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High-Tech After Chapter 11

By Brad Hill E-Commerce Times ECT News Network
Mar 25, 2003 10:31 AM PT

Bankruptcy is the most forgiving of all U.S. business regulations. While the word 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.

High-Tech After Chapter 11

Does that mean all of those companies went under? Many of them did liquidate. But Chapter 11 of the bankruptcy code is specifically geared toward extending and reorganizing a company's resources, not dispersing them. How can 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 tell different parts of the story.

Chapter 7 is generally the path chosen by companies that intend to liquidate their 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 in a complicated case, its physical and technical assets divided among various predatory 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 road can 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 in Chapter 11. Eliminating, or at least attenuating, the debt load can put a company on new footing.

Andrew Bartels, research leader at Giga Information Group, told the E-Commerce Times that WorldCom presents a laboratory case of a debt-easing bankruptcy in the tech sector. "The elimination of the debt burden and the financing cost associated with that is a big plus. It can allow a company to be 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 and judgments 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 to Chapter 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 and management," Nicholas Maynard, senior analyst at the Yankee Group, told the E-Commerce Times. "You've got to ask, is [their emergence] just a temporary phenomenon leading to Chapter 7?"

Required changes, of course, vary by company. Eliminating certain portions 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's Bartels 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. Small companies do not necessarily plan several years down the line, and they probably do 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&D budget might be to find new ways of servicing customers. "It's not what we think of first 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 through bankruptcy," Bartels noted. "They fear it might return to bankruptcy and wonder if they can count on it as a supplier."

He added that companies with locked-in customers fare better in this scenario. "WorldCom has customers locked into long-term contracts. That type of client immobility is an advantage over smaller companies with fewer captive 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 and the 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 a company emerging with its brand intact, its customers on board and its profitability 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 call to new ways of doing business. Maynard put it succinctly: "If it's not a reality check, the company is in real trouble."

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