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The e-gang rules - But should you trust them with your money?

Friday 7th April 2000

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There's no reason to think that the situation in New Zealand is any different. Using Gardner's logic, only one of our e-gang - companies like Advantage, E-Force, E-Phone, Ihug, IT Capital, Strathmore and Spectrum - is likely to be a good investment at current share prices. In fact, given that we have fewer than 10 Internet stocks on our market, it's possible they may all plummet, if not actually crash. In the best scenario, only a handful will survive. The question is, do we have a New Zealand Amazon lurking?

The answer is, you never know, but, right now, it doesn't look like it.

For a start, our present listed Internet companies break many of the rules of wise Internet investing - albeit pretty untried rules.

Think big, say the experts. Think Amazon, AOL, Cisco. When Morgan Stanley examined the 1200-plus US initial public offerings (IPOs) since 1980, it found that just 5% of the companies have created 86% of the wealth. "The winners in the end," says America's most influential Internet analyst, Morgan Stanley's Mary Meeker, "will be the companies that have the most customers." New Zealand's Internet companies are small in local terms, minuscule globally.

Think dominance, say the experts. Advantage, for example, has a good chunk of our Web development scene, though it would be hard to argue that many of our e-gang have dominant positions in the local market, let alone internationally.

Think strong, captive technology - that killer application or patented technology that everyone, or at least everyone in a big market needs, and only you have got. Virtual Spectator, part of the IT Capital stable, is one such piece of technology, though, so far, very much in a niche market: yachting. There are others, but most of the e-gang don't have a killer app, so far, at least. Even when you have it, experts say, the hard part is maintaining a competitive advantage. Technology is moving so fast that attempts to patent products are largely useless so companies must constantly chase new and upgraded products.

Think market size. "If the concept works, you want the company to be able to get huge," says broker Merrill Lynch in its Internet investment philosophy. Some New Zealand analysts argue that our size means there are never going to be many local Internet opportunities with enough scale to make significant money. Doing well globally requires either huge resources or captive technology.

Think access to capital, either through a strong share price or cash in the bank. IT Capital and Strath-more, both venture capital-type companies, have excess cash. Others have share prices reflecting the benefit of the boom, though New Zealand companies are not running at the sort of multiples attainable overseas. Mind you, most are debt free, a sign, says Ord Minnett research analyst Arthur Lim, that our companies will survive. "Personally, I'm a lot more optimistic about New Zealand's listed Internet companies than I am about offshore companies. I argue they have a more sustainable business model."

Accessing capital may not be our problem.

The really big unknown, the criteria that may be the one difference between success and failure of our e-gang, is great leadership. It's the most difficult to assess, but the most important, according to Jim Clark, the founder of three different billion-dollar companies, including Internet browser, Netscape. "The only thing I invest in is people," Clark told the Trade Development Board's IT investment forum in Auckland in February. "If you have the people sorted then I think you will probably be all right."

DF Mainland's research head, Bruce McKay, reckons New Zealand's listed Internet stocks are all headed by strong bosses, giving the companies a good chance of survival. Certainly New Zealand's e-gang, the leaders of our listed stocks - people like Advantage chairman Evan Christian, Ihug managing director Nick Wood, IT Capital managing director Keith Phillips, Strathmore executive chairman Phil Norman, Internet investor Eric Watson, Spectrum boss John O'Hara and others - have energy, entrepreneurial flair, deal-making skills and the desire to do well. Some may also pass the Merrill Lynch leadership test: "Strong, deep management teams that are motivated by more than increasing their net worth - if Bill Gates just wanted the money, he probably would have stopped about $US75 billion ago."

Fact is, the mushy stuff of leadership is hardest to judge and requires the test of time. Meanwhile, we've asked the experts for advice on what makes a great Internet or other high-tech company leader (see page 40). And we examine the track record of New Zealand's e-gang. Whether the gang is made of the right stuff, well, you be the judge.

Eric Watson,
entrepreneur and investor

Ambitious, driven, dynamic, able to make quick decisions, cut advantageous deals, Watson is described by some of his underlings as the "puppeteer" behind many of the Net stocks. His actual stakes in listed companies Advantage and Strathmore are well hidden. Last month he transferred his Advantage stake into ePac, about to be renamed Qixel, a combined investment vehicle with Advantage directors Evan Christian and Nick Gordon. Qixel owns 46% of Advantage, or 22.7 million shares, making their combined stake worth $107 million. Watson's share is around $30 million. He owns Strathmore shares through Cullen Investments, with about a 10% stake, and through his holding in Advantage (just under 20% of Strathmore). Watson came in at Number 11 on National Business Review's 1999 Rich List with a net wealth of $110 million in July 1999, but since then, Advantage's share price has risen from $2.50 to $4.70 and Strathmore has leapt from just over $0.06 to nearer $0.40, as Unlimited went to press. He has a reputation for being canny. "He has a wonderful feel for the market and what the market wants," muses one analyst, "and he takes full advantage of the trends before other people." A mixture of good judgement and luck means the share price of virtually everything he has touched has gone through the roof.

