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FIN 413 Professor Clifford W. Smith Jr. Corporate Financial Policy Spring 2007

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Debt-Driven Deals Shake Up Holders of Highly Rated Bonds Karen Richardson and Serena Ng. Wall Street Journal. (Eastern edition). New York, N.Y.: Feb 8, 2007. Abstract (Document Summary) On Dec. 26, before Vornado appeared on the scene, EOP and Blackstone announced plans to buy back all of EOP's $8.4 billion in bonds as part of the Blackstone buyout. The offer covered short-term bonds due within the next 10 years and longer-term bonds due as late as 2031. But debt investors rallied against it, rejecting the terms as too little for the long-term bondholders.

"It was an impressive effort, especially the way bondholders seemingly looked out for each other," says Sid Bakst, a bond manager at Robeco Weiss, Peck & Greer who wasn't involved in the EOP affair.

"It's one of the first things we ask for nowadays," says Mr. Bakst of Robeco Weiss. "It's an insurance policy that protects against the worst-case scenario." If companies choose not to include covenants, they may have to commit to higher interest rates before investors will buy their bonds. Full Text (1002 words) (c) 2005 Dow Jones & Company, Inc. Reproduced with permission of copyright owner. Further reproduction or distribution is prohibited without permission.

The flurry of debt-driven corporate mergers, spinoffs and buyouts is putting a normally staid group of investors -- investment-grade bondholders -- on the defensive.

Typically a genteel bunch populated by life insurers and pension- fund managers, these risk-averse investors are learning the hard way that their bets on high-quality corporate bonds, some of the safest debt around, are more vulnerable than believed.

Holders of highly rated bonds in companies like casino operator Harrah's Entertainment Inc. or energy firm Kinder Morgan Inc. have seen their investments dropped in value overnight after private-equity shops launched bids for the companies.

The bids came with plans to load the companies up with new debt. The heavier debt burden meant existing bondholders became more exposed to default. They had added exposure, because the new debt would be paid off first if a default actually occurs. In both cases the credit rating on the existing bonds tumbled from investment grade to junk.

"The whole culture of high-grade bondholders for a very long time was lackadaisical, where nobody was ever worried," says Robert Haines, a bond analyst in New York at CreditSights, an independent debt- research firm.

That might be changing as buyout shops search out more big, high- quality companies to take over.

In a rare show of solidarity, some debt investors are fighting back. Blackstone Group's purchase of Equity Office Properties Trust, the nation's largest office landlord, for $23 billion is one example.

EOP's shareholders voted yesterday in favor of a buyout deal, concluding Blackstone's bidding war with Vornado Realty Trust.

The deal came with significant gamesmanship between existing bondholders and the company. On Dec. 26, before Vornado appeared on the scene, EOP and Blackstone announced plans to buy back all of EOP's $8.4 billion in bonds as part of the Blackstone buyout. The offer covered short-term bonds due within the next 10 years and longer-term bonds due as late as 2031. But debt investors rallied against it, rejecting the terms as too little for the long-term bondholders.

"It was an impressive effort, especially the way bondholders seemingly looked out for each other," says Sid Bakst, a bond manager at Robeco Weiss, Peck & Greer who wasn't involved in the EOP affair.

In that case, bondholders had some leverage against the company. They were protected by provisions in the debt, known as covenants, that limited the amount of new debt EOP could take on in a buyout. Without the consent of existing bondholders, in other words, Blackstone might not have been able to finance the deal.

AIG Global Investment Group, which held both long-term and short- term bonds, banded other investors against the offer. By Jan. 11, EOP and Blackstone agreed to boost the offer to long-term bondholders by about 20%, paying nearly $950 million for the $725 million in outstanding bonds.

For the remaining $7.6 billion in debt, EOP and Blackstone agreed to pay about $8 billion. In total, bondholders will be paid about $9 billion for their $8.4 billion in bonds.

Bondholders in Tyco International Ltd., which is undergoing a restructuring that will split the conglomerate into three separately traded pieces, are bracing for a potential replay of the EOP situation, says one Tyco bondholder. Like EOP bondholders, investors in Tyco bonds have covenants that allow them to get their money back in a merger.

In many other cases, high-grade bondholders don't have these protections, making them especially vulnerable, even targets. Without covenants, they have little negotiating leverage with buyout shops. And because the bonds are high-grade and pay relatively low interest rates, they are appealing to buyout shops looking for companies that can bear more debt.

Now more investors are demanding these provisions. Home Depot, Federated Department Stores, and Black & Decker were among the companies that included such provisions.

Even with the provisions, some bond investors are finding themselves vulnerable. This week, some bondholders in junk-rated Lear Corp. found themselves on the losing end of a buyout offer by Carl Icahn even though their bonds contained change-of-control provisions.

Lear had issued $900 million in bonds last November with terms that ensured the bonds would be paid off in full if ownership of the company changed -- but not if certain "permitted holders" took control of it. These holders were defined elsewhere in the bond agreement as Mr. Icahn, his affiliates and funds controlled by him. As a result, prices of the newly issued bonds slumped on news of the buyout bid.

In Trade Deal, a Shift on Generics; Agreement Opens the Door To Cheaper Drugs Abroad, Easing Some Patent Rules Sarah Lueck. Wall Street Journal. (Eastern edition). New York, N.Y.: May 17, 2007. pg. A.4

Abstract (Document Summary) marks the first big setback for the pharmaceutical industry since Democrats claimed Capitol Hill. The administration "has permitted the weakening of intellectual- property protections in these agreements," For now, the provisions likely only affect pending trade said Billy Tauzin, president of the Pharmaceutical deals with Peru, Panama and Colombia. But the plan Research and Manufacturers of America, the drug also signals a broader shift as congressional leaders industry's main trade group, in an interview. "They were give greater weight in trade talks to providing cheaper desperate to get continuing trade authority" from medicines for the poor, even if it means denying the Democrats in Congress, he said. "The fact is, their Republican-friendly drug industry some of the protection leverage changed since November." it says it needs.

"Compared to the many steps backward that have been The administration "has permitted the weakening of taken since 2003, this is a bit of relief for people who intellectual- property protections in these agreements," want access to affordable medicines," said Ellen said Billy Tauzin, president of the Pharmaceutical Shaffer, co-director of the Center for Policy Analysis on Research and Manufacturers of America, the drug Trade and Health in San Francisco. "Compared to an industry's main trade group, in an interview. "They were actual policy that would provide affordable medicines for desperate to get continuing trade authority" from people and fairly balance that with innovation, it is a Democrats in Congress, he said. "The fact is, their small step forward." leverage changed since November." Under recent trade agreements, the U.S. The main focus of the pressed countries to bipartisan trade deal, agree to "linkage," announced last week, which requires local involves requiring U.S. drug regulators to make trade partners to meet sure a generic product new standards for doesn't violate any giving their workers patents before allowing labor rights and it on the market. Public- ensuring health advocacy groups environmental have said this puts protections. But the makers of brand-name deal also allows drugs at an advantage developing countries and burdens regulators. more flexibility in Drug companies dealing with U.S. drug support linkage because it prevents copies of their makers than they would have had under earlier products from being sold during lengthy court battles. versions. Without it, companies will have to be more vigilant. To take industry concerns into account, the new policy calls Specifically, the policy would ease requirements on for countries to set up fast procedures for resolving developing- country regulators to prevent the sale of patent disputes. patent-infringing products. It also releases trading partners from a requirement to extend the time for Full Text (884 words) patent protections as a form of compensation for delays (c) 2007 Dow Jones & Company, Inc. Reproduced with in drug approvals. permission of copyright owner. Further reproduction or distribution is prohibited without permission. Public-health advocacy groups have argued for years that U.S. trade policy under Mr. Bush often protected WASHINGTON -- A new trade agreement between brand-name drug makers at the expense of poor Congress and the White House contains provisions that countries in need of more-affordable treatments. Many open the door to more sales of generic drugs in of those groups said they weren't satisfied with last developing countries. The plan, reversing earlier gains week's deal. Even with the changes, they say, the Peru for American drug makers backed by President Bush, and Panama deals advance many of the protections the drug industry wants -- just fewer than would have Under recent trade agreements, the U.S. pressed existed if the Bush administration had stuck with its countries to agree to "linkage," which requires local drug earlier trade stance. regulators to make sure a generic product doesn't violate any patents before allowing it on the market. "Compared to the many steps backward that have been Public-health advocacy groups have said this puts taken since 2003, this is a bit of relief for people who makers of brand-name drugs at an advantage and want access to affordable medicines," said Ellen burdens regulators. Drug companies support linkage Shaffer, co-director of the Center for Policy Analysis on because it prevents copies of their products from being Trade and Health in San Francisco. "Compared to an sold during lengthy court battles. Without it, companies actual policy that would provide affordable medicines for will have to be more vigilant. To take industry concerns people and fairly balance that with innovation, it is a into account, the new policy calls for countries to set up small step forward." fast procedures for resolving patent disputes.

Trade is just one of many fronts where the Another change in the new trade policy would weaken a pharmaceutical industry faces a less friendly policy common provision in past trade agreements: that local environment, after enjoying strong support during years regulators "shall" compensate drug makers for delays in of undivided Republican rule. Some Democrats want to the process of approving their products, by awarding rewrite the Medicare prescription-drug benefit to allow extra time to sell their products free from competition. the government to negotiate lower prices with manufacturers. Some Democrats also want to legalize Some Democrats said this unfairly penalizes consumers imports of cheaper medications from Canada and other in those countries for slow bureaucracies. A description countries. The Bush administration has maintained its of the changes to the Peru and Panama agreements support for the industry on those issues, and the Senate says countries "may" extend a company's patent to has blocked those policy changes. make up for delays, suggesting more flexibility on what

But on exports, the administration last week changed they are required to do to compensate drug makers. course. For the last several years, U.S. trade officials and drug companies have worked to push new Health-advocacy groups complain the new policy still protections for drug makers in countries such as signers preserves the data-exclusivity provision used to block of the Central American Free Trade Agreement. generic competition. In many countries, including the U.S., makers of generic drugs can often win approval by Companies say stronger safeguards for their patents proving their products are equivalent to the original and proprietary data are needed in many countries, to drugs. In that process, regulators use test data delay generic competition and make it worthwhile for the submitted by makers of brand-name drugs. The data- industry to continue to invest in research and exclusivity provision typically prevents such use of the development of new treatments. data for five years, acting as an effective hurdle for generics. The new policy does, however, place more Under the new American trade strategy, the biggest loss restrictions on the five-year data exclusivity than for the industry is a change that may shift more previously existed in the Panama and Peru agreements. responsibility to drug makers for preventing the marketing of patent-infringing products.

Once Highflying Tech Industry Reboots for Era of Slower Growth Pui-Wing Tam, Robert A. Guth and Christopher Lawton. Jul 27, 2006.

Executives at Intel Corp., Dell and other companies are After years of hoping to regain its youthful exuberance facing the challenge of adapting to the slower growth as the dot- com meltdown receded into the past, the typical of more-mature industries. In doing so, they are computer industry is feeling its age. following in the footsteps of companies like Microsoft, H- P, Cisco Systems Inc. and Oracle, which have already begun to recalibrate their strategies and priorities. A raft of recent earnings reports suggests what some in the industry have long suspected: that the industry's markets are maturing and that slower growth may be During the era of go-go growth, computer companies here to stay, requiring a new business model and a new often threw all their resources into meeting demand, style of management. adding new employees and expanding their manufacturing, sales and distribution networks quickly, with only secondary regard for cost and efficiency. But Last week, computer maker Dell Inc. said it would report when growth rates slowed, the companies often found lower quarterly earnings and revenue, its second profit themselves saddled with overlapping layers of warning this year. Software giant Microsoft Corp., personnel and without a clear strategy for weathering meanwhile, announced a $20 billion share buyback and the slowdown. $1.5 billion in new product-development spending in an effort to shore up its sagging share price. Making money in maturing markets requires companies to compete more aggressively for market share. That Revenue growth for many big computer companies, can mean either buying access to new customers once in the double digits, has been stuck in single-digit through acquisitions or attracting them with more percentages. Hewlett-Packard Co. predicts its revenue compelling or cheaper products or services. Keeping will grow 4% to 6% this fiscal year. Dell, the world's prices as low as possible requires a keen eye on costs. largest computer maker, says its sales will rise just 4.3% in the fiscal second quarter ending Aug. 4. "If rates of innovation are lower than they used to be, controlling costs becomes more important, efficiency Profit growth hasn't recovered either. Morgan Stanley becomes more important and tailoring products to expects the tech industry's overall earnings to grow by customers becomes more important," says Andrew 14% this year and 10% next year, down from 18% in McAfee, an associate professor at Harvard Business 1999, near the height of the tech boom. School.

Computer stocks also remain in the doldrums. The In the past few years, H-P, Oracle and Cisco have tried Standard & Poor's 500 Information Technology index is to take advantage of opportunities to tap new markets or still down more than 70% from its March 2000 peak. to cut costs by combining operations with those of Tech stocks today account for just 14.1% of the value of former competitors. H-P, which bought PC rival Compaq the S&P 500-stock index, down from 34.5% in 2000. Computer Corp. in 2002 for $19 billion, Tuesday "Tech has not anywhere near come back," says Howard announced it would acquire software marker Mercury Silverblatt, a senior index analyst at S&P. "It's hard to Interactive Corp. for $4.5 billion. Oracle snapped up call it a growth industry anymore." software competitors like Siebel Systems Inc. and PeopleSoft Inc. in a $20 billion acquisition spree. And That hasn't come as a surprise to everyone. "There's Cisco earlier this year closed on its $6.9 billion purchase this bizarre notion in the computer industry that we'll of set-top box maker Scientific-Atlanta Inc., its biggest- never be a mature industry," Oracle Corp. Chief ever deal. Executive Larry Ellison declared in 2003, dismissing the idea that the tech boom might resume. "The industry is These tech titans also are emulating more-mature as large as it's going to be." companies in other ways. Microsoft has undergone a series of management restructurings, hiring executives Increasingly, it looks like Mr. Ellison might be right. from older-line companies such as International Paper Some economists argue that the tech industry is still Co. and Wal-Mart Stores Inc. In 2003, the Redmond, suffering a hangover from its blistering 1990s pace, and Wash., software giant began paying a dividend -- that growth will eventually ratchet back up. But market- something that industrial companies typically do. Cisco research firm IDC predicts that information-technology took on debt for the first time to finance its Scientific- spending by the world's largest companies is likely to Atlanta deal. Though borrowing to finance acquisitions increase just 5% a year between 2005 and 2009, down is common among mature companies, Cisco had from the double-digit growth rates of the boom years. previously paid for all its deals with cash or shares.

