Financing Puts North Greenbush, N.Y.-Based
Banking Software Firm at Risk
(19-Jun-2001 11:00 EST)
Jun 18, 2001 (Times Union - Knight Ridder/Tribune Business News via
COMTEX) -- In
July 1999, North Greenbush banking-software
publisher IFS International Holdings Inc.
relied on an arcane tool to borrow $1 million
from a group of three investors.
arrangement, known as a "floating convertible"
or "floorless convertible," has picked up a
not-so-endearing sobriquet in corporate-
finance circles: death spiral loan.
That's because some companies relying
on the last-resort financing find they wake up
with share prices in the toilet, and their
lenders holding on to a big part of the
say the tools are getting a bad rap, with too
much attention paid to the companies
eviscerated by the deals and not enough given
to those that would not have lived to see
another day if not for the loans.
"Without these types of financings,
these companies would go out of business,"
said Martin Weisberg, a New York City attorney
with Jenkens & Gilchrist, Parker, Chapin LLP
speaking on behalf of two of IFS' lenders,
investment firms Manchester Asset Management
Ltd. and Gilston Corp. Ltd. "They're not going
to get money from Fleet Bank; they're not
going to get money from Goldman Sachs."
Regardless, despite a funding market
that had been loose as a steel trap until the
past couple of months, companies are steering
clear of floorless convertibles -- a device
that, apparently, has its roots in the Capital
Region. One French academic's study of the
convertibles pins their first use, in 1995, to
CAI Wireless Systems Inc. That Albany company,
which specialized in wireless communication,
was bought by MCI WorldCom for more than $400
million in 1999.
IFS' former chief
executive, David Hodge, did not return a
message asking why the company relied on the
risky financing. And current CEO Simon
Theobald can't say for sure that the deal is
what caused his company's shares to tank,
plummeting to as low as 51 cents from an all-
time high of $7.62 in 2000.
(Nasdaq: IFSH) closed Friday at 84 cents,
But IFS' experience after
it took the $1 million matches the outcome at
many other companies -- mostly cash-hungry dot-
coms -- after they did the same.
Here's what can happen: In exchange
for a loan, companies promise to repay the
lenders in stock. But the number of shares the
investor gets depends on share price. So the
lower the price goes, the more shares of the
company the lender gets in return. This can
lead to severe dilution of the stock.
Sometimes, the lenders turn around and
sell the shares, pushing the share price down
further. And, sometimes, short-sellers take
advantage of the situation, taking bets that
the share prices will drop. As word about
death spirals picked up, professional short-
sellers often got in on the action, making
them a self-fulfilling prophecy.
IFS' case, short-selling started in earnest at
about the same time the company registered the
shares earmarked for the lenders. The shorts
peaked at 200,000 shares in April 2000, from
next to nothing the month before the shares
Whether the lenders
are responsible for that is nearly impossible
to determine. Theobald is not trying to figure
out who sold the company short and plans no
lawsuits; selling short is not illegal anyway.
And Weisberg denied that his clients, the
investment houses that loaned to IFS, sold
shares short, the catalyst for many death-
IFS paid off the
remainder of its convertible last week. That
does not mean the company will snap back to
life. Besides Theobald's unbounded optimism --
and recent news releases predicting a 2001
profit of $750,000 and touting sales of
banking-industry software to institutions in
various countries -- the company still lost
$4.3 million in its third quarter, which ended
And IFS is waiting to learn whether it will be delisted
from the Nasdaq trading market, a sentence it faces as a
result of its stock dipping beneath $1 a share.
Losses in share price is a common side-effect of the loans.
One study by a professor at Insead, a French business school,
shows that 85 percent of companies that issue "toxic
convertibles" lose share price in the year after the deal
That's why Theobald said he made it a priority to pay off
the loan. "I realized during the summer of last year that
this was a problem," said Theobald, who became IFS' chief
executive in December, replacing Hodge, who sat atop the
company when the arrangement was reached. "It came to my
attention during research I was doing on the company."
Few floorless deals are being done any longer, despite
assurances from one financier that it's not the convertibles
that are bad -- and, in fact, the companies themselves might
end up digging their own holes.
Statistics from DirectPlacement.com, an online exchange for
private security placements, show that of 925 floorless
convertibles issued since 1995, share prices dropped
approximately 9 percent, on average, in the six months
following the deals. "How that correlates to the term
death spiral is obviously a little bit of a mystery to
me," said Brian Overstreet, president of the California
Still, Dow Jones Newswires reported June 8 that
PlacementTracker.com, an offshoot of Overstreet's company,
reported that just 29 companies issued floorless notes from
November to May, off from 83 in the six months before that.
"They contain a great deal of risk, and probably on
both sides," said Robert Lowry, a former U.S. Securities
and Exchange Commission worker and now a private consultant
who has testified in death-spiral cases.
Overstreet gets frustrated that the same spoiled deals,
with companies such as failed online kiddie-store eToys Inc.
and Rhode Island telecommunications company Log On America
Inc., get played over and over again in the press. Lawsuits
some companies have filed against their investors also have
been widely covered.
Overstreet maintains those stories are at least partly
responsible for scaring companies away from the deals.
Recently, DirectPlacement.com managed a $17.8 million
offering for Cambridge, Mass.- based SatCon Technology Corp.,
a company partly backed by Mechanical Technology Inc. of
Albany. Overstreet said that offering was a first-of-its-kind
vehicle drawn up partly because so many investors were afraid
to get into a floorless convertible.
Sean Moran, SatCon's chief financial officer, said he was
approached by investors trying to palm off floating
convertibles on him before settling on the mini-secondary.
Despite Overstreet's support, Moran never considered a
"It's always been my opinion that's not a good
thing," Moran said. He can understand the advantages for
the lender; for him, though, "I would think that there
isn't any (advantage). It's only if you can't get any other
financing. I see a lot of downside."
Indeed, IFS was well aware of the problems floorless
convertibles posed. In a prophetic filing with the SEC, all
the woes that eventually befell the company -- diluted shares,
prices driven down -- were spelled out in a statement
detailing the risks of the financing.
Theobald, for his part, would not answer why previous
management felt compelled to enter the deal. "It's hard
for me to comment on what the thoughts of previous management
before December the fifth were," he said. "They
clearly believed this was the right avenue at the time."
Now, though, IFS has joined the pack of companies steering
clear. IFS' recent financing was more straightforward, with a
company buying shares at a prearranged price. "Quite
clearly, there were and are other avenues for the company to
do financing, should we need to," Theobald said.
IFS went through a management shake-up at the end of last
year. Hodge left his post as president and CEO, though he
remains as a director, and the company's chairman resigned as
By Kenneth Aaron To see more of the Times Union, or to
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