He comes, however, with a warning. Past actions indicate Watson's modus operandi is to leverage the deals for Watson first, Watson second and Watson third. On the other hand, Securities Commission insider trading allegations into plays such as the takeover by Blue Star of McCollum Printers have produced nothing more than tough censuring.

Also, his reputation is such he can now rely on followers pushing up the value of his investment, allowing him to sell enough of the original investment to cover his original costs.

He's been successful in the retail market, though Watson isn't a techno-head and his e-commerce potential is unproven. But he's a great networker, with the ability to do deals on the hoof, say associates, leaving loose ends to be tied up by his team. "The key to his success," according to Independent Business Weekly "is his ability to pick the best people for the job, provide the capital and let them get on with it."

Keith Phillips
IT Capital

Phillips is considered by investment writer Brian Gaynor to be the best of the bunch, albeit in his view a mediocre bunch. He says Phillips has a proven track record in the IT sector and, with Terabyte and Virtual Spectator, has two genuine companies with reasonable prospects under his wing. Phillips' past jobs include managing director of Apple Computers in the UK, marketing director of Apple in the US and international marketing manager for Gillette. In New Zealand, Phillips co-founded, built and then sold to INL (at a good profit), Web development company Terabyte. "He's more of a thoroughbred than some of the others," Gaynor says.

There is strong pressure on management of investment companies like Advantage and Strathmore to have the skill to pick the right ventures and, more importantly, to get the right management team for those ventures, says Peter Cohan, author of US book Net Profit. "Contrary to popular belief, great technology alone does not make a successful new venture. A successful venture depends on finding or creating a great management team that has demonstrated its ability to build a large new business ... The venture capitalists who can put together winning teams will be the ones who earn the highest returns."

Is that Phillips? Past employees say Phillips' strengths include doing deals and picking good people, though they rate him less highly in terms of nuts and bolts running businesses.

"At Telecom he was thought of as a bit odd. But that's because he was racing on ahead while the rest of us were too focused on the day-to-day mechanics. I rate him a good entrepreneur," says one former co-worker.

Certainly, he has done well in bringing investment funds on board at IT Capital - New Zealand funds Armstrong Jones and Spicers Portfolio Management own stakes. Overseas, Canadian banking group CIBC is pushing IT Capital in Australia and US venture capitalists Don Caldwell and Jay Snider have each invested between $3 million and $4 million, plus have sidelined future capital and are on IT Capital's board.

"If anyone can deliver value in the New Zealand Internet sector it's [IT Capital]," says Spicers investment director George Kerr, though the company recently sold down its shareholding as the price soared.

Phillips has been successful at rebuilding the credibility of IT Capital, after the failures of its predecessor, Vietnam investment company Iddison. None of the Seton brothers, founders of Iddison, remain on the IT Capital board, though John Robertson is still chairman.

Evan Christian,
Advantage Group chairman

Christian is seen as a protégé of Eric Watson and cut from the same cloth. He is young (if 35 can be considered young in the e-commerce sector), passionate, personable and approachable. Not thought of as a nuts and bolts manager, he's a deal-maker, and is listed in Companies Office records as being a past or present director of 88 companies.

Staff report liking him; he's the sort of person who might drink with employees till four in the morning. In a business dominated by young people way outside the corporate mould - Advantage subsidiary ADV E-Commerce recently hired 20 new staff with an average age of 22 - Christian is seen as good for the company's culture. "Christian is an enabler," says Drew Gilpen, sales and marketing manager of ADV E-Commerce. "He's great at creating the environment and the confidence for us to do the business."

People management skills are important for Advantage. Selling Eftpos terminals, while producing steady profits, is no longer a growth area. And its PEC Retail software for petrol stations, potentially worth more than the rest of the business, Christian says, is still an unknown quantity in terms of its revenue-producing capabilities - as is newly acquired Aldridge Punter. For now, Web development is its main growth area. Advantage's 125-strong Web development team is a dominant player in the market, though loss-making and, like any brains-based business, potentially susceptible to being cleaned out by bigger salary offerings. Gilpen reckons the culture is an important part of making sure staff stay.