Even companies that have made relatively few slow- The current downturn, like past ones, is likely to produce growth adjustments are beginning to change their ways. a new set of winners. The success of consumer Chip giant Intel, whose revenues jumped 14% last year products such as cellphones and digital music players to a record $38.8 billion, has run into slowing demand has already helped companies like Apple Computer Inc. for chips and tougher competition from Advanced Micro and chip maker Qualcomm Inc. Devices Inc. that is expected to drive sales down as much as 8% in 2006. Stanford University economist Timothy Bresnahan says he has recently become bullish on the tech industry Intel has launched an internal review to guide it in again. Even with the PC market maturing, he says there coping with the tougher market. It has already are plenty of opportunities in segments of the industry, announced plans to eliminate 1,000 management jobs such as online content, where he points to the popularity and is expected to make further cuts in its payrolls. of Internet video company YouTube Inc. "There's a tremendous amount of ferment," he says. Dell, which has been hurt by lackluster demand for its consumer PCs and competition from H-P, last year However, some venture capitalists, who invest in start- combined its U.S. consumer unit with its overall ups with the hope of profiting later when they are sold or Americas business, in part to cut costs and increase its go public, are skeptical the ferment will produce a new efficiency in the ultra-competitive PC market. generation of successes as big as Microsoft. Alex Slusky, managing partner of San Francisco private- "We believe that the industry's competitive nature is equity firm Vector Capital, says he doesn't see anything more intense now than it has been or than we have that equals the kind of innovation brought about by the really acknowledged or understood," said Dell CEO PC or the Internet browser. "That worries me about what Kevin Rollins, at a meeting in May with employees of will happen in the next five years," he says. the Round Rock, Texas, company. "That has meant we have had to respond in a different fashion." In addition, the jury is still out on whether the management changes by the big computer makers will Mr. Rollins has committed $100 million to improving the pay off. After H-P bought Compaq in 2002, it delivered "customer experience," partly by hiring more than 2,000 inconsistent financial results that eventually led H-P's new sales and support staff in the U.S. Dell is also board to fire CEO Carly Fiorina in 2005. opening its own retail stores in New York and Dallas. Earlier this month, Dell said it also would simplify its Microsoft has tinkered with its management structure pricing for consumers. several times in the past few years hoping to find the right formula. Most recently, it has reassigned some of In the Internet arena, the electronic-commerce industry the company's best managers to Windows Live, a in particular is showing signs of age. Internet auctioneer recently launched service designed to attract more eBay Inc. and online retailer Amazon.com Inc. have online advertising to Microsoft. The company also seen their revenue growth slow to double-digit rates elevated several vice presidents who have overseen the from triple-digit ones. In a bid to reignite growth, eBay MSN online services. has gradually diversified away from its core auction business. In 2005, it purchased Internet telephone- Oracle is still in the process of integrating its many service provider Skype Technologies SA for $2.5 billion. purchases, which also include smaller software Last week, eBay for the first time announced a share companies such as Portal Software Inc. buyback, aiming to repurchase $2 billion of its stock, a move more typically associated with older-line Some big tech companies reject the notion that they've companies. lost their high-growth status. Cisco executives say the San Jose, Calif., networking company continues to grow On Tuesday, Amazon said its second-quarter operating faster than many of its large- company peers like costs rose 34% to $462 million as it spent more on new Microsoft, Intel and International Business Machines initiatives such as digital books and digital music in a bid Corp. to spark growth. The spending crimped the Seattle company's profits, which fell 58% for the quarter. And just last week, Dell's board recommended against a shareholder proposal to start paying a dividend, an Even in the hot Web-search market, the easy growth indication the company still considers itself a growth may be over, with a few big companies increasingly machine. The proposal was rejected by Dell's battling one another for share. Market leader Google shareholders. Inc. continues to flourish and recently reported quarterly --- revenue growth of nearly 80% and a doubling of profits. Bobby White, Mylene Mangalindan, Rebecca Buckman But Yahoo Inc.'s shares dropped 22% in one day last and Don Clark contributed to this article. week after the Sunnyvale, Calif., company said it would delay some improvements to its search-advertising platform, a delay that investors feared might benefit Google and other competitors.

WSJ(5/10) Heard On The Street: Tech Yahoo have each gained share, according to research firm NetRatings Inc. Firms Overspending? At a Microsoft conference last Thursday, Microsoft Chief Wednesday, May 10, 2006 0:11:16 AM ET Executive Steve Ballmer acknowledged Wall Street's Dow Jones Newswires discontent but reiterated the need to continue investing. "I think we surprised some in the financial community . . . and our stock showed that surprise," Mr. Ballmer said. "We're very serious about making [online-advertising] investments," (From THE WALL STREET JOURNAL) which the company believes will pay off over the long haul. By Mylene Mangalindan Amazon is fielding similar questions. The Seattle company's LEADING WEB and technology companies such as Microsoft shares are little changed over the past year, as the Internet Corp., Amazon.com Inc. and Google Inc. need to spend retailer has spent heavily to fund initiatives such as digital- more money to stay ahead of the competition. Now, all that music and digital-movie services, which have yet to spending is fueling investor backlash against some of the materialize. stocks. Overall, Amazon's technology and content costs rose 59% to Microsoft recently surprised Wall Street when it said it would $146 million in the first quarter. Purchases of fixed assets, spend about $2 billion more than analysts had estimated such as internal-use software and Web-site development, over the next fiscal year to improve areas such as online- rose 77% to $46 million. The spending increases ran ahead advertising services. Google said its capital-expenditure of revenue, which rose 20% to $2.3 billion. growth rate this year would be "substantially greater" than its revenue rate. Amazon said it plans to continue spending more on areas such as technology and content.

In some cases, investors and analysts say, the big expenditures haven't led to tangible results or have come at the expense of profitability. "Investors can't win," says analyst David Hilal of Friedman Billings Ramsey in a research note, though he recommends buying shares of Microsoft.

Some conservative investors advocate staying on the sidelines when companies spend heavily, to see how those investments pan out. To show their displeasure, investors have knocked down some stocks of Web and technology companies that have said they would ramp up spending.

Consider Microsoft. During its recent fiscal third-quarter earnings call, the Redmond, Wash., software giant said it plans to spend more to fend off Web-search leader Google. In total, Microsoft will rack up about $21.6 billion in operating expenses in fiscal 2007, which ends next June, estimates Mr. Hilal. Investors shaved 11% off Microsoft's market capitalization the next day, and the stock has declined since. In 4 p.m. composite trading yesterday on the Nasdaq Stock Market, Microsoft's shares fell 11 cents, or 0.5%, to $23.62, "There must come a point when spending needs to be giving the company a market value of more than $240 billion. justified and reeled in if the targeted [return on investment] appears unachievable," wrote Robert Peck, a Bear Stearns Mark Lebovitz, a portfolio manager for Munder Capital, which analyst, in a research note. Mr. Peck, who rates Amazon's has more than $40 billion under management and owns stock "outperform" and whose firm has done noninvestment- Microsoft shares, calls Microsoft's spending forecast banking business with Amazon during the past 12 months, "definitely disappointing." He had expected the company to believes Amazon is trying to make those assessments. enter a product cycle that would result in higher revenue and earnings. "Now we're not getting that earnings acceleration," An Amazon spokeswoman said the company expects its he says. "And we're not sure what they're going to spend this technology and content costs growth rate to decrease additional operating expenditure on." substantially in the second half, adding that the company expects the initiatives to pay off. Amazon shares rose 15 Indeed, while Microsoft has invested heavily since 2004 to cents, or 0.4%, to $34.84 at 4 p.m. on the Nasdaq Stock compete with Google, it has lost share of the Web-search Market. It has a market capitalization of about $14.5 billion. market, dropping to 10.9% of all U.S. search queries in March 2006 from 14.2% in February 2005. Google and EBay Inc. also suffers from some investor impatience over spending, says Michael Koskuba, a managing director at

Victory Capital Management, which has $56 billion under management and owns eBay and Google shares. The San Jose, Calif., Internet auctioneer's shares have declined 5% over the past year as investors worry about eBay's spending in countries like China and the acquisition of companies such as Internet-calling concern Skype, Mr. Koskuba says.

Skype contributed just $35 million of eBay's $1.39 billion in first-quarter revenue and some analysts estimate Skype and the company's China operations aren't profitable. EBay, which has a market value of about $45 billion, says Skype and its investments in China are long-term initiatives that will benefit the company. EBay's shares rose 54 cents, or 1.7%, to $31.86 on the Nasdaq yesterday.

Some shareholders are more forgiving about the big spending from some companies than others. More-mature companies such as Microsoft are held to a higher standard. Faster-growing companies carry less of that burden.

Take Google. While investors say they have reservations about spending levels at the Mountain View, Calif., search company, Google's revenue and earnings mostly have exceeded Wall Street's expectations. After it reported financial results and an increased spending forecast last month, Google didn't plunge. Instead, its stock rose $22.10, or 5%, to $437. Google shares rose $14.02, or 3.6%, to $408.80 yesterday on Nasdaq, giving it a market value of about $120 billion. A Google spokesman declined to comment.

Google says it plans to invest in computer servers, networking equipment, data centers, real estate and campus facilities. This year, Google expects its capital expenditures to outpace revenue growth. Last year, revenue rose 92% to $6.1 billion while capital expenditures more than doubled to $838 million from $319 million in the previous year.

Says Victory's Mr. Koskuba: "Companies can continue to spend as long as they can continue to deliver on top and bottom lines."

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Robert A. Guth contributed to this article.

What's Aiding Buyout Boom: Toggle Notes; An Innovative Means To Structure Debt Helps Defaults Remain Low Henny Sender. Wall Street Journal. (Eastern edition). New York, N.Y.: Feb 21, 2007. pg. C.1

In the fall of 2005, when Texas Pacific Group and Warburg Pincus LLC bought luxury retailer Neiman Marcus Group Inc., Jim Coulter, TPG's co-founder, was nervous, said people familiar with the deal. What if there was another terrorist attack or a sharp economic downturn? What if Neiman's management got fashion trends all wrong?

To protect against an unexpected turn, TPG came up with an unusual structure for some of the debt it put on Neiman Marcus to help pay for the purchase. If the retailer experienced unexpected head winds, it could stop paying cash interest on $700 million in debt, and instead agree to pay back much more when the bonds mature in 2015.

"If the company hits a speed bump, it gives it liquidity and a cushion," said Kewsong Lee, a partner at Warburg Pincus who worked on the deal. "This innovation was one factor enabling us to pay a more aggressive price."

The bond, formally known as a payment-in-kind toggle note, is becoming an increasingly important part of the arsenal of private- equity firms as they pile debt on their corporate trophies.

These "PIK toggle" securities allow borrowers to make a choice. They can keep paying interest on a bond, or they can defer paying interest until the bond matures, and in the process agree to pay an interest rate that is effectively higher. In the case of Neiman Marcus, the interest rate on its debt with this feature will rise from 9% to 9.75% if it decides to defer payments, which it hasn't done.

The increased use of these bonds is one of the latest examples of the easy lending terms that dominate the corporate borrowing market these days and have helped fuel the historic buyout boom. It also is a sign the boom could keep going for some time.

Corporate default rates are at record lows less than 1%. That has investors clamoring for corporate bonds and loans, because they don't seem very risky. In 2006, companies issued $624 billion in speculative grade bonds and loans, up from $389 billion in 2005.

Easy lending terms such as those of PIK-toggle bonds make it possible for even companies with strained cash flows to stay afloat longer than they otherwise would by putting off interest payments. The downside is that borrowers and investors in the end could find they have even more debt than expected if the credit cycle turns.

"Cheap debt is the rocket fuel," said Bill Conway, a co-founder of Carlyle Group, at a January conference. "We try to get as much as we can as cheaply as we can and as flexibly as we can."

The health of the debt market matters hugely to private-equity firms, which have used massive dollops of debt to go after ever larger prey and reap higher returns on their investments. Nearly every TPG deal since Neiman Marcus includes debt with the PIK toggle feature. All the megadeals, including Freescale Semiconductor Inc., HCA Inc. and ballpark-concessionaire Aramark Corp. do as well.

A similar feature that allowed companies to defer interest payments was popular during the late 1980s buyout boom, but fell out of favor in the 1990s.

Although default rates are low, and easy lending terms make it easier to stay solvent, the credit quality of some companies show some signs of deteriorating. Some 30% of companies issuing debt in 2006 carry "junk" credit ratings of "B plus" or below, compared with 7% in 2002, according to Standard & Poor's Leveraged Commentary & Data group. In many cases, the debt itself isn't going to fund new investments; rather it is used to finance takeovers or to pay new owners a special dividend.

Many companies have been able to issue debt without the usual terms, known as covenants, that require them to meet certain performance metrics to avoid defaulting. Last year, there was about $24 billion in such debt, ten times the amount in 2005.

This is another factor that is making it easier for companies to avoid defaulting. In the past, when companies fell short of financial performance targets, "banks would take over the company at the worst possible time or we would have to put more money in," said Tony James, president of Blackstone Group at a conference at Harvard Business School. "Now we can live to fight another day."

To many analysts, such "covenant lite" loans or PIK toggle notes are glaring signs of the bull market in debt, and underscore the power of bond issuers at a time when investors are flush with cash and willing to take chances for high returns. Some bond issuers said the new features are in the interest of investors, because the features help companies avoid default and complex bankruptcy proceedings. Proponents have said the high interest rates attached to PIK toggle notes give borrowers an incentive to keep making interest payments unless times tur n dire.

Others are less sure. S&P's Leveraged Commentary & Data Group noted in a commentary, for example, that PIK toggle bonds could be risky because they have the potential to saddle investors with more debt in companies and less cash from them just as the companies are beginning to struggle.

"Because there is so much cash around, lenders are being pushed to give up more and more," said Howard Gellis, who runs the debt capital markets group at Blackstone Group.

So far this cycle, none of the issuers have taken advantage of their option and ceased paying interest. It remains unclear how investors will react if companies do start exercising this right. "Since the message is that a company can't afford to pay cash, it is hard to see how the market won't be spooked," said Steven Shapiro, a partner at GoldenTree Asset Management, which has $6 billion to invest out of its hedge- fund operations. "For the most part we don't invest in them." http://www.bloomberg.com/apps/news?pid=20601009&sid=a0mGxHpzf3co&refer=bond

Tyco Threatens to Withdraw Bond Rights in Breakup (Update3)

By Mark Pittman

May 11 (Bloomberg) -- Tyco International Ltd. threatened to take away the right of bondholders to approve its breakup plan after more than two-thirds of its debt investors refused to tender their securities because they say the offer is too low.

