player). In light of full disclosure, she did tell company's shareholders in an email that the loan is "subject to achieving certain product and operational milestones."  The loan from Fortress is collateralized by Theranos' patent portfolio and grants them warrants for 4% of the company's equity. The checkbook at Theranos was running on empty. Perhaps, we are unaware of something in the fine print of this deal. Regardless, the story clearly demonstrates that there are numerous smart people who hear what they want to hear, subsequently not asking those tough questions.

Update at the NLRB   We had described the National Labor Relations Board under the previous administration as operating more as a legislative body than a regulatory arbitration agency as outlined in its founding legislation.. There are two new policy changes that may be relevant to your company. 1.  It will be more difficult for contractors or workers at franchises to organize into unions.  2.  It will also be more difficult to form smaller groups of collective bargaining units within a larger organization.

Ed Note: Questions still before the courts:  Can public employees be required to pay union dues? Will there be an expansion of what type of employees are eligible for time and a half overtime pay?

Two Thoughtful Investments, Whoops !   

Uber is trying to sell Xchange Leasing which it started in 2015. The goal was to recruit more drivers by providing cars to individuals who had insufficient or poor credit. The individual would pay for the automobile lease out of their Uber income up to $500 per month. Last year, the company estimated that it was losing $9000 a car, approximately 18 times the number it had first calculated. Can a part-time driver generate the extra $500 per month to pay for an automobile lease? What about the dead time on the car when the Uber driver is working at their other job? What about Uber previously avoiding the investment in fixed assets because it was a transportation service or is it now a digital platform company?

Hedge fund manager Philip Falcone is suing Apollo Global Management saying his firm, Harbinger Capital Partner, was defrauded when it invested $2 billion in 2010 in the ill-fated wireless venture called Light Squared, Inc. In 2012, the Federal Communications Commission brought the company to a screeching halt when it stated that Light Squared Inc.'s products/services infringed on the operation of existing GPS equipment.

Ed Note: The lesson learned in both cases is a simple one. Despite how good/exciting the opportunity appears on the surface, there is no excuse for not conducting extensive due diligence and modeling.

Risk Management, The Weakest Link   In recent weeks, there were two instances that involved poor risk management one of which resulted in several deaths. The first was the power outage at the Atlanta airport for nearly 11 hours. Electrical switches and power cables ran through the same tunnel so a fire took out both primary and secondary. If, as a senior executive or board member, you accepted the simple premise that there was a secondary power supply you would have been sadly mistaken.

The other case was in Seattle, Washington. A train derailment took place on a new section of track that was rated for 30 miles an hour. The engineer approached the curve at close to 80 miles an hour. The result was three people killed and multiple injured. Did senior executives and board members know that mandated safety equipment that would have automatically slowed down the train was not yet installed? What questions were asked relative to the testing and safety of this new section of track?

Ed Note: In both cases, if the questions were asked, do we have redundancy or has the track been previously tested, the answer would be in the affirmative. Clearly there is the need to ask those probing questions, not simply accept the basic answer. That answer may have been generated at a lower level without senior level review. In risk management, the chain is no stronger than its weakest link. 

The Directors Letter

by Daly & Company Inc.

184 High Street, Boston, MA 02110
Dan Daly, Publisher

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