E-BUSINESS SPECIAL REPORT

High-Tech After Chapter 11

Bankruptcy is the most forgiving of all U.S. business regulations. While theword may conjure abject failure when applied to individuals, bankruptcy in the corporate world is regarded almost as part of the operational handbook. More than 190 public companies filed for bankruptcy in 2002 — down from the previous year’s 257, but representing far greater assets (US$378.8 billion vs. $258.5 billion in 2001), according to BankruptcyData.com.

Does that mean all of those companies went under? Many of them did liquidate. But Chapter 11 of the bankruptcy code is specifically geared towardextending and reorganizing a company’s resources, not dispersing them. Howcan high-tech best make use of Chapter 11? Which types of businesses are likely to succeed or fail in such a reorganization attempt?

The Chapters

Like a tragic novel, bankruptcy law is divided by chapters that telldifferent parts of the story.

Chapter 7 is generally the path chosen by companies that intend to liquidatetheir assets and go out of business. It does not always work out that way, though.Napster, the beaten-down file-sharing company, slogged through Chapter 7 ina complicated case, its physical and technical assets divided among variouspredatory parties. The Napster brand and some of the company’s original management are now owned by media software company Roxio, which intends to relaunch the service this fall.

Chapter 11 is geared toward continued operation — but, again, twists in the roadcan lead to different results. Plenty of companies bomb out of Chapter 11 after a brief attempt to jump-start their business. In some cases, they reenter bankruptcy through what is caustically termed Chapter 22.

The Causes

Overwhelming debt is the traditional reason why a company may seek refuge inChapter 11. Eliminating, or at least attenuating, the debt load can put acompany on new footing.

Andrew Bartels, research leader at Giga Information Group, told theE-Commerce Times that WorldCom presents a laboratory case of a debt-easingbankruptcy in the tech sector. “The elimination of the debt burden and thefinancing cost associated with that is a big plus. It can allow a company tobe more aggressive in its pricing,” he said.

Companies also may dive into bankruptcy as a defense maneuver against sudden, overwhelming and temporary legal liabilities. Final settlements andjudgments are often set to punish a company without killing it, but the legal costs of reaching that point could be financially impossible. “This type of bankruptcy is generally less damaging than when a company resorts toChapter 11 because of liquidity problems,” Bartels noted.

A third bankruptcy justification involves reducing labor problems,especially for companies with highly unionized employee bases. Bartels said that United Airlines is one company that used Chapter 11 to lower its labor costs.

Sorting Priorities

The overwhelming imperative of most bankruptcies is simple: Change.

“Many times, companies come back out with [the] same business model andmanagement,” Nicholas Maynard, senior analyst at the Yankee Group, toldthe E-Commerce Times. “You’ve got to ask, is [their emergence] just atemporary phenomenon leading to Chapter 7?”

Required changes, of course, vary by company. Eliminating certainportions of the business is a drastic approach; reorganizing operations without cutting departments is a gentler one. When liquidity is the primary bankruptcy issue,reducing costs should be on the agenda.

“One of the focal points must be to cut the right kinds of costs,” Giga’sBartels said. “Sales and service must be maintained. At the same time, you want to maintain investment in R&D to create the next generation of products.”

The R&D solution varies, too, depending in part on the company’s size. Smallcompanies do not necessarily plan several years down the line, and they probablydo not own valuable, half-developed products sitting on the shelf. In such cases, according to the Yankee Group’s Maynard, the best deployment of a new R&Dbudget might be to find new ways of servicing customers. “It’s not what we think offirst in research and development, but it’s just as important,” he observed.

Keeping Customers

It is important to remember that a company’s customers and suppliers are likely to be just as rattled by Chapter 11 as the bankrupt company. This is where communication and public relations can play a role.

“There is an impact on customers of a company having gone throughbankruptcy,” Bartels noted. “They fear it might return to bankruptcyand wonder if they can count on it as a supplier.”

He added that companies with locked-in customers fare better inthis scenario. “WorldCom has customers locked into long-term contracts. Thattype of client immobility is an advantage over smaller companies with fewercaptive customers.” For this reason, he said, service-oriented companies can use Chapter 11 more effectively than more product-oriented hardware and software companies.

Keeping customers in place also requires both a convincing new business plan andthe communications skill to convey it persuasively. “Clearly articulating direction is absolutely necessary — not just as PR, but as an operational issue,” the Yankee Group’s Maynard said. “Whatever you have left must be a cohesive company.”

Odds of Success

Chapter 11 may offer a second chance, but what are the chances of acompany emerging with its brand intact, its customers on board and itsprofitability curve on the rise?

“More commonly, you see an acquisition or an outright failure,” Bartels said. “Instances of successful emergence are relatively few today. WorldCom is obviously a major focal point.”

Above all, companies working through Chapter 11 must heed the wake-up callto new ways of doing business. Maynard put it succinctly: “If it’snot a reality check, the company is in real trouble.”

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