Tyco may waive the ``majority consent'' covenant in its bond indentures, the Bermuda-based company said in a press release today. Tyco bondholder American International Group Inc. this week sued the owner of ADT security systems in an effort to block it from buying back $6.6 billion of debt as part of a plan to split into three companies.

Bondholders claim Tyco, which also makes health-care and electronics products, is offering about $95 million less than what they are entitled to under the indentures. Tyco has said it is paying market rates.

``If they can somehow get the bondholders to agree, the upside is enormous,'' said Adam Cohen, New York lawyer who advises hedge funds on the value of bond covenants. ``What risk do you have? A couple of million in legal fees and angering some people? It's a cheap option.''

Tyco said today that holders of less than one third of its U.S. debt, totaling $5.6 billion, agreed to the tender. It also said it was extending the offer, which expired at 5 p.m. yesterday, by three days.

Hearing Set

The company has claimed in statements that it doesn't need bondholders' permission to go through with the breakup because the plan doesn't affect ``all or substantially all'' of the assets backing the bonds. AIG, in its lawsuit, disagreed.

A federal court hearing is scheduled for 5 p.m. May 14 in the Southern District of New York in Manhattan. Andrew Rosenberg, a lawyer at Paul, Weiss, Rifkind, Wharton & Garrison LLP that is representing AIG didn't immediately respond to telephone messages and e-mail requests for comment. Tyco spokesman, Paul Fitzhenry, declined to comment.

Tyco's tender is the latest to test bondholder resolve against offers that debt investors say are less than what they are entitled to under their lending agreements. Bondholders united in January to force Blackstone Group LP to pay almost $225 million more than face value for the bonds of Equity Office Properties Trust this year when it bought the company.

``It comes down to lawyers and a more aggressive campaign to scare bondholders,'' said Glenn Reynolds, chief executive officer of independent research firm CreditSights Inc. in New York in an e-mail. ``Bondholders will be setting their own course on risk-reward for future spinoffs and whether Tyco's strategy proves an anomaly or a new way to beat the system and dishonor the value of indentures.''

Tyco Separation

The tender offer is being managed by Goldman Sachs Group Inc. and Morgan Stanley, both based in New York.

Tyco wants to separate into three publicly traded companies under a plan announced in January 2006. The split may be completed by June 30. Bond investors say the plan may leave them with fewer assets backing their securities, reducing their value.

``So far the bondholders are way ahead by this early count,'' Reynolds said. ``The extension buys time for Tyco to keep twisting arms and making subtle threats on what will happen to those securities who do not go along.''

The extra yield investors demand to own Tyco's 7 percent bonds due in 2028 rather than Treasuries narrowed to as little as 42 basis points, according to Trace, the bond price reporting service of the NASD. The company is offering to pay a spread of 60 basis points, which implies a lower value for the bonds.

``We made fair offers for our bonds,'' Tyco Chief Financial Officer Chris Coughlin said on a May 8 conference call.

The biggest holders of Tyco's bond includes Europe's second-largest pension plan, Stichting Pensioenfonds ABP, with $1 billion, Prudential Insurance Co. of America with $206.8 million and Goldman Sachs with $127.5 million, according to data compiled by Bloomberg.

To contact the reporter on this story: Mark Pittman in New York at [email protected]

Ford's Convertible-Debt Offering May Race Off Lots, Analysts Say Michael Aneiro. Wall Street Journal: Dec 6, 2006. Abstract (Document Summary) The company has included a call option on the notes after seven years and another "soft-call" redemption option three years later. With current guidance on the coupon rate at 4.75% to 5.25% and a conversion premium between 23% and 27%, investors could easily lock in profits before the company could buy back the notes, regardless of where the stock goes, according to Mr. [Paul Berkman]. He expects the deal to be a "blowout."

"Looking at the worst-case scenario -- the lowest coupon and the highest conversion premium -- you would break even in about 4 1/2; years," he said. "It's very unusual to see a convertible break even in a period before the call protection ends."

Standard & Poor's yesterday assigned a CCC-plus rating to Ford's convertible offering, placing it deep in speculative-grade territory. Moody's Investors Service assigned an equivalent Caa1 rating. Fitch Ratings gave a B rating to the convertible debt offer, along with a recovery rating that indicates unsecured debt holders would recover between 30% and 35% of their principal in the event of a bankruptcy. Full Text (808 words)

Ford Motor Co. has unveiled its latest convertible.

And early indications are it will be a hit among investors as the terms of the planned convertible-debt deal lure potential buyers despite the highly speculative ratings the notes will carry.

In a prospectus filed with the Securities and Exchange Commission yesterday, Ford detailed its plans to issue $3 billion in 30-year senior unsecured convertible notes, which could increase to $3.45 billion if the deal's underwriters exercise an overallotment option. Convertibles are securities that pay interest like a regular bond but can be turned into shares when certain conditions are met.

The redemption options included in the offering coupled with initial guidance on the coupon rate for the notes adds up to an uncommonly attractive deal for investors, according to Paul Berkman, a convertibles analyst at J. Giordano Securities Group.

The company has included a call option on the notes after seven years and another "soft-call" redemption option three years later. With current guidance on the coupon rate at 4.75% to 5.25% and a conversion premium between 23% and 27%, investors could easily lock in profits before the company could buy back the notes, regardless of where the stock goes, according to Mr. Berkman. He expects the deal to be a "blowout."

If the kind of demand Mr. Berkman anticipates materializes, the analyst said that Ford would have some leeway to change the size of the deal before it prices, or else to lower the coupon rate or raise the conversion premium.

As they stand right now, the terms of the deal appear extremely attractive, according to Mike Revy, director of research at Froley Revy Investment Co., which lists over $3.5 billion in convertible securities under management and is planning to invest in the Ford deal.

The proceeds from the notes, as well as the $8 billion credit facility and $7 billion term loan that round out the financing package, will help sustain Ford for the next several years, as the company said it expects to continue to bleed cash while it tries to turn around its struggling North American operations.

Standard & Poor's yesterday assigned a CCC-plus rating to Ford's convertible offering, placing it deep in speculative- grade territory. Moody's Investors Service assigned an equivalent Caa1 rating. Fitch Ratings gave a B rating to the convertible debt offer, along with a recovery rating that indicates unsecured debt holders would recover between 30% and 35% of their principal in the event of a bankruptcy.

The Ford issue will rank as one of the largest new convertible issues of 2006.

The large offering weighed on Ford's stock early yesterday, as fears of dilution resulting from the convertible issue drove the share price to its lowest level since August, before rebounding later in the day.

A Ford spokesperson declined to discuss pricing terms or why the company elected to tap the convertibles market and said the company didn't have any comment on the drop in stock price following the announcement of the convertible offer.

Ford's previous foray into the convertibles market came in 2002.

Rating Cut for Boston Scientific

S&P lowered the corporate credit rating for Boston Scientific Corp. to BBB from BBB-plus, two notches away from the junk, or speculative- grade, status, saying it expects "financial strengthening will take longer than previously expected." S&P last cut ratings on Boston Scientific to BBB-plus from A on April 21.

Paul Donovan, spokesman for Boston Scientific, said "we are pleased that all our ratings continue to be investment grade, and we look forward to strengthening our ratings in the future."

Treasury Bond Prices Fall

Longer-dated U.S. Treasury-bond prices ended lower yesterday, as the stronger-than-expected report on the U.S. nonmanufacturing sector "provided an excuse for some profit-taking," said John Canavan, analyst with Stone & McCarthy in New York. The 10-year note was down 5/32 point, or $1.5625 per $1,000 face value, at 101 13/32. Its yield rose to 4.448% from 4.431% Monday. The 30-year bond fell 16/32 to 98 26/32 to yield 4.575%.

AUCTION RESULTS

Here are the results of the Treasury auction of four-week bills. All bids are awarded at a single price at the market- clearing yield. Rates are determined by the difference between that price and the face value.

FOUR-WEEK BILLS

Applications ...... $41,566,643,000 Accepted bids ...... $18,000,143,000 Accepted noncompetitively ...... $418,243,000 Accepted frgn noncomp ...... $0 Auction price (Rate) ...... 99.629778 (4.760%) Coupon equivalent ...... 4.844% Bids at market-clearing yld accepted ...... 60.20% Cusip number ...... 912795YM7

The bills are dated Dec. 7, 2006, and mature Jan. 4, 2007. ---

Kellie Geressy and Deborah Lynn Blumberg contributed to this article.

Metalico Converts Debt to Equity Business Wire- 11/29/2006 11:26:00 AM EST

Metalico, Inc. (AMEX:MEA) has substantially completed conversion of its November 2004 Series 7% Convertible Notes to common equity in the Company.

The conversion of the notes (assuming all remaining conversions) coupled with the Company’s free cash flow from operations has resulted in overall debt reduction of $13.7 million so far this calendar year. As of November 28, 2006, Metalico’s total debt (assuming all remaining conversions) stood at $15.7 million, of which $8.2 million represented borrowings under Metalico’s $35 million revolving credit agreement.

In November and December of 2004, Metalico completed a private placement of two-year convertible notes to fund the acquisition of a scrap metal recycling company in Rochester, New York. The notes were redeemable in cash or convertible to common stock. By November 29, 2006, each noteholder had voluntarily either converted 100% of its principal to Metalico common stock or arranged for full conversion on its note’s maturity date. Noteholders included certain directors of the Company, members of its management, and other stockholders.

In addition, the Company has received preliminary approval from its lender to increase the commitment under its senior secured revolving credit and term loan agreement to $50 million. Metalico intends to utilize the available capital to finance acquisitions and internal development projects in the scrap-metal recycling and lead-fabricating segments and, secondarily, to support investment initiatives through AgriFuel Co., a producer and marketer of biofuels with a particular focus on biodiesel. Metalico previously announced its agreement to acquire controlling interest in AgriFuel.

Metalico, Inc. is a rapidly growing holding company with operations in two principal business segments: ferrous and non-ferrous scrap metal recycling, and fabrication of lead-based products. The Company operates seven recycling facilities through New York State and five lead fabrication plants in four states. Metalico’s common stock is traded on the American Stock Exchange under the symbol MEA.

Forward-looking Statements

This news release may contain “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements with respect to Metalico’s beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond Metalico’s control, and which may cause Metalico’s actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. Metalico assumes no obligation to update the information contained in this news release.

CONTACT: Metalico, Inc. Carlos E. Agüero or Michael J. Drury 908-497-9610 Fax: 908-497-1097 [email protected] www.metalico.com

to offer the same protection to In Emerging Markets, bondholders as a company with shakier Fewer Debt Covenants credit. By WAILIN WONG May 19, 2007 For many investors, the concern focuses on emerging-market companies that are With emerging-market governments further down the creditworthiness scale receding from international capital and drawing heavy investor interest for markets, companies in those countries are their deals, which often result in price eagerly stepping up to fill the void. tightening and oversubscription.

Corporate issuance is outpacing that of Alfredo Chang, portfolio manager at GE sovereigns by a rate of 2 to 1, with the Asset Management, said at the EMTA corporate market now at $600 billion, or event that bondholders are appearing to about two-thirds of the U.S. high-yield "take on faith" that they will escape market. Companies in emerging relatively unscathed from negative credit economies are also finding investors eager events. to take on risk in the search for higher yield, as emerging-market sovereign-bond Investors also point out that weak risk premiums are at record-tight levels. regulatory and legal frameworks in developing countries can render With so many investors looking for bigger covenants a moot point. Bondholders returns, emerging-market companies -- could still get squeezed if they don't get like their high-yield counterparts in the treated fairly in local courts. U.S. -- are finding that they don't have to offer as much protection to bondholders in "Covenants don't protect you that much -- the form of covenants. property rights will," said Andrew Feltus, who oversees about $9 billion in global "More and more, as you still see a lot of high-yield debt at Pioneer Global Asset liquidity held by investors, locally and Management, with about $1.5 billion of globally, this high liquidity may be that amount in emerging markets. reflected in looser covenants," said Eduardo Uribe, managing director of Mr. Feltus said he prefers deals that are corporate and governmental ratings at more similar to asset-backed securities. Standard & Poor's in Mexico City. He cited the case of Russian bank Alfa, which has done several bond issuances Covenants on corporate bonds can restrict under a diversified payment-rights a company's capital expenditures and program that securitizes financial flows. In ability to take on additional debt, or March, the bank sold $400 million in require management to maintain a certain bonds under this program. level of free cash flow. These restrictions are traditionally present in bank loans, For Mr. Uribe of S&P, bondholder and a growing number of emerging- protection could also decline in local- market companies are choosing to issue currency deals done in domestic markets, bonds, because they can now raise capital which, in countries such as Mexico, are with more flexible terms. flush with liquidity, as local pension funds become increasingly important players. Looser restrictions aren't necessarily negative, especially because there are a Treasurys Slid growing number of companies in emerging economies that are investment- U.S. Treasurys wilted on Friday, with grade international players and don't need pessimism over the market outlook fueling selling by those who believe yield Eduardo Uribe, managing director of movements are driven by patterns, and corporate and governmental ratings at who then act accordingly. Standard & Poor's in Mexico City.

John Canavan, a bond strategist with Covenants on corporate bonds can restrict Stone & McCarthy Research Associates, a company's capital expenditures and noted that Treasurys began the day ability to take on additional debt, or selling off, and yields, which move require management to maintain a certain inversely to price, eventually found some level of free cash flow. These restrictions equilibrium. But when that cracked, it sent are traditionally present in bank loans, yields moving upward again. "In the near and a growing number of emerging- term, this area should provide a little bit market companies are choosing to issue of bottom-fishing support" that should bonds, because they can now raise capital blunt any further swings, he said. with more flexible terms.

The benchmark 10-year note was down Looser restrictions aren't necessarily 12/32 point at 97 20/32. Its yield rose to negative, especially because there are a 4.804% from 4.756%, as yields move growing number of companies in inversely to prices. The 30-year bond was emerging economies that are investment- down 21/32 point at 96 25/32 to yield grade international players and don't need 4.958%, up from 4.915%.In Emerging to offer the same protection to Markets, bondholders as a company with shakier Fewer Debt Covenants credit. By WAILIN WONG May 19, 2007; Page B4 For many investors, the concern focuses on emerging-market companies that are With emerging-market governments further down the creditworthiness scale receding from international capital and drawing heavy investor interest for markets, companies in those countries are their deals, which often result in price eagerly stepping up to fill the void. tightening and oversubscription.