One part of Christian's business past might cause investors to pause for thought. He was one of the directors of now defunct investment bank Case Weston Morgan and was key in the formation of transport company Transport Investments Limited. Confronted with legal threats, Christian last year paid out around $600,000 to buy shares from just over 15 disgruntled TIL shareholders. The investors alleged breaches of the Securities Act and directors' fiduciary duties, according to the Independent. Christian says there were no regulatory breaches, but he repaid investors' original premium, plus 20% - about 75 cents in the dollar of what they expected to get back - against the advice of his lawyer, because he believed he shouldn't have sought money from "mums and dads". The other 40 TIL investors are left with shares worth a third what they paid. Christian says he was personally out of pocket to the tune of $400,000 in the transaction.

Under Christian's chairmanship, Advantage has also been the subject of five NZSE market surveillance panel "please explain" enquiries relating to sharp rises in the share price. Christian says the stock exchange doesn't understand that volatility in tech stocks is normal.

Phil Norman,
executive chairman of e-commerce investment company, Strathmore Group

Responsible for bringing Microsoft into the country in the late 1970s, Phil Norman has 25 years of industry knowledge. He was a founding partner in technology advisory firm Foresight Partners and, before then, worked for e-commerce trail-blazers like Paxus Corporation (now CSC) and Microsoft (New Zealand). More recently, he helped develop and roll-out Telecom's Internet site, Xtra. Successes include his role in establishing Internet software developer Glazier Systems (now part of Advantage Group). His worst judgement call was off-loading the Microsoft agency when selling down his turnkey solution and packaged software development company to Paxus in the late 1970s.

Norman's vision for Strathmore? To build a successful e-commerce "incubator" company and create wealth for investors. "It's our job to see these companies realise a significant uplift in these valuations by helping them migrate into offshore markets." So far, Strathmore has made six investments, the most significant being a 37% shareholding in Auckland telephony company CommSoft Group, and the most recent, a 30% stake, worth $1.2 million, in US Web software start-up Inspar. Norman and Strathmore, which was only set up in November 1999, have attracted scepticism so far, including from stockwatcher Brian Gaynor, a Strathmore shareholder. "Brokers are claiming that the proven expertise of Phil Norman is one of the company's major assets," Gaynor said in the Business Herald. "Long-term shareholders will remember that brokers originally promoted [Strathmore] Group's [now failed] bloodstock activities because of the board's expertise - and its [also unsuccessful] investment company activities because of the expertise of Chase and Omnicorp ... In the long run it will be a pleasant surprise if the group's IT activities are anymore successful than its earlier adventures."

Others, though, are excited by the company's technology and prospects, including a probable Australian listing for CommSoft in the next couple of months. Ord Minnett's Arthur Lim compares CommSoft with New Zealand stellar performer Telemedia, which has increased in value by 600% since listing on the ASX. Shareholder Eric Watson made the same link at a Strathmore meeting late last year, for perhaps less altruistic reasons, and Telemedia boss Chris Jones is said to bridle somewhat at the comparison. Strathmore's record is unproven, Lim says, but the fact that Norman and fellow directors - including former Southpac CEO Don Cowrie - have been able to get CommSoft to a position where it is ready to list in Australia, is a good sign. "Based on what I have seen, they have shown they have expertise first, to identify investments and second, hand in hand with the owners of the companies, to take them one step further to realising their potential. A few [of Strathmore's investments] will go bad, because you inevitably can't get it all right, but all have unique features that potentially could allow the companies, plus Strathmore, to tap into blue sky potential."

Allan Morton, chief executive of Software Images, a business associate, says Norman's integrity means when the e-commerce bubble finally pops, Strathmore will come out in better shape than those operators thriving on hype alone.

John O'Hara,
head of re-incarnated mining company, Spectrum Resources

O'Hara, described as "techno-savvy" by a former colleague, has a computing background dating back to an OE in the 1970s and experience in software development. However, his early career was in marketing, including six years promoting kiwifruit under Don Brash, then head of the Kiwifruit Authority. He was an inaugural director of IT Capital, and, through that company, a founding chairman of Exo-net.

"I'm good at developing high-growth strategies, particularly licensing arrangements and joint-venture companies. In negotiating, I have a good empathy with the other side and usually spend a lot of time understanding their position and issues before proposing a solution."

