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Case Study: Aria Systems Chooses Oracle to Keep IT Costs in Check.

ANALYSIS

Weekly Review: New Life for USi
Loosely CoupledPhil Wainewright


Oct. 16th 2001: In this week’s commentary on ASP industry news: Bain rescues USi, but dilutes shareholders’ equity; Divine and Sun bet on ASPs.

The people at Bain Capital evidently know how to strike a hard bargain. Last week, the investment group positioned itself to take control of leading ASP USinternetworking (Quote, Chart), in the first tranche of a deal agreed on Monday by USi’s board, but which has yet to win the approval of shareholders.

The deal is effectively a rescue for a company in trouble. Although USi has built a strong business as one of the world’s largest ASPs, it did so on financial foundations that weren’t resilient enough to withstand the economic shocks of the past year. Last November it announced more than $300 million in funding that would, according to CEO Andy Stern at the time, “provide USi with the capital required to reach cash-flow breakeven.”

But it was not to be. The downturn in the first half of this year proved so severe that USi was losing more business as customers failed than it was signing up in new contracts. That meant it could no longer draw on certain lines of credit that were tied to the value of its contract backlog.

Reporting its Q2 results in July this year, USi quietly noted that it was seeking “more permanent sources of capital” to replace the disappearing contract-based credit lines. What this really meant was that its business plan was no longer fully funded — a development that we highlighted for subscribers to our executive newsletter, ASP News Review, back in August:

“Although USi says it remains on target to reach EBITDA breakeven this quarter, the interruption to its growth has triggered restrictions on some of the funding commitments it secured last year. That leaves it exposed to a potential funding shortfall before it reaches the more distant target of cashflow breakeven.”
Or, to put it more bluntly, USi was in peril of running out of money. In a funding climate where raising money is tough at the best of times, this left a highly geared company like USi with its back to the wall. That was the cue for Bain’s hard-nosed team to move in.

USi’s share price popped sharply higher last Thursday when the parties released news of the deal, briefly doubling in price, but everyone involved was at a loss to understand why. Closing the $100 million is subject to a recapitalization plan that will involve issuing new equity to Bain, and which will be “extremely dilutive to existing shareholders,” USi’s vice president of finance Dave Miller told Reuters on Thursday.

What this means is that USi is going to issue so many new shares to Bain in exchange for its infusion of new capital, that existing shareholders will end up owning a fraction of the company. Here’s the math:

  • Today, there are 145 million shares in issue, representing 100 percent of USi.
  • Based on Monday’s closing price of 28 cents, that values the company at just over $40 million.
  • At current market prices, Bain’s $100 million is worth more than 350 million shares in USi.
The actual deal is likely to come out even more favorable to Bain, leaving current shareholders owning anything from a quarter down to as little as a tenth of the recapitalised company. “At the end of this, I am confident that Bain will own substantially all the equity,” USi’s Miller confirmed to Reuters.

The buyers who leapt in last Thursday to trade as many as 2 million USi shares for prices of 40 cents or more perhaps should have paused to look more carefully at the details of the deal. In agreeing to go ahead, USi’s board has effectively conceded that its existing stock is as worthless as market prices suggest that it is. Indeed, the full extent of the company’s trading position is not due to be revealed until it publishes Q3 results on Oct 30th, when it’s possible that more bad news could emerge.

On the other hand, rescue by Bain does imply that the company now has a future, whereas previously its survival was very much in doubt. Current buyers of the shares may well be calculating that owning a possible 10 percent of a potentially viable company is worth a lot more than 100 percent of nothing. But it’s small consolation for those who bought equity at the April 1999 IPO price of $9.33 (the original $21 adjusted for subsequent stock splits), or for the unfortunate buyer who set the Mar 2000 all-time high of $107.50.

Betting on ASPs
Bain’s move on USi follows on from its successful restoration to health of another premium ASP business, Interpath, which it acquired control of from utility company Carolina Power and Light in May 2000 (see Interpath Undergoes Ownership Change). It will be interesting to see whether a merger of the two businesses is ultimately on the cards. In the short term, it seems likely that Bain will be looking to see USi adopting some of the best practice that appears to have worked at Interpath, which was the subject of a feature in last month’s ASP News Review.

Another company that’s been taking advantage of current market conditions to acquire the building blocks for a potential market giant is former dot-com incubator Divine. Those who were wondering when the company’s hodgepodge of content management and collaboration platform acquisitions would begin to start making sense had their curiosity rewarded last week. Divine unveiled its Enterprise Content Center, a suite of tools for delivering and managing external content on corporate intranets.

Whereas most corporate portal vendors concentrate solely on integration with existing internal systems, Divine has grasped the nettle of managing integration with external information sources. In doing so, it demonstrates a unique understanding of the business opportunity standing at the cusp where the enterprise meets the Internet.

Sun Shines on ASPs
The willingness of both Bain and Divine to invest in ASPs and related ventures is a sign that there are still plenty of companies out there willing to bet on the ASP model. Sun Microsystems also threw its weight behind the industry last week with the launch of its ASP enablement program for ISVs.

Sun has made a significant investment in this new program, which brings together its existing resources into a coherent and highly visible initiative designed to accelerate the successful development of ASP offerings by software vendors. At a time when many vendors are backing away from using the term ASP, it’s especially gratifying to see that Sun has chosen to call the program Destination ASP. Having polled analysts, it came to the conclusion that, although the ASP term has picked up negative associations over the past year, more and more companies are still asking how to become ASPs.

Microsoft Gets in the Groove
There’s just enough room to close by mentioning in passing the other notable event of the week, which was Microsoft’s participation in a $54 million investment in peer computing startup Groove Networks. Readers who recall my January column, P2P Meets ASP, will understand why this development is of significance for ASPs.

This review of the week’s news highlights is by ASPnews.com founder and consulting analyst Phil Wainewright. A comprehensive news digest is published every month in the ASP News Review newsletter, available exclusively to subscribers.


Phil Wainewright founded ASPnews.com in 1998 and is the publisher of Loosely Coupled. He can be contacted at

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