Mr. Feltus said he prefers deals that are corporate market now at $600 billion, or more similar to asset-backed securities. about two-thirds of the U.S. high-yield He cited the case of Russian bank Alfa, market. Companies in emerging which has done several bond issuances economies are also finding investors eager under a diversified payment-rights to take on risk in the search for higher program that securitizes financial flows. In yield, as emerging-market sovereign-bond March, the bank sold $400 million in risk premiums are at record-tight levels. bonds under this program. With so many investors looking for bigger For Mr. Uribe of S&P, bondholder returns, emerging-market companies -- protection could also decline in local- like their high-yield counterparts in the currency deals done in domestic markets, U.S. -- are finding that they don't have to which, in countries such as Mexico, are offer as much protection to bondholders in flush with liquidity, as local pension funds the form of covenants. become increasingly important players. "More and more, as you still see a lot of Treasurys Slid liquidity held by investors, locally and globally, this high liquidity may be U.S. Treasurys wilted on Friday, with reflected in looser covenants," said pessimism over the market outlook fueling Eduardo Uribe, managing director of selling by those who believe yield corporate and governmental ratings at movements are driven by patterns, and Standard & Poor's in Mexico City. who then act accordingly. Covenants on corporate bonds can restrict John Canavan, a bond strategist with a company's capital expenditures and Stone & McCarthy Research Associates, ability to take on additional debt, or noted that Treasurys began the day require management to maintain a certain selling off, and yields, which move level of free cash flow. These restrictions inversely to price, eventually found some are traditionally present in bank loans, equilibrium. But when that cracked, it sent and a growing number of emerging- yields moving upward again. "In the near market companies are choosing to issue term, this area should provide a little bit bonds, because they can now raise capital of bottom-fishing support" that should with more flexible terms. blunt any further swings, he said. Looser restrictions aren't necessarily The benchmark 10-year note was down negative, especially because there are a 12/32 point at 97 20/32. Its yield growing number of companies in rose to 4.804% from 4.756%, as emerging economies that are investment- yields move inversely to prices. grade international players and don't need The 30-year bond was down 21/32 to offer the same protection to point at 96 25/32 to yield 4.958%, bondholders as a company with shakier up from 4.915%.In Emerging Markets, credit. Fewer Debt Covenants By WAILIN WONG For many investors, the concern focuses May 19, 2007; Page B4 on emerging-market companies that are further down the creditworthiness scale With emerging-market governments and drawing heavy investor interest for receding from international capital their deals, which often result in price markets, companies in those countries are tightening and oversubscription. eagerly stepping up to fill the void. Alfredo Chang, portfolio manager at GE Corporate issuance is outpacing that of Asset Management, said at the EMTA sovereigns by a rate of 2 to 1, with the event that bondholders are appearing to of bottom-fishing support" that should "take on faith" that they will escape blunt any further swings, he said. relatively unscathed from negative credit events. The benchmark 10-year note was down 12/32 point at 97 20/32. Its yield Investors also point out that weak rose to 4.804% from 4.756%, as regulatory and legal frameworks in yields move inversely to prices. developing countries can render The 30-year bond was down 21/32 covenants a moot point. Bondholders point at 96 25/32 to yield 4.958%, could still get squeezed if they don't get up from 4.915%.In Emerging Markets, treated fairly in local courts. Fewer Debt Covenants By WAILIN WONG "Covenants don't protect you that much -- May 19, 2007; Page B4 property rights will," said Andrew Feltus, who oversees about $9 billion in global With emerging-market governments high-yield debt at Pioneer Global Asset receding from international capital Management, with about $1.5 billion of markets, companies in those countries are that amount in emerging markets. eagerly stepping up to fill the void.

Mr. Feltus said he prefers deals that are Corporate issuance is outpacing that of more similar to asset-backed securities. sovereigns by a rate of 2 to 1, with the He cited the case of Russian bank Alfa, corporate market now at $600 billion, or which has done several bond issuances about two-thirds of the U.S. high-yield under a diversified payment-rights market. Companies in emerging program that securitizes financial flows. In economies are also finding investors eager March, the bank sold $400 million in to take on risk in the search for higher bonds under this program. yield, as emerging-market sovereign-bond risk premiums are at record-tight levels. For Mr. Uribe of S&P, bondholder protection could also decline in local- With so many investors looking for bigger currency deals done in domestic markets, returns, emerging-market companies -- which, in countries such as Mexico, are like their high-yield counterparts in the flush with liquidity, as local pension funds U.S. -- are finding that they don't have to become increasingly important players. offer as much protection to bondholders in the form of covenants. Treasurys Slid "More and more, as you still see a lot of U.S. Treasurys wilted on Friday, with liquidity held by investors, locally and pessimism over the market outlook fueling globally, this high liquidity may be selling by those who believe yield reflected in looser covenants," said movements are driven by patterns, and Eduardo Uribe, managing director of who then act accordingly. corporate and governmental ratings at Standard & Poor's in Mexico City. John Canavan, a bond strategist with Stone & McCarthy Research Associates, Covenants on corporate bonds can restrict noted that Treasurys began the day a company's capital expenditures and selling off, and yields, which move ability to take on additional debt, or inversely to price, eventually found some require management to maintain a certain equilibrium. But when that cracked, it sent level of free cash flow. These restrictions yields moving upward again. "In the near are traditionally present in bank loans, term, this area should provide a little bit and a growing number of emerging- market companies are choosing to issue bonds, because they can now raise capital He cited the case of Russian bank Alfa, with more flexible terms. which has done several bond issuances under a diversified payment-rights Looser restrictions aren't necessarily program that securitizes financial flows. In negative, especially because there are a March, the bank sold $400 million in growing number of companies in bonds under this program. emerging economies that are investment- grade international players and don't need For Mr. Uribe of S&P, bondholder to offer the same protection to protection could also decline in local- bondholders as a company with shakier currency deals done in domestic markets, credit. which, in countries such as Mexico, are flush with liquidity, as local pension funds For many investors, the concern focuses become increasingly important players. on emerging-market companies that are further down the creditworthiness scale Treasurys Slid and drawing heavy investor interest for their deals, which often result in price U.S. Treasurys wilted on Friday, with tightening and oversubscription. pessimism over the market outlook fueling selling by those who believe yield Alfredo Chang, portfolio manager at GE movements are driven by patterns, and Asset Management, said at the EMTA who then act accordingly. event that bondholders are appearing to "take on faith" that they will escape John Canavan, a bond strategist with relatively unscathed from negative credit Stone & McCarthy Research Associates, events. noted that Treasurys began the day selling off, and yields, which move Investors also point out that weak inversely to price, eventually found some regulatory and legal frameworks in equilibrium. But when that cracked, it sent developing countries can render yields moving upward again. "In the near covenants a moot point. Bondholders term, this area should provide a little bit could still get squeezed if they don't get of bottom-fishing support" that should treated fairly in local courts. blunt any further swings, he said.

"Covenants don't protect you that much -- The benchmark 10-year note was down property rights will," said Andrew Feltus, 12/32 point at 97 20/32. Its yield who oversees about $9 billion in global rose to 4.804% from 4.756%, as high-yield debt at Pioneer Global Asset yields move inversely to prices. Management, with about $1.5 billion of The 30-year bond was down 21/32 that amount in emerging markets. point at 96 25/32 to yield 4.958%, up from 4.915%.

Mr. Feltus said he prefers deals that are more similar to asset-backed securities.

Business Finance Article Archives

Upfront: Choosing the Equipment Leasing Option by John Cummings

Leasing -- rather than buying -- equipment may conserve capital.

As interest rates inch higher and companies move to conserve their capital, leasing equipment rather than buying it is becoming an increasingly attractive option. In its 2005 State of the Industry Report, the Equipment Leasing Association in Arlington, Va., predicts a healthy 7 percent increase in new business volume for 2006.

IT asset leasing is a fast-growing segment of the market. "Our experience over the years in every type of economic cycle shows that leasing becomes a more popular and attractive option when interest rates escalate," notes John Carcone, senior vice president, financial services, with Forsythe Technology, a Skokie, Ill.-based IT infrastructure and leasing provider. "Even companies with substantial cash reserves discover that there are better ways to use that cash than tying it up in depreciating assets such as IT equipment.

"Leasing provides fixed scheduled payments to simplify expense budgets and provides a hedge against rising interest rates," Carcone adds. "This tactic protects businesses from inflation and allows them to project future cash outlays with greater accuracy."

Qualified leases may also allow payments to be written off for operating expenses, reducing short-term taxable income, according to Forsythe Technology.

Originally printed in the February 2006 issue of Business Finance

Departments - Insight Pros and cons of global outsourcing Charlie Masi 1 December 2006 Control Engineering, 14, Volume 53, Issue 12

Outsourcing, in general, is the strategy of contracting with a third party to add significant value to your standard products. The primary reason companies outsource is the dictum, “Do what you do best, and leave everything else to the rest.” Put more succinctly by one of my management professors, David Bohm: “Stick to your knitting!”

Outsourcing makes it possible to assemble a team of companies, each doing what they do best, that together create the best product at the best price. As technology advances, this team approach becomes increasingly necessary because the mix of skills needed to produce even a simple household appliance (such as, say, a microprocessor controlled dishwasher) exceeds what any one company can assemble—or, more importantly, manage.

Global outsourcing allows high-technology companies to widen the skills available in their teams. For example, semiconductor design is best done in countries with exceptional technical education systems. Fabricating those semiconductors, however, is best done in developing countries where the cost of mass production tends to be low.

A second reason to engage in global outsourcing is to improve customer support programs. U.S. based machine- vision-camera manufacturer Imperx, for example, partnered with a Moscow-based software company to provide technical support for its cameras in Europe and Asia. Moscow’s location near the center of the Eurasian supercontinent meant the new office could handle daytime inquiries from all the relevant time zones simply by extending its business hours. The same geography allows them to rapidly ship hardware throughout the region.

Another important consideration is skill with local languages, laws and customs. The idea that VCRs were impossible to program came not from poorly designed user interfaces, but from poor Japanese-to-English translations of directions. The new stuff is almost intuitive to use, because technology companies now expend so much effort to localize their products.

German electronics manufacturer Kontron’s forte is providing embedded-computer hardware for automakers, appliance manufacturers, and telecommunications providers. The fact that a large fraction of Kontron’s output goes to multinational companies with assembly plants around the world, however, has forced the company to develop serious international distribution expertise.

A North American company that wants to penetrate the overseas markets for, say, police in-vehicle data communications equipment, would be well advised to consult Kontron about telecommunications regulations, customs laws, and so forth in that that country. That expertise might even be a good reason to choose Kontron as a hardware supplier over another company that lacks the international expertise.

Seek experience

Swedish manufacturer SKF, on the other hand, sought IT expertise through outsourcing. “We used to write all of our own software and manage all of our own data systems,” says Jon Stevens, vice president of industrial marketing at SKF USA. “Five to seven years ago we contracted with EDS in Plano, TX [to maintain and expand those systems]. They [are now] globally responsible for all of our information technology infrastructure, software development, and hardware. We’re not in the business-software business. We’re a knowledge engineering company for [technology associated with] bearings, sealing, and lubrication.”

SKF has not, in fact, swapped out any business-critical systems. What they outsourced was maintenance of their existing infrastructure. EDS is responsible for understanding what SKF wants, and doing all the work necessary to meet SKF’s needs and standards.

This points out one of two elements embedded system development consultant Jack Ganssle says any company intending to engage in outsourcing activity must have in place. Those two elements are:

Near-perfect specification documentation, including all deliverables, documents, media, design notes, build scripts, and tool compatibility requirements;

More sophisticated monitoring than when using in-house resources.

Ganssle was talking specifically about embedded-system development projects, but equivalent elements are needed for any ongoing outsourcing relationship. He says the two most dangerous outsourcing pitfalls are: poor oversight, which always creates problems, and sacrificing core competencies.

SKF avoided these pitfalls by being very clear about what they considered their core competencies and hanging on to them, and by being explicit about what they expected their outsourcing partner to be responsible for.

Global outsourcing presents these same pitfalls, but in a more virulent form. Just as home-sourced documentation can be cryptic to foreign users, agreements and contracts with overseas partners can be misinterpreted as well. The danger of sacrificing core competencies is also exacerbated. Intellectual property laws, for example, differ from country to country. In general, it is important to know the laws governing your prospective outsourcing partner.

Finding partners, resources

Your best source of this information is, of course, your oursourcing partner. But that assumes you have already selected an outsourcing partner and developed a relationship of trust. So what do you do to find a partner in the first place?

Assuming that you are a naïve outsourcer—one that is new to outsourcing in general and/or the particular outsourcing situation you envision—your best source of information is many sources of information.

Start with other companies that you deal with who have previous outsourcing experience. For example, if you are already buying embedded computers from Kontron, ask them for advice about your outsourcing needs. Most people with whom you have a business relationship will answer honestly to the best of their ability. They are unlikely to deliberately steer you wrong, but you cover that possibility by asking multiple sources. Through this strategy, you will soon assemble a list of potential candidates along with some information about their competence.

Check with international trade commissions and those representing the prospective partners’ home countries. Country-specific trade commissions are definitely not disinterested sources—their stated objective is to attract business activity to their home countries—but they can identify relevant local laws and procedures. They probably won’t recommend specific outsourcing partners, but likely can provide lists of companies actively seeking U.S. partners.

Finally, there are companies set up specifically to help businesses find and work with overseas partners. Francois Freres ( www.francois-freres.com ), for example, is located in Guangdong province, PRC (People’s Republic of China) and offers services for companies needing to establish a business presence in mainland China. Services vary from localization of your website content to renting manufacturing space.

Outsourcing, in general, is the strategy of contracting with a third party to provide significant value added for your standard products. Global outsourcing can help even the smallest company provide the best product at the lowest price while tapping the fastest developing markets. To be successful, however, you have to do a lot of legwork to find the right partner, then be very, very clear on what you expect them to do.

Charlie Masi is senior editor at Control Engineering. For a list of links to additional outsourcing resources, view this article online at www.controleng.com .

Market Scan Ryanair Soars Thanks To Hedged Fuel Parmy Olson, 02.05.07, 3:50 PM ET

No guesses as to which airline was gazing enviously at Ryanair Holdings's third-quarter results on Monday. Last week, British Airways announced that its third-quarter earnings had plummeted 14% thanks to fuel charges, fog-related delays and the cost of heightened security requirements at London's Heathrow Airport.

Yet none of those problems seem to have made a dent on Ryanair's balance sheet. Europe's largest low-cost airline reported stunning results on Monday: third-quarter earnings had shot up by 30% to 47.7 million euros ($61.8 million), while sales rose 33% to 492.8 million euros ($638.4 million).

Its stock followed suit, rising 5.9%, or $5.25, to $94.99, while shares in British Airways (nyse: BAB - news - people ) fell 2%, or $2.20, to $107.20 in Monday-afternoon trading in New York.

