Repealing the SOX tax

I’m now back in town after a combined business/personal trip late last week, one without much Internet access. So I’m catching up on some back reading.

One of the articles I missed was printed in Friday’s WSJ, where a commentator noted:

Last quarter marked the first time in 30 years that not a single company backed by venture capital went public in the U.S.

Yes, OK, the market was not very favorable for IPOs, but we’ve had other down markets in the past three decades; the absence seems extraordinary. One obvious implication is that if the traditional exit strategy has been foreclosed, it will be harder to get funding for new startups.

Commentator James Freeman lays the blame at Sarbanes-Oxley, and IMHO (next to the convicted felons from Milberg Weiss), nobody deserves it more:

"A lot of our CEOs are reticent to go through the public process. The [Sarbanes-Oxley] and governance issues are cumbersome, and it means they spend all of their time as administrators versus growing their companies," reports Kate Mitchell of Scale Venture Partners. She adds that chief executives don't want the liability risks of running a public firm and the same goes for candidates to serve as outside board members.

As for Sarbanes-Oxley, or SOX, the hope was that by now firms would have gotten over the hump of learning to comply, and auditors would have stopped obsessing over minute risks. Last year the Securities and Exchange Commission explicitly advised firms to focus only on material threats to the integrity of a firm's financials. "The SEC's heart was in the right place, but the accounting firms' hearts are not," says Mark Heesen of the National Venture Capital Association. He adds that the Big Four accounting firms "continue to feast on SOX audits."

Ms. Mitchell says the "SOX tax" runs up to $3 million per year per company, which can reduce a firm's market value by much more. Mr. Harrick says the costs of being a public company can approach $5 million.

Despite the visibility of this problem, neither presidential candidate plans on eliminating the infamous Section 404. Interestingly, if one kook libertarian (no not that one) somehow had made it to the White House, 404 would be history.

The SEC is trying to improve things but it’s not clear if they’ll be effective. If they don’t succeed before Christmas, it seems unlikely that their reform efforts will survive the next administration.

Freeman identifies another form of innovation drag with Elliot “tripped on my zipper” Spitzer, the former chief persecutor of NY State. Since Spitzer’s onerous policies were not voted for by any national politician, it seems hard to see how they’ll ever be repealed, although some provisions seem ready to expire in another 12 months.

Of course, the history of politicians is to neglect a problem until someone screws up badly, and then overreact. There are other ways that the problems of Enron and WorldCom could have been solved, but those would not have made Sen. Sarbanes and Rep. Oxley household names.

Without IPOs, there’s still the acquisition alternative. Freeman aptly summarizes why this alternative tends to produce less innovation than the other:

Does anyone think that we would be better off if Bill Gates and Michael Dell had sold out to corporate behemoths early in their careers, instead of leading their firms for years as public companies? Would consumers enjoy the same vibrant market in Web services if Yahoo had gobbled up a nascent Google? How powerful would our computers be if Intel had become an IBM subsidiary, instead of going public in 1971?
…
An IPO generally means that the founders can continue to run the companies they have painstakingly built, except with greater resources. An acquisition generally means that the founders move on, see projects they championed get axed, and watch old colleagues get fired.

Clearwire 1, Shareholders 0

In response to my earlier posting on WiMax startup Clearwire, the company sold about 15% of its shares, netting $559 million in its Thursday IPO, by pushing 24 million shares instead of 20 million. The stock fell both Thursday and again Friday, meaning those who paid $25 at the IPO have already lost 11.4% of their initial investment.

Interestingly, 20 months ago the company got $900 million in strategic venture capital, including $600 million from Intel. One thing I had missed was the lopsided voting rights of the founder and strategic investors, as reported by Bloomberg:

Clearwire will have two classes of stock, a format used by some companies to ensure that founders keep control. Class A shares, which will be offered to the public, will have one vote each. Class B shares will have 10 votes. McCaw controls 52 percent of the votes, according to the filing.

Wireless Week reports that the net voting shares are McCaw 49%, Intel 30% and Motorola 4%. Other shareholders are clearly just along for the ride, and so far it hasn’t been pretty.

Technorati Tags: broadband, Intel, IPO, WiMax

Size Matters

Since re-introducing myself to Mike Mace, the iPhone introduction, and supervising a student project on mobile phone operating systems, over the past two months my research has been moving back towards cellphones. I started researching the industry in 1996 as part of an international research project, and originally hoped to do my dissertation on it, but due to problems with the data (Baby Bells not keeping archives of their launch of US cellular service in 1983-1985) I had to switch to another topic. Still, I got a couple of papers out of the early work, some teaching cases, and material that will eventually end up in my next book.

Now that I’m back on the cellphone beat, I’ve loaded my favorite RSS reader with a bunch of mobile phone industry blogs and news feeds. One of the most provocative sources of industry gossip is the wireless section of Seeking Alpha. Its timely stock-oriented snippets nicely complement Mace’s blog, which tends towards think pieces on long-term corporate strategies for making money (rather than which stocks to flip).

On Thursday, Seeking Alpha had a fascinating posting about the planned IPO next month for Clearwire, a company that hopes to get rich using WiMax to deliver local broadband service. Clearly Clearwire is benefiting from great press, as well as the big pile of money Intel is throwing at WiMax. Of course, there are serious concerns about whether WiMax can deliver on the hype any time soon.

The posting by Bill Koss on the planned Clearwire IPO was unusually long by Seeking Alpha standards (3,300 words), but I encourage you to read the whole thing. Three key points:

• There are eerie parallels between the Clearwire IPO and the Netscape [sorry, not NetScape] IPO. And we know what effect that had.
• Many expect Clearwire to succeed because its chairman (not CEO) is Craig McCaw, reprising his old script.
• Clearwire is competing against big companies in an industry where size matters.

The parallels to McCaw’s earlier career might be a positive or negative. Although McCaw has a book about him, most people don’t remember who he is. They might remember the Cellular One brand name he created, or that he sold McCaw Cellular to AT&T for $11 billion effective in 1994. (Of course, AT&T spun off AT&T Wireless in 2001, it was bought by Cingular in 2004 , and is now AT&T again.) Later he was in the news for funding the Nextel turnaround, and having to split his billions in a messy divorce.

Koss argues that McCaw is following the same pattern of amassing spectrum at any price, assuming that it will rise in value. That worked for cellphone licenses in the 1980s, but it remains to be seen whether it will work for wireless broadband.

I heartily concur with his last point, which is that an infrastructure business (building a nationwide network) requires a lot of cash and has huge economies of scale. As I teach my technology strategy class, this is the big change of the IT industry from 30 years ago — no longer is it enough to have a cool idea and launch a company in a garage, because the Intels, Ciscos and Oracles of the world (or AT&T, Comcast and Verizon) can throw more money at the problem if they decide you’re on to something.

As with other such businesses, I can see three outcomes:

• Clearwire gets enough money from the IPO to grow big;
• Clearwire does well enough to get gobbled up by one of the big boys (a successful strategy recommended by my old mentor Charlie Jackson); or
• Clearwire runs out of money and dies.

There’s a lot that can happen either way — uncertainty about the technology, about demand, about economics, about direct competitors (e.g. 3G), and substitutes (wired broadband). That’s why IPOs are not for the faint of heart.

Technorati Tags: broadband, IPO, mobile phones, WiMax