“When you take on the job of CFO you have a fiduciary responsibility to the management team and, more importantly, to the shareholders of your company,” says Kevin Parker, group CFO of PeopleSoft, the Pleasanton, California-based vendor of business and finance software. “It appears the finance team at Enron did not take that responsibility seriously. I hope we find Enron is the exception to normal, conservative, financial management whether it is in the US, UK or anywhere else,” he says.
At the time of our interview in early February, Enron was particularly topical for Parker in two ways. Firstly, PeopleSoft’s auditor is Arthur Andersen – and the audit firm had already been in contact with Parker and PeopleSoft’s audit committee to explain the situation and reinforce their relationship (see box, page 30). Secondly, Parker is currently contending with PeopleSoft’s own off-balance sheet vehicle, Momentum Business Applications, after Enron was exposed for using 3,000 such vehicles to hide losses.
Back in late 1998, two years before Parker was hired as CFO, PeopleSoft was on its knees. By his admission, the company’s products were uncompetitive and it was tipped to sink into oblivion or be snapped up by one of the major players in the market, such as SAP, Siebel or Oracle.
To save itself, PeopleSoft needed to invest heavily in research and development. So, it effectively spun-off its research activities into a separately-listed, independent company, called Momentum. For every 50 PeopleSoft shares they held, investors received one Momentum share.
The premise was that PeopleSoft was developing a new, internet-based enterprise resource planning (ERP) product, PeopleSoft 8. Momentum would develop modular applications that would be incorporated into the finished software. It had all the hallmarks of true independence, such as its own Nasdaq listing and a separate board of directors from the parent company.
There was also the fact that PeopleSoft did not exercise ownership control and that Momentum retained intellectual property over its technology, while PeopleSoft paid royalties to it and retained exclusive rights to sell the applications for a fixed term.
But, in July 2001, a money manager at US fund manager Azure Capital Partners wrote an electronic message to some of his investment colleagues claiming that the Securities & Exchange Commission was investigating PeopleSoft for using Momentum to take research costs off its balance sheet, and thereby misleading investors. PeopleSoft’s share price plummeted 27% in two days, wiping $3bn off the company’s market value.
The SEC refused to substantiate the rumour, PeopleSoft vehemently denied the allegations, the manager from Azure publicly apologised and PeopleSoft’s share price quickly recovered. But the seeds of doubt had been sown.
After Enron’s use of off-balance sheet vehicles to hide losses was exposed at the end of 2001, PeopleSoft’s only off-balance sheet vehicle was again in the spotlight. And, in the shadow of unconfirmed rumours that shareholders and regulatory authorities had put pressure on PeopleSoft to eliminate the Momentum problem, Parker is keen to down play accusations of opaque accounting.
“There were 32 separate disclosures to the SEC in the past two years discussing our relationship with Momentum. We have more than 50,000 words of cumulative disclosure about the spin-off. We had to be explicit to the investment community because we felt the more investors and shareholders knew about Momentum’s purpose the better they would be able to judge the benefits. Contrast that with what Enron did – it didn’t disclose and didn’t discuss with shareholders,” says Parker.
True enough, but it’s there on Momentum’s home page (www.mmtm.com) that Momentum has one employee, that it uses PeopleSoft’s own staff to do the necessary research and development, that there were restrictions placed on the $250m that PeopleSoft handed over to Momentum when it split away from the parent company, and that PeopleSoft had a call option to buy back the whole subsidiary – an attractive option should the R&D effort pay off, but an easy way out if it didn’t.
PeopleSoft is now buying Momentum – and exorcising any problems it may have caused – before US accounting standards regulator FASB gets to grips with the legislation concerning off-balance sheet vehicles. However, Parker claims the buy-back, which is scheduled for April 2002, is predominantly motivated by PeopleSoft’s reluctance to continue paying royalties and the fact that its exclusive right to sell Momentum software expires in four years.
The purchase price is an easily digestible $90m, a figure derived from the terms of the call option which was due to expire in December 2002.