The rising shares also came off the back of an announcement from Ryanair (nasdaq: RYAAY - news - people ) that it was hoping to renew its bid to take over Dublin-based rival Aer Lingus in May, assuming the European Union's competition authorities gave the conditional nod of approval by then.

Aer Lingus shares also rose 5.4% to 2.95 euros ($3.82) on Monday, their highest mark since Ryanair's 2.80 euros ($3.63) a share bid was launched on Oct. 5 last year. (See: "Scrappy Ryanair Targets Aer Lingus.")

Till now bid has looked like something of a lost cause. A loose alliance of Aer Lingus shareholders that hold more than 45% of the airline -- including the government, Aer Lingus pilots and an employee trust -- have vehemently opposed the offer. (See: "Aer Lingus Spurns Ryanair Bid.")

But Ryanair's confident chief executive Michael O'Leary said that even if the Aer Lingus bid did fall flat once again, it would still keep its 25.2% stake in the airline.

And what about the fuel costs that had so dragged on the earnings of British Airways? O'Leary pointed to a string of advance supply contracts that had adeptly locked in prices.

"We took advantage of the recent oil price weakness to extend our hedging position for fiscal 2008," the County Kidare-bred chief executive said. Those fuel-delivery contracts had involved half of Ryanair's needs for the April-September period and 90% for the October-March 2008 period.

Looking ahead, the no-frills carrier brightened its outlook for the fourth quarter, saying it expected net profit to stay flat rather than decline 5% as had originally been expected. It also forecast full-year profit to rise 29% to 390 million euros ($505 million), up from its previous forecast of 16%. http://www.businessweek.com/magazine/content/07_22/b4036057.htm?chan=search

MAY 28, 2007 NEWS & INSIGHTS

Pumping Cash, Not Oil Exxon's risk-averse stock-buyback strategy is the new profit model

With gas prices hitting record highs, Exxon Mobil (XOM) Corp. ought to be drilling like mad and refining more of that black gold, right? As it turns out, the world's largest oil producer thinks it is smarter to use more of its resources to buy back stock. The indirect result: increased pain at the pump for consumers.

It's Big Oil's new formula for making money. Last year, Exxon pumped out $49 billion in operating cash flow on sales of $365 billion. It's the world's most profitable company, but Exxon is plowing a smaller percentage of its spare cash back into the business. Although capital expenditures have risen from $11 billion at the start of the decade to nearly $20 billion, that spending amounts to roughly 40% of cash flow, down from 50% in 2000. Meanwhile, overall production has barely budged since its megamerger in 1999.

Instead, Exxon is bingeing on buybacks to help boost profits, which also benefit from higher commodity prices. Repurchases have been part of Exxon's strategy for decades, but they've exploded in recent years. Exxon spent 60%, or $29 billion, of its cash flow on repurchases in 2006, more than any other company in the Standard & Poor's 500- stock index and a tenfold increase since 2000. The company has retired 16% of shares in the past five years, adding an estimated 88 cents to earnings of $6.68 per share. With Exxon's stock handily beating the market and peers with a 15% annual return over the past decade, others in the oil patch are catching on to the strategy. "They don't need to grow production in order to generate shareholder returns," says energy consultant Richard Gordon.

Exxon takes pride in its fiscal restraint. At a three-hour-long meeting with Wall Street analysts in March, top brass used the word "discipline" no fewer than 29 times. In Exxon parlance, that refers to a sharp focus on returns. It means not chasing marginally profitable oil wells, not pouring money into costly new refineries, and not staffing up aggressively. Exxon employs 82,000 people, 10,000 fewer than in 2002. "Our business model," Chairman and CEO Rex W. Tillerson told analysts, "begins with discipline."

GETTING BURNED That mantra traces back to the early 1980s. Like many oil producers, Exxon tried to diversify during the 1970s boom, pouring billions into unsuccessful forays such as an attempt to produce oil from shale deposits in Colorado and the acquisition of Reliance Electric, an electric motor manufacturer. "We had huge cash flow and not many good investments to put it into," then-CEO Clifford C. Garvin Jr. said at the time, according to The Prize, Daniel H. Yergin's Pulitzer-winning book about the industry.

If anything, it's even more challenging for Exxon to find opportunities today. For one, there are issues with access to oil fields. In April, Venezuela President Hugo Chávez nationalized a number of large oil fields in that country, including Exxon's. Exxon also must compete for hot prospects with government-sponsored oil companies that don't have to worry about pleasing Wall Street. Plus, the really juicy fields are located thousands of feet underwater off the coast of Africa or in remote parts of the former Soviet Union, locales that require years of spadework to start producing. "An investment of any consequence takes a minimum of six years," says Kenneth P. Cohen, Exxon's vice-president for public affairs.

But sometimes it's important to take a little risk. Despite the failed ventures during the 1970s, that boom period also produced world-class fields in the North Sea and Alaska's Prudhoe Bay that appeared speculative at the time but are now critical sources of supply. Exxon seems to be shying away from such risks today. Citing higher-than- anticipated costs, it backed out of a project in February that would have converted natural gas in Qatar into diesel fuel for export. Similarly, Alaskan politicians have been begging oil companies to build a new pipeline to carry natural gas to the 48 continental states. Exxon says it would pursue the project only if the tax situation in the state is favorable. CEO Tillerson has also indicated publicly that he won't build a new refinery in the U.S., pointing to internal research that domestic gasoline consumption will plateau in coming years as ethanol and energy-efficiency measures crimp demand. Indeed, there's plenty of legislation in Congress right now aimed at curbing consumers' appetite for gasoline. So Exxon is partnering with two companies, one Chinese and one Saudi Arabian, to build a $3.5 billion refinery in China, where demand seems more assured.

Currently, Exxon pumps out 4.4 million barrels of oil and natural gas a day, roughly the same as its output seven years ago. The company's production of gasoline, jet fuel, and other refined products is 5.7 million barrels a day, modestly higher than 2000. Exxon says it has added 130,000 barrels of capacity but also divested plants to improve profitability.

Exxon isn't the only big company facing essentially flat output. Oil and gas volumes slid 1% last year at Royal Dutch Shell (RDS ) PLC. After adjusting for recent acquisitions, they were flat at BP (BP ), Chevron (CX ), and ConocoPhillips (COP ). "Companies say, 'There are fewer places we can find big oil,' and there's some truth to that," says Amy Myers Jaffe, who heads the Baker Institute Energy Forum at Rice University in Houston. "Wall Street has to ask itself whether it made sense to create these big oil companies when some smaller, nimbler players are doing better [at finding opportunities]."

Although Exxon has said it will increase oil and gas production from 4.4 million barrels to just under 5 million barrels by 2010, it has a poor record, like other oil majors, of generating such growth. It's also unclear whether it really makes sense from a profit standpoint. After all, Exxon has proved that buybacks enhance earnings nicely. And management doesn't seem to be easing up. In the first quarter, Exxon repurchased $7.8 billion worth of stock.

'RELIEF VALVE' Exxon is not alone. Chevron, which also says it plans to increase production, bought back some $4.5 billion of its stock in 2006, vs. $2.6 billion the prior year. Overall, the industry spent $52.4 billion on buybacks last year, nearly double the amount in 2005. "Exxon has established the path most companies are following," says Arthur L. Smith, chairman of industry researcher John S. Herold Inc. "The profound fear is that prices are going to fall again, and the relief valve is stock buyback."

But as gas soars past $3.10, politicians and others are increasingly scrutinizing the way Big Oil does business. On May 9 a handful of lawmakers held court at an Exxon station near the Capitol to offer their prescription for lower prices. Senator Maria Cantwell (D-Wash.) is promoting an "anti-gouging" bill aimed at oil companies. Senator Bernie Sanders (I-Vt.) wants a windfall tax on outsize profits such as Exxon's and hopes to break up the massive oil companies formed through mergers, which he says have curbed competition.

Still, even Sanders concedes that his proposals are a long shot. "Economists tell us high prices should send the signal for Exxon to invest [in growing production]," says Tyson Slocum, director of the energy program at the consumer group Public Citizen. "But that's not happening. They're transferring that money from the wallets of consumers to shareholders."

breakingviews.com / Financial Insight: Dean Foods' Healthy Binge; Plan to Load Up on Debt Looks Questionable at First But Should Benefit Holders Wall Street Journal. (Eastern edition). New York, N.Y.: Mar 7, 2007. pg. C.14 Abstract (Document Summary) Mr. Prince isn't behaving entirely out of character. While he's taking a risk, it's a calculated one. Buying Japan's third-largest brokerage firm fits in well with Citi's overall strategy. Mr. Prince wants to increase international revenue. Nikko's problems offer the chance to buy a big and potentially valuable asset without paying a fat premium.

If anyone knows the extent of Nikko's problems, it's likely to be Citi. The bank owns just shy of 5% of Nikko and the two have had a Japanese investment-banking joint venture for a number of years. While Nikko's regulatory problems are serious, they center on its private- equity business. There's no evidence the reputational fallout has hit the core brokerage operation.

That, of course, might change if Nikko were delisted. Then clients might defect, crushing the value of the business. That may explain why Nikko's managers are backing Citi's no-premium bid. If Citi can buy Nikko for just over book value and turn it around, it will have done a smart deal. Nikko's principal rivals, Nomura Holdings and Daiwa Securities Group, trade at two times their book values. A Citi deal would give it a platform through Nikko's branch network to expand its retail banking and wealth-management presence in Japan. And it would please regulators, who support the deal. Full Text (671 words) (c) 2007 Dow Jones & Company, Inc. Reproduced with permission of copyright owner. Further reproduction or distribution is prohibited without permission.

One trick that struggling executives of public companies use to keep their jobs is to borrow to the gills. By pulling off what is effectively a pre-emptive leveraged buyout, they repel the private- equity shops that might otherwise swoop in, buy the firm and fire them. So what should one make of the latest corporate debt binge, by dairy titan Dean Foods?

Well, the $6.2 billion company's plan to boost its debt by 60%, to a total $5.3 billion, to fund a $2 billion dividend looks suspect at first. But in this case, Dean's management appears to have holders' best interests in mind.

Granted, the $15-a-share special dividend creates only a little value in itself. But strategically, it makes sense. Dean has been on a buying binge for more than a decade, but it has run out of attractive targets. Now it plans to focus on growth from within. So it may as well deliver part of its future cash flows to investors today, while taking advantage of attractive debt-market rates.

Shareholders like the plan. They've pushed Dean's shares up nearly 4% since the announcement March 2. And after factoring in lower earnings estimates for 2007, due to the company's higher interest expense, Dean's stock still traded at a multiple more than 26 times forecast 2007 earnings per share, giving it one of the food sector's highest ratios.

Compare this with the $2.4 billion debt-financed dividend unveiled by Health Management Associates in January. After the special dividend was unveiled, its shares didn't budge. Investors appear to have concluded the deal didn't help the company address its business problems. Still, the move warded off buyers who might have brought new ideas -- and managers. That sort of defensive move gives these transactions a bad reputation. But Dean's deal shows that, with the right intentions, they can be cash cows for shareholders.

Citi's Calculated Risk

Citigroup Chief Executive Chuck Prince has been accused of being too conservative about acquisitions. But no one could say Citigroup's $11 billion bid for Japanese securities firm Nikko Cordial isn't bold.

It means entering a market where Citi has had big regulatory problems in the past. It was stripped of its private-banking license there a few years ago. And Nikko itself has its share of problems. The Tokyo Stock Exchange is threatening to delist its shares over an accounting scandal.

But Mr. Prince isn't behaving entirely out of character. While he's taking a risk, it's a calculated one. Buying Japan's third-largest brokerage firm fits in well with Citi's overall strategy. Mr. Prince wants to increase international revenue. Nikko's problems offer the chance to buy a big and potentially valuable asset without paying a fat premium.

Of course, the prospect of Citi storming into their backyard may make Japanese banks sit up and take notice. Mizuho Financial Group, for instance, has been sniffing around Nikko. If it or others have any interest, Citi's bid should galvanize them into action.

-- Dwight Cass, Taron Wade and Jonathan Ford

Private Firms Lure C.E.O.'s With Top Pay ANDREW ROSS SORKIN and ERIC DASH. New York Times. Jan 8, 2007.

Robert L. Nardelli's unceremonious departure from This willingness to pay big money may bolster the Home Depot may spell the end of the era of super-size argument of defenders of corporate pay practices who pay packages for chief executives of public companies, have contended that companies have simply been but a new refuge for lavish compensation and private paying the going rate in the market to attract top talent. jets is emerging elsewhere. At the same time, however, private equity may be quicker than a public company to fire an executive if he Flush with hundreds of billions of dollars, private equity is not getting results. firms are beginning to offer compensation on a previously unimaginable scale to the chief executives ''There's also huge risk,'' said Mr. Paulin, whose firm who run the once-public companies that the firms have advised on some of the richest pay packages for bought out. At the privately held firms, the executives executives at a number of big public companies. ''It's the still get salaries and bonuses, but a crucial difference classic pay-for-performance model.'' lies in the ownership positions they can secure, which can turn into particularly bountiful riches when these Of course, the great irony is that private equity businesses are sold or go public again. executives usually get their biggest paydays when a private company is either sold or taken public again. While executives like Mr. Nardelli are being deposed, Then they again find themselves in the public view. other public company chieftains are deciding that they no long want to be judged by their shareholders and Mark P. Frissora is an example of the risk being worth regulators, and are going to work for businesses owned it. Up until last year, Mr. Frissora was the chairman and by private equity. The imperial chief executive is still chief executive of Tenneco, the auto parts manufacturer. very much alive and well in the private realm. He was making only a few million dollars a year at Tenneco when executive recruiters approached him last ''Five or 10 years ago, it used to be that private company year with several job offers. Among them was one to C.E.O.'s wanted to return to the public markets because lead a big public company. they wanted to run their own ship, not have private equity managers second-guessing their decisions,'' said But then he was offered the chief executive's job at Jeffrey A. Sonnenfeld, associate dean of the Yale Hertz, the rental car chain owned by a group of big University School of Management. private equity firms, including Carlyle Group, Clayton, Dubilier & Rice, and an investment arm of Merrill Now, that pattern has reversed. ''You regularly hear Lynch. The public company offers could not compete. public company C.E.O.'s talk about how they can make two or three times the money in what they feel is half Mr. Frissora left Tenneco for Hertz in July and was the effort because they don't have the same degree of granted a $4 million ''make-whole'' cash award and a scrutiny,'' Mr. Sonnenfeld said. guaranteed bonus of almost $1 million for 2006. He also was given millions in stock options and the chance to David Calhoun, a 50-year-old vice chairman at General buy company stock -- both at a very steeply discounted Electric who ran the company's $47 billion aircraft unit, prices -- and a special dividend that would put another left G.E. last year to become chairman and chief $1.2 million in his pocket. executive of privately held VNU, a $4.3 billion media company whose holdings include Nielsen Media Less than six months and an initial public offering later, Research and The Hollywood Reporter. Mr. Frissora is more than $33 million richer on paper, according to an analysis by Brian Foley, an independent Mr. Calhoun, who was a contemporary of Mr. Nardelli's compensation consultant in White Plains. He stands to at General Electric, was offered a compensation make even more money if Hertz's share price goes up. package worth more than $100 million, according to executives involved in negotiating the agreement. VNU, ''It's nice work if you can get it,'' Mr. Foley said. And which up until last year was a public company, is Mr. Frissora is not the only one to reap such riches. controlled by a consortium of private equity firms led by Kohlberg Kravis Roberts & Company. Millard S. Drexler made hundreds of millions of dollars and his reputation as the merchant prince in his 16 years Private equity investors ''think about compensation running the Gap retail chain. Now, four years after the differently. They will spend the money to get the right Texas Pacific Group, a private equity firm, recruited person,'' said George B. Paulin, an executive pay him in to turn around J. Crew, he has made a princely consultant at Frederic W. Cook & Company. They are sum of money: at least $300 million, and growing. ''not under pressure to reform the same way big public companies are,'' he said.