O'Hara is risk averse, but says his biggest failure was a missed opportunity. "As Voyager's founding general manager [in New Zealand] I was unable to convince major shareholders that flat-rate pricing models represented a golden opportunity to be a strong number-two Internet player." (Oh, and there was that blank signed payroll cheque sent out on an account that had a $12 million float, when O'Hara worked for an Australian bureau in the 1970s. Exactly whose fault? O'Hara won't elaborate.)

Spectrum was a sad case as a mining company and is still very much untested in the e-commerce world. O'Hara began Spectrum's e-commerce make-over with the $2 million acquisition of WEL Technology, a Hamilton-based software developer that he ran until recently - but has made no moves since. O'Hara's vision of "focusing on business to business vertical software companies" sounds somewhat ... unfocused. But Exo-net founder Maurice Bryham believes O'Hara potentially has what it takes to make his company a success: "His innovative approach, and experience at managing rapid-growth organisations are hallmarks of a good e-commerce operator."

O'Hara also deserves respect for pioneering New Zealand's software export industry, says former colleague, Brent Smith, general manager of E-Phone. "Embracing and fully understanding the technology aspects is almost a given. What differentiates people like O'Hara is their ability to share the vision with all stakeholders."

Nick Wood,
founder of Internet service provider, Ihug

Wood is a tough businessman, with strong views on technology and the way forward for the company - views sometimes seen as arrogant by detractors.

His reputation is for having made some canny - and brave - decisions, notably launching a flat-rate pricing structure, and pumping for satellite rather than fibre, thus allowing the company to break away from Telecom's potentially monopolistic clutches and get better pricing. Aware of the competitive pressures on Internet service providers, Wood has moved Ihug into satellite and wireless technology and pay TV, though the jury is out on whether these will be money-spinners.

Nick Wood's hands-on style, and insistence on "having control of our destiny", was a key factor in the success of the company, he says, certainly in the early stages. There is only one piece of software in the business not written internally, and Wood wrote the early accounting software package himself. "We need to be able to change things. So having control of our own software has enabled us to stay nimble," he says.

Wood sees his major strength as the ability to take "uncalculated risks" - to shut his eyes and jump. "I don't stop to think what I'm doing. Otherwise I'd be scared shitless. Some of the things have taken off - like going to satellite. Some, if they hadn't worked, would have been the end of us."

His biggest weakness? Management technique, Wood says - a view backed up by some present and former staff. As the company has grown from two dozen closely-knit enthusiasts to 300 people, Nick Wood hasn't found the switch in cultures easy. Abrasive management might work with a few people you know well - and who know you - staff say, but not in a larger company. Some complain Wood is arrogant and doesn't respect others' opinions. He also finds it hard to delegate responsibility and let a team get on with its work, but is quick to allocate blame for failures, they say.

"Nick has definitely got an eye for the future and for opportunities, and he's an effective deal-maker, but it's very personality-driven as an organisation," says one former employee. "Senior management is impotent to make things work because [Nick and director brother Tim Wood] don't delegate power in the proper way." Staff turnover is high, another staff member says.

The issue of employee share options, dangled but so far unmaterialised, rankles, as does the Great Toilet Roll Saga, when management stopped supplying loo rolls for a couple of weeks because staff were stealing them.

Nick Wood's colourful business background includes a picture-framing business, expanded in to Australia and then sold, and shares in and management of two Auckland hostelries. A student bar, owned with brother Tim, was eventually converted to New Zealand's first Internet café. The brothers came out of these ventures with their shirts and a few computers, plus faith in the future of the Internet. Ihug was born.


In the end, does the success or otherwise of our e-gang mean much for New Zealand? The tech sector still only occupies 2% of the NZSE and none of the companies are yet in the NZSE's top 40 companies. Neville Jordon reckons, even if some or even all of our present ones come a cropper, it doesn't matter - overseas at least. "We are seen as a credible country. If these companies fire it will be good for New Zealand's profile. If they don't, no one will notice." And if a few overseas investors get burnt, there will always be another thousand who've never even heard of the ones that lost out.

At home though, the scenario is a bit different.

"You have to be a brave investor to be involved [in the Internet/high-technology] sector," says Wellington Drive Technology boss Ross Green. "It's easy to spend money and hard to make it." But New Zealand hasn't got a great history of investment, he says, so the onus is on the management of our listed stocks to perform and to achieve results for investors. "In New Zealand, people have a greater duty of responsibility to get good results, because, if not, they will poison the investment community against the [technology] sector as a whole. And if you can't get the advanced technology sector functioning on a big scale, New Zealand is going to become nothing more than a tourist destination."

Nikki Mandow is Unlimited's business editor
Additional reporting by Mark Story

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