The exercise amount, payable in cash, was calculated as the greatest value calculated from four pricing formulae: (i) 15 times PeopleSoft’s royalty payments to Momentum in the preceding four quarters; (ii) the “fair market value” of 600,000 shares of PeopleSoft Common stock at the exercise date of the call option; (iii) $300m less the amounts incurred to develop Momentum’s applications; or (iv) a fixed price of $90m if the call option was exercised no later that 15 February 2002 – this amount increases steadily until the end of 2002 expiry date. PeopleSoft exercised its option on 30 January 2002 and so pays the greatest of the four amounts – $90m.
Parker believes that all’s well that ends well. “The true test for Momentum is, did it enhance shareholder value?” he says. “Did PeopleSoft and Momentum shareholders benefit from the strategy? The anecdotal evidence is that when we launched Momentum in 1998, PeopleSoft stock was valued at $12-a-share. It is now valued at closer to $30-a-share. Momentum shares are now worth $20 each. So, it has worked exactly as it was supposed to.”
PeopleSoft’s investment in research and development has certainly paid off. Although the company faces the same economic pressures as Siebel, Oracle and SAP, it has consolidated its number-four market position and, with PeopleSoft 8, has set out to threaten the business of its bigger rivals. Parker says PeopleSoft’s resurgence is due to its focus on constant product development and a reliance on internet technology, rather than thick, client-based implementations. “I think our competitors are taking us more seriously now,” he says. “We have gained market share against all our major competitors and we are now being invited to compete for more contracts.”
The combative attitude of PeopleSoft’s management team, spearheaded by Parker and CEO Craig Conway has also guaranteed the company exposure.
Parker and Conway were hired in 2000 to shake up the failing business and, along with encouraging research, Conway went all-out to publicly rubbish the opposition. At the launch of PeopleSoft 8 in July 2000 Conway famously called Larry Ellison’s Oracle “a sociopathic company”, and more recently reportedly told the Financial Times that “making a strategic partnership with SAP is like making a pact with the Devil”.
One might expect a risk-averse CFO to shy away from dangerous talk, but not Parker. “We live in a tough neighbourhood and it is important we don’t forget it,” he says.
PeopleSoft has recently been making most progress in Europe, and 43% of its licence revenues in Q4 2001 were generated outside the US. But some parts of Europe have been more receptive to PeopleSoft than others.
Germany, for instance, the home of competitor SAP, has been a tough market to break. “Historically we have found that the further away we get from Germany the more successful we are,” he says.
PeopleSoft’s push in the UK has been a success, especially, argues Parker, because the UK technology market has held up during difficult economic times. “I think the IT market in the UK is very good. There is a tremendous opportunity here. We expect to continue to gain share in the UK in 2002,” he says.
Parker also sees the UK and continental Europe as an opportunity to generate further investment in PeopleSoft, partly because he believes European investors are more prepared to take a long-term view than their US counterparts.
“Many investors in the US are only interested in the past 90 days,” he says.
One thing common across the global technology market has been the shift away from the defensive buying that typified IT procurement in the late 1990s. Parker gives the example of the situation in which company A bought a multi-million dollar ERP system just because company B had one. Now companies are more likely to look for quantifiable return on investment.
Suddenly the FD or CFO is driving deals rather than the IT manager. “It is part of my role to make sure we have the right information in the hands of the right decision makers,” says Parker. “The progression of the finance and accounting function has gone hand-in-hand with the development of applications. Previously, you could never describe how company A was using the product to reduce costs or improve efficiency.
The dollars spent didn’t improve much. We have seen customers change their focus over 2001 onto core business processes. Projects need to have real-time ROI, where profitability can be measured in explicit terms in a short period.”
So, as a CFO who uses his company’s technology on a day-to-day basis, what does Parker think the next big technology will be to improve the operating efficiency of FDs and CFOs? “The CFO desktop will be the next big thing,” he says. “The use of analytics and key performance indicators can point you to areas you should be concentrating on. You should not manage everything, but should concentrate on exceptions – setting KPIs and getting real-time alerts when problems arise.”
PEOPLESOFT AT A GLANCE
Pre-tax profit: $237.2m
Pre-tax profit: $289.6m
Market cap: $11,373.0m (19 March 2002)
Auditor: Arthur Andersen LLP