Mr. Drexler took $200,000 in annual salary and ''He will wind up making a lot more money with a lot received no bonus, but he was granted millions of stock less grief in the private equity world,'' Leon Cooperman, options and shares of restricted stock. Those awards are one of Home Depot's largest shareholders, said on now worth $190 million after J. Crew's initial public CNBC about an hour after news of Mr. Nardelli's offering last in June. Over the last three years, the departure. ''I think it will be long time before Bob company also reimbursed Mr. Drexler hundreds of Nardelli gets involved in a public company again.'' thousands of dollars for moving expenses, a personal chauffeur and business use of a personal jet, according Some worry that with executives all rushing to take to public filings. their companies private, the United States is going to become less competitive. Last month, the Committee on Even more lucrative was the chance to invest $10 Capital Markets Regulation published a report, which million of his own money. That investment is now was endorsed by Henry M. Paulson Jr., the Treasury worth at least $120 million today, and has helped him secretary, calling for a lightening of the regulatory solidify a 12 percent ownership stake -- a size virtually burden on public companies. unheard of for a public company chieftain who is not the company's founder. Henry Silverman, who spent the last decade building Cendant into an $18 billion conglomerate -- it owned That kind of money is exacerbating the tension at public dozens of the nation's most prominent businesses like companies, where directors weigh the demands of top Century 21, Avis, Days Inn and Orbitz -- through a officers, who are aware of the riches elsewhere, against number of stock deals, says being public is no longer the demands of shareholders, who expect to see some attractive. He broke up Cendant into four pieces and last gains in return. month sold Realogy, its former real estate unit, to Apollo Management, a private equity firm. ''You have conflicting pressures where people in the private markets are driving up the numbers of ''There is no reason to be a public company anymore,'' compensation at public companies,'' said William W. he said. George, the former Medtronic chairman who serves on the boards of Exxon Mobil and Goldman Sachs. ''You don't need access to the public market,'' because, he said, of the enormous amount of money sloshing It is probably not surprising that some of the best around private equity and hedge funds. examples of imperial chief executives of the recent past -- John F. Welch Jr. of General Electric, Louis V. Like Mr. Nardelli, Mr. Silverman of Cendant had been Gerstner of I.B.M. and Lawrence A. Bossidy of accused of being an imperial chief executive with an Honeywell International -- have all since ventured into outsized pay package. He is estimated to have made private equity after their retirement as advisors. Even $36.6 million in salary and bonus and reaped $223 Mr. Nardelli, who departed abruptly on Wednesday and million from exercising options between 1998 and will exit with a $210 million pay package, has already 2002. And he will make $135 million more as a result received phone calls, e-mail messages and letters from of selling Realogy. the nation's largest private equity firms all seeking his services and dangling the possibility of even more ''Wherever I show up next, it will not be at a public money, according to people in private equity who company,'' Mr. Silverman said. approached him.

http://www.businessweek.com/smallbiz/content/feb2005/sb2005023_1326_sb037.htm?chan=search

FEBRUARY 3, 2005

VIEWPOINT By Gabor Garai Fine-Tuning Stock Incentives Options aren't the only way to motivate staff. Equity can be offered in several ways that, if structured well, benefit all players

If you're the founder of a growth-oriented company with venture-capital financing on the horizon, you probably plan to establish a stock-option program. If so, you may have to adjust those plans.

All the debate and discussion -- and the eventual move last year by the accounting profession to make stock options count as an expense against profits -- is percolating down to early-stage startups. Suddenly, options aren't the obvious choice for employers wanting to use company equity as a way to attract top-flight talent.

ALLOCATION TUSSLE. The diminished status of stock options is, at first glance, unfortunate for today's fast-growing companies. Venture investors have been comfortable with stock-option programs as a cash- free way to create incentives, with the added bonus that options have been free of any financial accounting penalty.

Coming up with new incentives that venture capitalists accept is no simple task. An inherent tension exists between entrepreneurs and venture capitalists over the allocation of equity. While both sides invariably say they want the founders and management team to have enough equity to keep everyone motivated, the amount each side considers "enough" usually differs. Not surprisingly, entrepreneurs want to see more equity staying with founders and management than do the venture capitalists.

When entrepreneurs put together stock-option programs, they typically set aside 10% to 20% of the business' equity for options, available to key employees on a vesting schedule usually ranging from three to five years. These options have been set aside in addition to founders' stock.

WIN-WIN DISTRIBUTION. Now, as the professionals like to say, a level playing field has been created between options and other types of equity. This actually offers an opportunity to establish a flexible and balanced portfolio of equity offerings -- a menu of different types of equity vehicles that provide the right combination of incentives to key employees in various demographic groups, career paths, and performance objectives.

If properly structured, these equity incentives result in a "win-win" situation: Providing more meaningful performance impetus and higher value to recipients, while minimizing the percentage of equity committed to employee stock incentives.

This new suite of equity incentives includes the following components:

1. Restricted stock These shares are handed out on a basis that's the reverse of stock options. A key person receives an agreed number of shares and under a vesting schedule that requires the return to the company of a certain

percentage of the shares if the employee leaves early. For example, if the stock vests over four years, the individual might have to return all the shares for leaving before year one and three-fourths for leaving before year two.

Restricted stock can also be issued for free or for full value, for meeting performance objectives, or in a matrix of time-based and performance-based systems. One big advantage of restricted stock is that it often qualifies for capital-gains treatment, while options can incur higher ordinary income tax rates on gains that occur from the time they're awarded to when they're exercised.

2. Phantom stock These "synthetic equity" awards range from simple cash bonuses tied to increases in an outfit's equity valuation to comprehensive programs linked to various performance objectives and subject to the same vesting schedules as options and restricted stock. From an employer's perspective, the awards don't dilute "true" equity, while still giving employees an equity-like incentive.

3. Stock options Yes, stock options. The fact that other equity approaches are gaining popularity doesn't mean that stock options are completely out of fashion. They remain the best-understood model for entrepreneurs and venture capitalists. Because of the new financial penalties they incur, though, they can be expected to hold dwindling prominence -- and account for a smaller percentage of equity-incentive programs.

If properly structured, a blend of equity and synthetic-equity incentives can reduce the overall percentage of the business' stock reserved for key employees from the 15%-to-20% range customary for stock-option plans to approximately 10% to 15% of total capitalization. This is equally attractive to founders and venture capitalists.

The emergence of these more comprehensive equity packages will likely force entrepreneurs to set up and improve their systems and methods for awarding equity. These can be based on the importance of particular management positions, when an individual joins the team, and the background/experience of team members. Venture capitalists usually welcome improved systems.

Garai is a partner in the Boston office of national law firm Foley & Lardner, specializing in venture capital and private equity Edited by Rod Kurtz

Northwest CEO's Pay Deal Irks Pilots; Chief to Get $26.6 Million In Restricted Stock, Options Following Bankruptcy Exit Susan Carey. Wall Street Journal. (Eastern edition). New York, N.Y.: May 7, 2007. pg. A.3 Abstract (Document Summary) The pilots union condemned Mr. [Doug Steenland]'s package. The CEO "grossly overreached and missed another opportunity to share the gain with the employees whose excessive concessions funded the airline's turnaround," said Capt. Dave Stevens, chairman of the Northwest branch of the Air Line Pilots Association.

According to the carrier's April 30 proxy statement, Mr. Steenland last year received compensation of $2.66 million, including a base salary of $516,384 and $994,146 in cash-incentive awards. Northwest said the new management equity plan aims to help the airline recruit and keep management talent, ensure that executive compensation is linked to the company's financial performance and compensate the CEO at a "reasonable" level for his responsibilities.

Doug Steenland, Northwest Airlines Corp.'s chief executive, is to receive $26.6 million of restricted stock and options in the recapitalized company once it steps out of bankruptcy-court protection next month, according to documents filed Friday with the court.

The awards, which vest over four years, would give Mr. Steenland 9% of the 13.6 million new shares that will be granted to the airline's top 400 managers, who as a group will hold 4.9% of the equity of the company. Four existing executive vice presidents each are in line to receive equity grants valued at $10 million to $13.5 million, Northwest said.

The pilots union condemned Mr. Steenland's package. The CEO "grossly overreached and missed another opportunity to share the gain with the employees whose excessive concessions funded the airline's turnaround," said Capt. Dave Stevens, chairman of the Northwest branch of the Air Line Pilots Association.

The value of these awards is based on the projected price of new Northwest shares at emergence from Chapter 11. This suggests that nation's fifth-largest airline by traffic will have 277.5 million new shares valued at about $27 a share when they start trading, giving the enterprise an overall value of more than $7 billion.

The majority of the new shares will be assigned to unsecured creditors, including employees. It is expected, based on current claims trading, that they will recoup 65 cents to 75 cents on the dollar for their claims. Most unionized workers and the nonexecutive salaried employees are expected to gain a total of $1.6 billion in contributions in proceeds from sales of stock, profit sharing and other incentives through 2010, the company said.

Northwest, based in Eagan, Minn., filed for Chapter 11 in September 2005. It is the last of the big airlines that sought protection from creditors to emerge from reorganization following an unprecedented industry downturn precipitated by the 2001 terrorist attacks. Like the others, Northwest struck new, cheaper labor agreements, renegotiated its leases and shed debt. Unlike some of the others, it retained its employee pension plans.

Northwest said the 4.9% equity grant to its officers is lower than the packages awarded to management in the postbankruptcy plans of UAL Corp.'s United Airlines and US Airways Group Inc. Subject to creditor approval of Northwest's reorganization plan, a confirmation hearing is scheduled for May 16, and the airline could emerge in early June.

From “The Wall Street Journal”, April 9, 2007

Reducing Rewards Facing greater disclosure, boards are cutting back on CEO extras from chauffeur service to deferred compensation

By JOANN S. LUBLIN April 9, 2007; Page R3

Golden goodies for America's highest bosses are starting to lose their luster. A growing number of corporate boards no longer treat chief executives like monarchs -- largely because their royal rewards lack justification. Boards are trimming or dropping everything from perquisites to severance pay, deferred compensation and supplemental pension plans.

The moves come amid toughened pay-disclosure rules and directors' increased risk of shareholder lawsuits and election challenges. The Securities and Exchange Commission adopted sweeping regulations last year that widen what companies must reveal about executive compensation -- and for the first time require the full board to approve and be legally responsible for the proxy statement's report on pay practices.

"Some of the recent changes in CEOs' perks and overall compensation levels are clearly driven by the changed disclosure rules," says David Yoffie, a Harvard Business School professor on the board compensation committees at Intel Corp. and Charles Schwab Corp.

Such "pay practices are now being discussed by the entire board to an unprecedented degree," says Charles Elson, a HealthSouth Corp. and AutoZone Inc. director who runs the Weinberg Center for Corporate Governance at the University of Delaware business school.

Boards' hottest target? Perquisites. On top of their salaries, bonuses, stock options and restricted shares, most chiefs enjoy a stunning array of benefits. These often include free financial planning, home-security systems and chauffeur- driven cars. The perks frequently cost a company relatively little, but draw considerable criticism as symbols of irrational largess.

Fear Factor

Under the new disclosure rules, proxy statements must list executive perks valued at $10,000 or more apiece. The old rules limited disclosure to perks valued above $50,000. With their reputations on the line, directors fear being embarrassed by the enlarged list.

FEWER GOODIES

A sample of companies that have recently cut or curbed the following perks for the top boss • Financial Counseling: Fannie Mae, Lockheed Martin Corp., Exelon Corp.*, Sunoco Inc., Fortune Brands Inc.

• Club Membership Dues: Fannie Mae, Toro Co., Exxon Mobil Corp., Lockheed Martin, Exelon, Fortune Brands, Florida Rock Industries Inc., Gannett Co.*, Sunoco

• Personal Use of Corporate Aircraft: General Mills Inc., Wendy's International Inc.

• "Gross Up" Payments to Cover Executives' Tax Bite on Certain Benefits: E*Trade Financial Corp., Fannie Mae, AT&T Inc., Sunoco, Sara Lee Corp., First Horizon National Corp., Avaya Inc.

• Company Car: Exelon*, Fortune Brands, Florida Rock Industries, Sunoco, Wendy's International

*Effective in 2008 Source: Regulatory filings or company announcements

Twenty-eight businesses cut or curbed at least one CEO perquisite in 2006, concludes a proxy analysis of 350 major U.S. corporations by Mercer Human Resource Consulting for The Wall Street Journal. Among them: personal use of corporate aircraft, club membership fees, and "gross up" payments to cover officers' tax bills for other compensation. Washington Mutual Inc., one of the 28 companies, said CEO Kerry K. Killinger had just one perquisite last year -- personal usage of corporate aircraft -- and began reimbursing his employer for such use at the start of this year.

Some companies acknowledge the expanded proxy requirements played a role in their killing certain perks. "We certainly had our eye on the new disclosure rules," says John Daniel, an executive vice president at First Horizon National Corp. In December, the Memphis, Tenn., bank holding company stopped reimbursing executives for taxes paid on benefits such as a car allowance, disability-insurance premiums and personal use of corporate aircraft.

First Horizon's board pay panel primarily halted the reimbursements because they no longer were seen as good governance, according to Mr. Daniel. When a business covers a senior official's taxes, "the perception is that the executive is getting something special," he says.

