CRITICAL Path embodied the Internet boom. Its wild-haired founder, David Hayden, saw the future of e-mail early on, raising US$40 million in venture funding to fill a former chocolate factory in San Francisco with engineers.
It had no profit and less than US$1 million in revenue, yet it raised almost US$600 million in a year. Its shares started out at US$24 and rose to US$150 in a month, fuelling a US$1.8 billion acquisition binge.
Then it unravelled. A new chief financial officer noticed something was very wrong. Executives had been inflating revenue and profit, backdating contracts and booking phoney deals. On Feb. 2, 2001 the company confessed to possible accounting irregularities. Turns out sales for the second half of 2000 were 25 per cent lower than reported, and losses – purported to be US$20 million – were twice as large.
Critical Path's stock plunged 75 per cent, to US$2.50, weeks after the painful admission; it never recovered. More than two-dozen shareholder lawsuits followed, and four executives were hit with criminal charges.
On the mend
Dozens of dotcoms have died of lesser wounds. Yet two years later the one-time poster child for glut and greed is on the mend. “Arguably we shouldn't be around today,” says William E. McGlashan Jr., an outsider who joined two months into the scandal. Now he expects to turn a profit in 2003, the first ever for the company.
McGlashan, 39 and a Stanford MBA, had founded an herbal medicine outfit called Pharmanex, which he sold to Nu Skin Enterprises US$125 million in 1998 (his stake was less than 5 per cent). Later he started a venture firm that focused on helping US tech firms set up abroad, and one of his clients was Critical Path.
When the scandal broke, founder Hayden, who had been sidelined but returned after the two top executives left, asked McGlashan to help out temporarily.
He got hooked.
“I became very attached to the outcome. I have this psychosis that my life is on the line,” says McGlashan.
It was a wild ride. As the bubble swelled, Critical Path grew so fast that its weaknesses went undetected. Sales increased from less than US$1 million in 1998 to a restated US$136 million by year-end 2000. In three years payroll swelled from 42 at one site to more than 1,000 people in 77 offices. Internal budgets were all but nonexistent; US$3.5 million servers were being bought like lunches.
The company acquired ten firms in 16 months, losing sight of its core business, managing e-mail accounts. Some properties had little to do with e-mail: FaxNet lost US$25,000 a day providing businesses with a hosted service that diverted incoming faxes when lines were busy.
McGlashan arrived in April 2001, vowing to revive the disgraced dotcom, but with one condition:
Avoid Chapter 11. “Bankruptcy isn't a turnaround,” he said, “it's a copping-out of everyone's interests.”
McGlashan immediately dumped eight of the acquisitions, taking a $1.3 billion write-off.
“We didn't have the luxury of being sentimental.”
He shut down 53 of the 77 offices and laid off 55 per cent of the staff, trimming the total to 562; he is likely to cut more.
McGlashan also began signing the checks to rein in expenses. In his first six months he halved costs to US$27 million.
Creditors at bay
McGlashan kept creditors at bay and silenced suing shareholders by artfully exploiting Critical Path's failing health.
He calls this his “squeeze play.”
McGlashan dwelled on the firm's near-death experience, suggesting that if they didn't cooperate they would end up owning a corporate corpse.
“We weren't viable, and I didn't try to persuade them into thinking otherwise,” he says unapologetically.
Thus did Critical Path wipe out 87 per cent of its debt, US$262 million, for just 30 cents on the dollar, and settle the lawsuits in three months. The company paid out a mere US$17.5 million, all of it covered by insurance (as well as warrants, still underwater), to dispose of claims that could have totalled US$240 million.
All along, though, customers were getting a decidedly more upbeat message from McGlashan, who logged 650 kilometres promoting his rescue efforts. A big win came in late 2001, when Morgan Stanley signed on to use Critical Path's identity management software, albeit at a significant discount.
Now he must get this company to grow – and look for the right time to sell out. Revenues were expected to fall almost 20 per cent last year to US$85 million. Critical Path's core business will likely grow by 4 per cent (after accounting for discontinued entities). IBM and Microsoft control 70 per cent of the e-mail market.
McGlashan insists, “Around scalability and reliability, we're the best in the world.”
On a standard server, he claims, Critical Path can manage 2 million mailboxes, compared with 10,000 for Microsoft Exchange software. One independent study shows that Microsoft's wares cost 34 times more than Critical Path's over a three-year period.
But the company's sullied past remains a huge roadblock.
“The competition talks it up,” complains sales director James Underwood.
The former president, David Thatcher, has pleaded guilty to one count of conspiring to commit securities fraud and awaits sentencing, as do two vice-presidents who have admitted guilt on insider-trading charges; a third veep got a six-month jail sentence.
In August the company nearly lost a deal with Hewlett-Packard to co-host messaging for telecom carriers. A news story in the San Jose Mercury News ran under the headline, “Authorities accuse three more executives at Critical Path,” although the three had left long before.
HP execs grew uneasy.
“This isn't the time to be associated with a questionable company,” says an HP vice-president, Stephen Huhn.
McGlashan threatened to kill the deal unless the service was co-branded.
Huhn persuaded his HP colleagues that Critical Path was no longer crooked; the pact was signed in October. It could enhance Critical Path's credibility and give it an instant entree into hundreds of HP corporate accounts that could stir millions of dollars in new business.
Yet Critical Path's stock barely budged on the news. “No one cared,” McGlashan says.
It hurt him personally, too: He bought 1 million shares in May at US$1.74 a share. Lately the stock trades at 53 cents. McGlashan insists he is unfazed: “If I focused on the stock price I wouldn't be here right now.”
Yet if McGlashan can lift the stock price to a mere US$5 a share, his entire stake (including options) would be worth more than US$20 million.
At its current burn rate Critical Path can survive two more years without turning a profit – but then what?
McGlashan is refreshingly candid about what a successful turnaround might mean: “The probability is that we get acquired.”
Critical Path: Powering premier organisations worldwide Chairman and chief executive officer – William E. McGlashan, Jr
Chairman and chief executive officer - William E. McGlashan, Jr
WILLIAM McGlashan was named CEO of Critical Path in January 2002 after his success in helping to lead the company to financial stability in 2001. McGlashan, a veteran executive from both the corporate and private equity world and previously interim CEO, was originally appointed Critical Path's interim president and chief operating officer in April 2001.
McGlashan also served as chief executive of technology investment firm Vectis Group LLC and as a Venture Partner at Whitney & Co., the first established venture firm in the US, with approximately US$5 billion under management. He co-founded and served as president of Pharmanex, a leading phyto-pharmaceutical and dietary supplement company with annual sales of approximately US$450 million in 20 countries.
Prior to Pharmanex, McGlashan was co-founder and CEO of Generation Ventures, a firm funded by Whitney & Co that started new ventures and facilitated the entry of US technology companies in China.
He also co-founded and served as President of TRADE Inc, a venture funded trade information database company, and was a senior associate with Bain Capital and Information Partners.
McGlashan earned a Bachelor of Arts degree in history at Yale University and a master's degree in business administration from the Stanford Graduate School of Business.
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