STRATEGY

Surviving the New Economy

He soared, he crashed, he merged. Then his new parent went bankrupt. Should he buy his company back?
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It was the fall of 1999, and Sunny Vanderbeck was on top of the world. Just three years earlier, he had founded his first company, a Web-hosting outfit called Data Return. Now, here he was in the Manhattan offices of Bear Stearns watching shares of his company trade for the first time on the Nasdaq stock exchange. By the time the market closed that day, the stock was at $16, up 25%, and Data Return had raised some $90 million. A night of celebration was in order, but Vanderbeck had other plans: He flew home to Irving, Texas, and went to sleep.

Before the Internet bubble burst, says COO Todd Steitle, "We got a glimpse of what it's like to be a celebrity."

As it happened, it would be his last chance to rest for some time. Data Return shares soared to $92, only to plummet to pennies less than two years later. His company close to ruin, Vanderbeck agreed to merge with another firm, only to see the new parent go bankrupt. That left Vanderbeck with a tough choice: Should he try to purchase the company he founded and take it private? He had poured everything he had into Data Return and was convinced he had a winner. But could he rescue his company from the wreckage of the New Economy?

A precocious computer whiz who graduated from high school at 16, Vanderbeck dreamed up Data Return while in Microsoft's support services division, where he began working after a four-year stint in an Army special operations unit. Vanderbeck, then 24, realized that companies eager to hop on the e-commerce bandwagon would need someone to build and manage their websites.

Scores of entrepreneurs, of course, had the same idea. But from the outset, Data Return did things differently. Rather than plowing millions of dollars into costly data centers (the physical space where servers and hardware are located), Data Return leased space and equipment from partners like telecom networking outfit Level 3 Communications and outsourced other tasks to contractors. "They built a more efficient, more cost-effective business model," says Bill Dering, vice president of investment bank Pharus Advisors, who used to cover Data Return's stock.

Dering wasn't the only one who was impressed. As the company's stock price soared, Data Return became the subject of articles in national newspapers and magazines. These were heady days. At one company party, employees were pulling up in Porsches and Ferraris and even flying in on helicopters. "We got a glimpse of what it's like to be a celebrity," says chief operating officer Todd Steitle.

Then the tech bubble burst, and survival, not stardom, became the order of the day. Vanderbeck dismissed about 300 employees, closed the St. Louis data center, and scrambled for options. With the Nasdaq plunging, raising more financing wasn't promising. That left selling or merging. Divine Inc., a Chicago-based Internet conglomerate, came forward with an attractive proposition. The company, which had purchased some 50 smaller tech firms, had a skilled, 800-person sales force--just what Vanderbeck felt he needed to jump-start his business. What's more, Divine's offer, a 33% premium on Data Return's share price of about 70¢, seemed like the best deal for shareholders. The all-stock transaction, valued at about $33 million, closed on January 9, 2002. Data Return was merged into Divine's managed services unit and Vanderbeck was named president.

Vanderbeck and Steitle immediately got to work. They launched a major streamlining effort that cut $5 million in annual costs. Jobs were slashed, top contributors were promoted, and business units consolidated. That helped speed up the decision-making process and increased productivity. Revenues reached $60 million, and the business became cash-flow positive.

Unfortunately, Divine wasn't as healthy. The bloated company repeatedly pushed back its profitability projections. Vanderbeck began planning his resignation. But then, on February 25, 2003, Divine filed for bankruptcy protection. Data Return, like the rest of the conglomerate's assets, would be auctioned to the highest bidder. And a stunned Vanderbeck was left to plot his next move. Should he find new investors and attempt to buy the company back? Informally align with another bidder? Or throw in the towel and do something else?

The Decision

Vanderbeck considered walking away. But he decided to wait and see how the auction played out. Who knew? Maybe a white knight would emerge to save Data Return. He and his team also considered raising money to bid for the company themselves, but after consulting an attorney, decided against it. If he lost the bid, he figured, he'd probably be out of a job. If he won, competing bidders could claim that the management team was hostile during the due diligence period and that the auction was invalid. That likely would have sparked a drawn-out legal battle, which would have been a disaster for Data Return.

Besides, Data Return was an attractive property, and a number of interested parties came calling. Vanderbeck decided to hear them out. While two potential bidders just wanted to grab Data Return's customers, there were two others who really seemed to believe in Vanderbeck and his team. If one of them succeeded at auction, there was a good chance that the company would survive--without a legal mess. The chemistry was particularly good with one suitor, New York City investment firm Saratoga Partners. "You know when your team is clicking with someone," says Vanderbeck.

In May, Saratoga paid $28 million for Divine's managed services unit. It renamed the entity Data Return, and installed Vanderbeck as chief executive officer, with a significant minority stake in the new business. All told, more than 100 members of the original Data Return team remain, along with most of its longtime customers. Just as in the old days, Vanderbeck now spends his time running the 210-person company, meeting with his new partners about once a month. So far, the relationship is working. "They understand the business," says Vanderbeck.

Would he ever go public again? It's always an option. But for now, Vanderbeck is happy being private. "It's a rough time to be a public company," he says, referring not only to the uncertain stock market but also to the Sarbanes-Oxley Act. The law, which was passed in July 2002, has made disclosure requirements for publicly traded companies more stringent than ever. That has led a record number of public companies to "go private." In the 12 months since the act was passed, 114 companies have submitted "going private" filings to the SEC, a 16% jump from the same period a year earlier, according to FactSet Mergerstat.

Does Vanderbeck miss the New Economy thrill ride--the sports cars, the media attention, the parties? Not particularly, he says. "When you run a company, you're working for someone else...your investors, your customers, or your employees. Being a CEO is about results," he says, "not ego."

The Experts Weigh In

Yakov Amihud, New York University

Professor of finance entrepreneurship and innovation

Vanderbeck made the right move by not bidding for Data Return himself. Let's say he raised money for the buyback from an investment firm with the understanding that he'd receive an equity stake in the business. The added competition in the auction would have raised the selling price--which would have been good for Divine's creditors, but not for Vanderbeck. If he won, he'd be paying more for the company. If Saratoga won and agreed to give him a stake, the inflated price would cut into that equity. So it's a good idea to align with an existing bidder.

David Marcus, Netrox, a Miami-based Internet service provider

Founder and chairman

I sold my ISP business to a big public company in 2000 but stayed on as CEO. It hit the skids that year, and creditors were trying to push it into bankruptcy. The company was going to shut us down until I proved that it would actually be cheaper to pay me to take the company back, since negotiating out of our existing telecom contracts would have been costly. If I were Vanderbeck, I would have tried to raise the money myself because loss of control is hard for entrepreneurs to deal with. But it sounds like he has the best of both worlds: a good amount of control with very little financial risk. There's also a lot to be said for having a financial partner that's also a mentor.

Andrew J. Weidhaas, Goodwin Procter, a New York city-based Law firm

Partner

Data Return has certainly teamed with an excellent private equity shop with a great reputation. That said, Saratoga could have easily lost at the auction, so it's always advisable for management to talk to as many potential acquirers as possible to make sure they still have jobs after the deal closes. In this case, it worked out. Now, Vanderbeck can go back to his roots after being enmeshed in a company that was having a lot of problems. Private equity firms often give management more flexibility than a corporate owner. Getting that feeling of control back is important, particularly for an entrepreneur who started the company and managed it through so many ups and downs.

Last updated: Oct 1, 2003




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