Dissident investors occasionally claim credit for pared perks. Applebee's International Inc. is struggling with depressed earnings and a proxy fight by hedge-fund activist Richard Breeden. His Greenwich, Conn., investment firm, Breeden Partners LP, holds about 5.4% of Applebee's shares. In a January letter to the chairman of the Applebee's compensation committee, Mr. Breeden lambasted what he suggested were extensive flights on corporate planes by former Applebee's CEO Lloyd Hill. The company's planes had flown 29 times since last April in and out of Galveston, Texas, where Mr. Hill "happens to own a beach house," the letter said.

Mr. Hill has remained board chairman since he left the corner office last September. Laurie Ellison, an Applebee's spokeswoman, says she doesn't know how many of those 29 flights Mr. Hill was on.

Shareholder interests aren't served "by turning corporate aircraft into flying limousines for senior executives' personal vacations," the Breeden letter argued. Mr. Breeden, a former SEC chairman, thinks his attack persuaded Applebee's directors to ban senior officers' personal use of the company's sole remaining plane, effective March 1. (It recently sold its other plane.) The rides will occur only "in the case of a medical emergency or other extreme hardships," the Overland Park, Kan., restaurant chain states in its latest proxy. The board updated the policy to reflect "best business and governance standards," Ms. Ellison says.

A handful of chiefs are encouraging the perks retreat, undoubtedly "because they're worried about internal optics as lavish benefits can demoralize a work force," says G. Steven Harris, a Mercer senior executive-compensation consultant. Sunoco Inc.'s John G. Drosdick asked the Philadelphia refiner and gasoline retailer to cease tax gross-ups for his personal use of corporate aircraft, the current proxy says. He also abandoned his company-provided car, financial counseling and country-club dues. In addition, he decided to pay Sunoco upfront for the full annual cost of his company parking space and home-security monitoring system.

Mr. Drosdick can well afford the extra tab. Perks accounted for $77,855 of his total 2006 compensation, which Sunoco valued at about $23 million. "The proxy statement speaks for itself," says spokesman Jerry Davis.

'Good Year'

Similarly, Exelon Corp.'s plan to drop most executive perquisites next January was strongly supported by Chief Executive John W. Rowe, says Gary Snodgrass, chief human-resources officer for the Chicago electric utility. And Mr. Rowe rejected the $50,000 he is entitled to under the company's plan to give officials one-time transition payments to cover their canceled company cars, financial planning and club memberships, because "he felt it was unnecessary," Mr. Snodgrass says. "John had a pretty good year last year." Mr. Rowe's 2006 compensation totaled $16.4 million, a regulatory filing reported.

Not all CEOs simply lose out when they lose perks. Norman H. Wesley, the longtime chief of Fortune Brands Inc., received $87,826 in perks last year -- a small piece of his $10.8 million total compensation. The Deerfield, Ill., consumer-products giant abolished some of those perks -- his allowance for a car, financial planning and country-club membership -- last month. In return, the company bumped up his salary $14,000, to $1.25 million. The idea was to simplify compensation "and keep everyone whole in the process," says company spokesman Clarkson Hine.

Perquisite reductions "get rid of this nickel-and-dime stuff," says Charles Haggerty, a retired leader of Western Digital Corp., who's mulling similar moves at four other companies where he chairs the pay panel. But "in the grander scheme of things," he adds, "perks aren't a big item."

Harder to Let Go

The more-valuable goodies -- such as severance pay, deferred compensation and supplemental pensions -- are disappearing more slowly, even though the new proxy rules highlight their stupendous size. Jerry A. Grundhofer, chairman of U.S. Bancorp and CEO until his December retirement, amassed $111.4 million in deferred compensation and pension benefits, for instance. Teri Charest, a U.S. Bancorp spokeswoman, says Mr. Grundhofer can now collect his years of accumulated benefits, but she declines to say whether he does.

Among these big-ticket items, huge severance deals have come under the sharpest attacks. At least a dozen big businesses recently shrank or ended senior officers' promised severance. Abbott Laboratories CEO Miles D. White and two top lieutenants terminated agreements that would have rewarded them handsomely after a takeover of the Abbott Park, Ill., drug and medical-device maker. More than $25 million of Mr. White's stock options and restricted shares would have vested if Abbott had changed hands last Dec. 31, the latest proxy reports. He would have been eligible for three years' salary and bonus, too. Mr. White believes a change-in-control accord isn't necessary, says company spokeswoman Melissa D. Brotz.

Sumner Redstone, executive chairman of Viacom Inc. and CBS Corp. in New York, is among the few business titans to relinquish deferred compensation. He and fellow directors revised his pay packages so they're more closely tied to shareholder returns, according to both companies.

Mr. Redstone previously collected $1.3 million a year in deferred compensation from Viacom and CBS -- plus two salaries. He changed his mind partly because Philippe Dauman spurned deferred compensation when he took the helm of Viacom last September, Viacom spokesman Carl Folta says.

Mr. Redstone, the media conglomerate's chief before it split early last year, also swapped his $9.4 million of deferred compensation for Viacom options and lowered his $1.75 million salary to $1 million at both companies. CBS recently agreed to settle a shareholder suit filed against Viacom before the split that alleged directors breached their fiduciary duty by approving nearly $160 million in compensation for Mr. Redstone and two other executives after a year in which Viacom's share price fell nearly 20%.

Still Not Happy

Several other employers are curtailing their chief's potential payout from a supplemental executive retirement pension, or SERP. Such pensions can be very expensive because they usually reflect compensation earned during the last years of an individual's career.

Wendy's International Inc. will roughly halve its annual SERP contributions for officers this year following a review launched by CEO Kerrii Anderson while she was finance chief, recalls Jeffrey M. Cava, an executive vice president at the Dublin, Ohio, fast-food chain. "Times had changed," he says.

Such steps, however, fail to mollify disgruntled investors. They say too many chief executives still reap sizable compensation despite poor performance. They vow to step up their activism by seeking lifetime limits on equity grants, eradication of employment contracts -- and board seats.

Businesses with the worst investor returns typically "have not made any attempt to link performance and compensation and are substantially overgenerous," says Mr. Breeden, the Applebee's dissident. He finds board members only "get religion about executive pay when somebody runs against them."

Write to Joann S. Lublin at [email protected]

http://www.businessweek.com/magazine/content/07_03/b4017001.htm

JANUARY 15, 2007 COVER STORY Out At Home Depot Behind the flameout of controversial CEO Bob Nardelli

In the end it came down to the headstrong other points of contention: a sluggish stock price CEO's refusal to accept even a symbolic in an otherwise rising market and Nardelli's reduction in his stock package. Home Depot notoriously imperious manner. Judged solely by Inc.'s (HD ) board of directors wanted their certain company financial measures, Nardelli, controversial chief executive, Robert L. Nardelli, 58, should have enjoyed acclaim for to amend his whopping compensation deals for transforming Home Depot from a faltering retail recent years. After he pulled down $38.1 million chain into an earnings juggernaut. Driven by a from his last yearly contract, angry investors housing and home improvement boom, sales were promising an ugly fight at the company's soared from $46 billion in 2000, the year Nardelli annual meeting in May. Nardelli agreed that he took over, to $81.5 billion in 2005, an average would continue to receive a guaranteed $3 annual growth rate of 12%. Profits more than million bonus each year, but not more. When doubled, to $5.8 billion that year. board members asked him to more closely tie his future stock awards to shareholder gains, he TUMULTUOUS TENURE refused, according to people familiar with the During the current housing slowdown, however, matter. Nardelli has complained for years that the financials have eroded. In the third quarter of share price is the one measure of company 2006, same-store sales at Home Depot's 2,127 performance that he can't control. After weeks of retail stores declined 5.1%. And with the stock secret negotiations, things came to a head at a price recently stuck at just over 40, roughly the board meeting on Jan. 2, leading to Home same as when Nardelli arrived six years ago, he Depot's stunning announcement the next day could no longer rely on other sterile metrics to that the company and Nardelli had "mutually assuage the quivering anger his arrogance agreed" that he would resign. provoked within every one of his key constituencies: employees, customers, and "The board loved him and hates the way this shareholders. Nardelli's "numbers were quite ended up," says a person familiar with the good," says Matthew J. Fassler, an analyst at matter. But in a season of growing antipathy Goldman Sachs Group Inc. (GS ) But "the fact is toward extravagantly paid executives, the that this retail organization never really directors felt they had no choice. On his way out embraced his leadership style." The CEO's the door, however, Nardelli negotiated another reputation also suffered because of Wall Street's jaw-dropper: a $210 million retirement package affection for Home Depot's smaller archrival, that assures that he and his former employer will Lowe's Companies (LOW ), whose stock price remain at the center of the swirling debate over has soared more than 200% since 2000, while CEO compensation. Nardelli declined to Home Depot's shares declined 6%, according to comment. Bloomberg data. A simmering options The sudden fall of one of America's best-known backdating investigation at Home Depot hasn't CEOs illustrates how perilous times have helped matters either, though an internal become for corporate leaders. Pointing to company review has thus far exonerated gargantuan pay and widespread manipulation of Nardelli. stock options, institutional shareholders are calling for top executives and board members to At another time, Nardelli's impressive operating be held accountable. At Home Depot there were numbers might have saved him. Perhaps he

38 would have learned to temper an ego nurtured America's most talented executives, and Home during a long career at General Electric Co. (GE Depot seemed to have scored a big victory by ). But in a prolonged season of hostility toward snaring him. Almost immediately, he embarked overweening CEOs, the former GE power on an aggressive plan to centralize control of the systems phenom couldn't hold on. "He's not a nation's second-largest retailer after Wal-Mart very humble guy. He seems to have enormous Stores Inc. (WMT ). He invested more than energy but needs to be front and center, and $1billion in new technology, such as self- that can wear on the board and the employees checkout aisles and inventory management after a while," says Edward E. Lawler, director of systems that generated reams of data. He the Center for Effective Organizations at the declared that he wanted to measure virtually University of Southern California's Marshall everything that happened at the company and School of Business. hold executives strictly accountable for meeting their numbers. All this was new at a relatively Before the final fallout over pay, the half-hour laid-back organization known for the that defined Nardelli's tumultuous tenure began independence of its store managers and the at 9 a.m. on Thursday, May 28. That was the folksy, entrepreneurial style of retired co- time set for the giant home-improvement founders Bernard Marcus and Arthur M. Blank. retailer's 2006 annual meeting in a Wilmington One of Nardelli's favorite sayings is: "Facts are (Del.) ballroom. The assembled shareholders--a friendly." He seemed less concerned about sparse crowd of longtime stockholders, people being friendly. Some saw this as a employees, and union representatives-- strength. "This guy is maniacal about goals, expected the usual corporate routine: a objectivity, accomplishments within the presentation on the state of Home Depot's $81.5 boundaries of the values of the company," billion business, a vote on an assortment of Kenneth G. Langone, the third co-founder of shareholder proposals, and plenty of time for Home Depot, a member of its board of directors, questions aimed at Nardelli and the other 10 and a strong Nardelli ally, said in a 2004 members of Home Depot's board. interview.

But something strange soon became apparent: But among many of Home Depot's 355,000 The board wasn't there. Citing time constraints employees, especially rank-and-file workers in and the imperative of working on important its orange big-box stores, there was little matters back home at Atlanta headquarters, the sympathy as Nardelli dug himself into a deeper eminent overseers of Home Depot failed to and deeper hole. They resented the show up at their own event. That left Nardelli to replacement of many thousands of full-time handle the meeting on his own. He did that in an store workers with legions of part-timers, one abrupt 30 minutes. Shareholders were limited to aspect of a relentless cost-cutting program just one question each. A digital clock timed Nardelli used to drive gross margins from 30% in them: One minute, then the microphone cut off. 2000 to 33.8% in 2005. As the news of his resignation on Jan. 3 shot through Home Nardelli spent much of last spring offering half- Depot's white-walled Atlanta headquarters and hearted mea culpas for the board's disappearing reached stores, some employees text-messaged act. "We tried a new format. It didn't work," he each other with happy faces and exclamation said. But then, as the months unfolded, it points. "I think that it is being received well. Most became clear he had a problem on his hands people believed that Bob was autocratic and that he couldn't just summarily dismiss. A stubborn," says an assistant manager in an chagrined board signaled that it planned to Atlanta store who asked not to be named. reduce his 2006 pay package, setting the stage for the ultimate Jan. 2 showdown on the stock Possibly more devastating to his chances of a plan. longer reign at Home Depot, Nardelli alienated customers just as thoroughly as he did "MANIACAL" employees. Staffing cuts led to persistent Nardelli arrived at Home Depot after losing out complaints that there weren't enough workers in in 2000 in a three-way race to succeed GE's Home Depot's cavernous stores to help do-it- legendary Jack Welch. Despite that setback, yourself customers. That was a marked change Nardelli was anointed one of Corporate from the era when Blank and Marcus, who 39 started the company in 1978, preached that Balter says Nardelli didn't get along well with employees should "make love to the customer." Wall Street because he was unhappy with In 2005, Home Depot slipped to last among analysts' skepticism of the move away from major U.S. retailers in the University of consumer retailing and into servicing Michigan's annual American Consumer professional contractors. "He blamed a lot of his Satisfaction Index. To try to make amends, problems on Wall Street," says Balter. "But Wall Nardelli announced a plan in August to add 5.5 Street wanted to see results, and they just million man-hours back to stores and invest weren't there." $350 million to spruce up aging outlets. "Bob Nardelli is a smart man, but he doesn't need to The lack of results, at least in terms of an be in a high-profile business like retail," says a improving stock price, gradually stirred anger former top Home Depot executive. "He needs to among shareholders. Speculation mounted late be in manufacturing, a business that does not last year that Home Depot could be a prime have such consumer attention." target for private equity firms hungry for retail assets. While the company spent $20.3 billion to Indeed, Nardelli's data-driven, in-your-face buy back shares and issue dividends under management style grated on many seasoned Nardelli, investors saw almost no gains in their executives, resulting in massive turnover in share value. Their frustration was exacerbated Home Depot's upper ranks. Former chief by Nardelli's eye-popping pay package: more marketing officer John H. Costello, a retailing than $200 million in salary, bonuses, stock veteran from Sears Holding Corp. (SHLD ), quit options, restricted stock, and other perks over in late 2005, and Carl C. Liebert III, the the last six years. executive vice-president who oversaw store operations, resigned last October. "He would Last month, activist investor Relational Investors say that you're just not leadership material, sharply criticized Home Depot management and you're just not Home Depot material, you're just called on the board to form a special committee not the type of person we need," says a former to review the company's direction and even the senior executive. Managers who weren't hitting possibility of a sale. Relational attributed Home their numbers--"making plan" in Home Depot Depot's difficulties to "deficient strategy, parlance--were routinely culled, their posts often operations, capital allocation, and governance." filled with former executives from GE. That led After the announcement of Nardelli's leaving, a some bitter insiders to dub the company "Home source familiar with Relational called the GEpot." In fact, since 2001, 98% of Home departure "a positive" but added that "the major Depot's top 170 executives are new to their strategy, capital, and management issues positions; 56% of the changes involved bringing remain. Fresh new blood remains an objective." new managers in from outside the company. It wasn't only activist investors like Relational Nardelli's relationship with Wall Street analysts who had grown tired of Nardelli's leadership. He was often just as frayed. He chafed at their irritated Atlanta locals, too. In a Nov. 25 letter to constant focus on "same-store sales," a Nardelli, reviewed by BusinessWeek, A. Leigh standard retail measurement that tracks sales at Baier, an Atlanta attorney and Home Depot stores open at least a year. In Nardelli's view, shareholder, requested that the company's same-store sales was an out-of-date metric board include a "non-binding" resolution in because Home Depot was diversifying away Home Depot's proxy statement allowing from being strictly a retail operation. Under his shareholders to vote on whether "they are in leadership, the company has invested more than favor, or opposed to, the board of directors of $7.6 billion to build Home Depot Supply, which Home Depot terminating your contract." provides services to professional contractors. Explaining his now-moot proposal, Baier says, With $3.5 billion in revenue in the third quarter of "You can't s--t on your employees and deliver" 2006, up 159%, HDS accounted for 15% of total results. Home Depot sales. In Nardelli's view, this successful new arm can't be accurately Others remain outraged, even with Nardelli measured on the basis of same-store sales. gone. A group of unions whose pension funds own shares in Home Depot plans to challenge Credit Suisse First Boston (CS ) analyst Gary his $210 million payout at the annual meeting in 40

May. Meanwhile, in Washington, Representative Nardelli departure was already brightening the Barney Frank (D-Mass.), the incoming chairman mood at some company stores. "It's amazing the of the House Financial Services Committee, said reaction of people on my floor. People are in a statement on Jan. 3: "The actions of Home openly ecstatic. High-fiving," said an Atlanta Depot's Board of Directors to simultaneously store operations manager only hours after the dismiss Robert Nardelli and provide him with Jan. 3 announcement. "There's a group talking $210 million in severance is further confirmation about going to happy hour at noon." of the need to deal with the pattern of CEO pay that appears to be out of control." Corporate America hasn't seen the last of Bob Nardelli, however. According to people familiar It's unlikely Home Depot's new chief executive, with the situation, while store workers were Frank Blake, will change the Nardelli-driven celebrating, the former CEO was already fielding demand for data and centralized control. A calls from private equity firms interested in his former Deputy Energy Secretary and GE formidable operational talents. The bright side veteran, Blake played a key role in executing for Nardelli in the world of privately owned Nardelli's strategy at the retail chain. But corporations, of course, is that he won't have to company executives say he lacks Nardelli's deal with any annual meetings or shareholder sharp edges and prefers to build consensus questions. rather than dictate orders. While Blake is an unknown to many Home Depot employees, the

Bearing Down: Probes of Backdating Move to Faster Track; Stock-Option Emails At Broadcom Are Focus; Monster Worldwide Plea James Bandler and Charles Forelle. Wall Street Journal. Feb 16, 2007 Abstract (Document Summary) Mr. [William J. Ruehle] stepped down as Broadcom's chief financial officer a few days before he was to be interviewed by outside lawyers doing the internal investigation. Broadcom said in a securities filing that Mr. Ruehle was "at the center" of backdating. Mr. Ruehle's lawyer, Richard Marmaro, said that if his client is charged, he "will not plead guilty because he did not commit any crime."

Broadcom said in its federal filing that co-founder Mr. [Henry Samueli] was "involved with" the "flawed option granting process." The company cleared him, saying he "reasonably relied on management and other professionals" regarding proper treatment of the options. According to people familiar with the matter, Mr. Samueli, as a member of the Equity Award Committee, received a number of emails that discussed retroactive date selection.

Several emails written by Ms. [Nancy Tullos] suggest she may have been aware the dating practices were troublesome. In a period when Broadcom's stock was falling, a business-unit head repeatedly asked her when his subordinates would get options. Eventually, she told him "I cannot tell you what we are doing" in a "post-Enron" world, according to people familiar with the matter. In a message to another employee asking about options, she wrote, "I cannot answer in writing."

Prosecutors in a half-dozen jurisdictions are zeroing in on On Jan. 4, 2002, the chief financial officer of Broadcom other cases. The filing of criminal charges in some of these in Corp. tapped out an email about stock options to his chief coming months would mark a watershed in the scandal, as executive and others. prosecutors and regulators winnow the roster of some 140 "I VERY strongly recommend that these options be priced companies with options problems to a tighter list of as of December 24," he wrote. promising cases.

They were, and that was fortunate for recipients. The government is nearing charges against a former official Broadcom's share price rose 23% between the two dates. of computer-security company McAfee Inc., say people The pretense that the options had been granted on the familiar with the situation, and is earlier date made them extra valuable. strongly considering bringing cases against ex- executives of Apple Inc. It also violated the rationale of stock options. They give and semiconductor-equipment recipients a right to buy stock in the future at the price maker KLA-Tencor Corp. In St. when the options are granted, so that recipients can profit Louis, at least one former executive only if the price of their company's stock goes up. Setting a of Engineered Support Systems Inc., lower "exercise price" for the options gives recipients a a defense contractor now owned by head start on profiting. DRS Technologies Inc. of Parsippany, N.J., has been told of a The Broadcom correspondence, found in an internal likely charge, says a person close to investigation at the maker of communication chips, is just the matter. one of a number internal documents that have drawn the attention of federal prosecutors and Federal Bureau of The former Monster Worldwide general counsel who pleaded Investigation agents in Orange County, Calif. Prosecutors guilty yesterday is Myron Olesnyckyj, 45. He admitted that are strongly considering filing criminal charges against the he and others conspired to systematically backdate stock former Broadcom chief financial officer who wrote the options, inflate the company's earnings and mislead auditors. email, William J. Ruehle, and at least one other former Separately, the Securities and Exchange Commission filed a executive, according to people familiar with the situation. civil complaint against him. Mr. Olesnyckyj agreed to forfeit $381,000 in personal gains. He faces sentencing in August. Mr. Ruehle's lawyer said his client didn't break the law. Mr. Olesnyckyj, fired last year, is expected to cooperate with The Broadcom probe is a sign of how long-running prosecutors investigating Monster founder Andrew investigations of stock-options backdating are heating up. McKelvey. Mr. McKelvey, who hasn't been charged, quit late Yesterday, a former general counsel of Monster last year rather than be interviewed in an internal company Worldwide Inc. pleaded guilty to securities fraud in federal probe of options. A lawyer for him declined to comment. court in Manhattan. The day before, the founder of Take- Two Interactive Software Inc. pleaded guilty to a New In a 1999 email cited by the government, Mr. Olesnyckyj York State charge in a backdating scheme. wrote to a human-resources official: "No written document should ever state lowest price over next 30 days! The 42 auditorw [sic] will view that as backdating options and Last year Broadcom admitted rampant backdating. It restated we'll have a charge to earning in the amount of the several years of results, taking $2.24 billion in charges difference between price on day 30 and any lower price against earnings -- the biggest restatement so far in the which is used." scandal.

That's the type of evidence investigators are looking for -- Mr. Ruehle stepped down as Broadcom's chief financial "plus factors" that can give a case officer a few days before he was to be interviewed by outside more promise of success. Such lawyers doing the internal investigation. Broadcom said in a factors might include written securities filing that Mr. Ruehle was "at the center" of indications of deliberate backdating. Mr. Ruehle's lawyer, Richard Marmaro, said that backdating; falsified documents; if his client is charged, he "will not plead guilty because he efforts to hide manipulation from did not commit any crime." auditors or investigators; or indications that top executives gave Broadcom in its filing also blamed a former human-resources themselves backdated options. chief, Nancy Tullos. It said she "encouraged, assisted in and With so many companies admitting enabled" the backdating. A lawyer for Ms. Tullos, who left in to an improper options practice, 2003, declined to comment for this article. The lawyer has investigators have an abundance of said previously that Ms. Tullos followed the directives of possible cases. superiors, didn't select any grant dates and always acted in the company's best interests. Broadcom illustrates some of the elements investigators are focusing on as they set their priorities. The Irvine, Broadcom's backdating, which it has said occurred from Calif., company is one of the biggest companies in the 1998 to 2003, took place amid a gyrating stock price and a options spotlight. It makes chips that help power all sorts heated technology industry in which valued employees were of communications devices and has a stock-market value often poached by others with big options packages. of more than $19 billion. The SEC in addition to the Broadcom emails, described by people who have seen them, Justice Department is looking at Broadcom. suggest that executives sometimes deliberately gave grants earlier dates and sometimes cautioned others not to mention Also being investigated are Henry Nicholas -- the former the dating process in writing. chief executive to whom the CFO's email was addressed -- and Henry Samueli, Broadcom's chairman. Messrs. Broadcom's auditor, Ernst & Young, raised concerns in 2000 Nicholas and Samueli co-founded Broadcom. The two about an aspect of the options process and reminded made up the committee that handed out options Broadcom executives about the rules, say people familiar with the has admitted were backdated. matter. At that time, options granted at the current stock price didn't affect companies' earnings. But a grant at below- Mr. Nicholas said in a statement his focus was on running market prices was considered compensation, so that Broadcom, and "the minutiae of employee paper-work and companies had to count it as an expense. documentation were not at the top of my list." Mr. Samueli's attorney declined to comment except to say that In 2000 Broadcom made a giant options grant to a large some of the Journal's information was "misleading." number of employees, purportedly on a day in May when the stock had its lowest close for the quarter. Ernst discovered Mr. Nicholas founded the company in 1991 with help from that the company hadn't finished divvying up the grant Mr. Samueli, his former engineering professor. After they among employees until months later. Accounting rules say an took it public in 1998, its stock soared 20-fold in two option isn't recorded as granted until recipients are years. Together the men sold more than $1 billion in determined. Broadcom shares near the end of the tech boom. Each still holds about $1 billion of Broadcom stock. Ernst warned company officials, including Mr. Ruehle, not to make such "subsequent allocations" again, according to A domineering figure, Mr. Nicholas routinely scheduled people familiar with the matter. Ernst reminded executives of late-night staff meetings and boasted of working for days how options should be accounted for, taking them through without sleep. At a yearly sales conference, he quizzed the rules. subordinates about chip designs, forcing those who erred to gulp down shots of hard liquor. He stepped down from his Like many stocks, Broadcom's sank after the Sept. 11, 2001, CEO post in 2003. Along the way, he settled into a 15,000- terrorist attacks. It hit its lowest price in three years on Oct. 1, square-foot mansion, which he outfitted with a billionaire's before recovering and then more than doubling by year-end. toys: waterfalls, secret tunnels into the hills, a sports bar. Broadcom claimed to have granted a slew of options to non- officers on Oct. 1. Investigators are looking at whether the Mr. Samueli cuts a less flamboyant figure. A leading company may actually have made this grant later and philanthropist in Orange County, he also owns the Mighty backdated it, say people familiar with the situation. Ducks hockey franchise. Two University of California engineering schools bear his name. 43

Broadcom said in its federal filing that co-founder Mr. themselves. The two received just one grant, for a million Nicholas was "at times" involved in the backdating, and options each, in 2002. Broadcom has said no grants to the bore a large responsibility for the problems because of "the founders or to directors were among those misdated. tone and style of doing business he set." A person familiar with the grant dated Oct. 1 said it engendered jealousy Ms. Tullos and Mr. Ruehle, by contrast, received numerous among those who didn't get options then, and that Mr. options, including grants the company has said were Nicholas and others appear to have retroactively added manipulated. Mr. Ruehle had $32 million of unexercised more people to the list. options when he left last year. The company canceled them. Last year the company canceled $4 million of options Ms. In an email on Jan. 2, 2002, Mr. Nicholas sent a list of Tullos held. employees included in the Oct. 1 grant to at least two people, including Several emails written Ms. Tullos, say by Ms. Tullos suggest people familiar she may have been with the email's aware the dating contents. "I practices were found my old troublesome. In a share grant period when spreadsheet from Broadcom's stock was before October," falling, a business-unit he wrote. head repeatedly asked her when his But the subordinates would get electronic time options. Eventually, stamp on the she told him "I cannot computer file tell you what we are indicated the doing" in a "post- spreadsheet had Enron" world, been created according to people toward the end of familiar with the 2001, long after Oct. 1, say people familiar with the matter. matter. In a message to another employee asking about The discrepancy has led investigators to examine whether options, she wrote, "I cannot answer in writing." the email and spreadsheet might be an attempt to provide written cover for manipulated grants. Prosecutors would need more than suggestive emails to make a successful criminal case. A document that seems like a Broadcom said in its federal filing that co-founder Mr. smoking gun can grow cold when the context is explained to Samueli was "involved with" the "flawed option granting a jury by an experienced defense lawyer. process." The company cleared him, saying he "reasonably relied on management and other professionals" regarding Another obstacle for the government in prosecuting proper treatment of the options. According to people backdating is at some companies the practice was discussed familiar with the matter, Mr. Samueli, as a member of the openly, making it harder to argue that executives knew they Equity Award Committee, received a number of emails were engaged in wrongful conduct. that discussed retroactive date selection. Defense lawyers will doubtless pass blame around. Those Mr. Samueli cooperated with the internal probe but so far representing CEOs are likely to argue that their clients -- has declined a request to speak to government investigators being business leaders, not accountants -- relied on others to -- unusual for a sitting chairman. When weighing how figure out how options should be issued and accounted for. much responsibility corporations themselves bear for Those representing subordinates are likely to argue that the fraudulent conduct, prosecutors are supposed to consider boss made them do it. how cooperative top officials have been, according to Helping boost momentum toward the filing of charges is the Justice Department guidelines. statute of limitations. It's five years for securities fraud and wire fraud. But there's some flexibility, based on the notion An outside lawyer for Broadcom said it wouldn't comment that misdated options might affect earnings in later years. on the investigation except to say that it was cooperating --- fully. "Dr. Samueli did cooperate fully and voluntarily with Paul Davies contributed to this article. the company's independent internal investigation," said the lawyer, David Siegel.

In any effort to link backdating to Messrs. Nicholas and Samueli, prosecutors would face a potential hurdle: The co-founders didn't regularly receive option grants 44