The Boston tech world is small town enough that there’s at most two degrees of separation between you and everybody else who’s worked in any local technology company. Thus, I was certainly aware of Dragon Systems – pioneers in speech recognition – and knew that at least a couple of former colleagues had worked there at one point or another.
So, while I hadn’t followed the company’s travails, I was very interested in an article in The New York Times on Dragon’s lawsuit against Goldman Sachs.
James and Janet Baker spent nearly two decades building Dragon, a voice technology company, into a successful, multimillion-dollar enterprise. It was, they say, their “third child.” So in late 1999, when offers to buy Dragon began rolling in, the couple made what seemed a smart decision: they turned to Goldman Sachs for advice. And why not? Goldman, after all, was the leading dealmaker on Wall Street. The Bakers wanted the best.
And they were, of course, delighted when Goldman advised them on their $580 million sale to Lernout & Hauspie (L&H), a Belgian competitor.
For Goldman, this was apparently a chump-change deal. They were paid a flat fee of $5 million, which didn’t buy them all that much. One can even argue – as the Bakers are doing now in court – that what they got was royally screwed.
The full article is definitely worth the read, but here are some of the highlights:
…in December 1999, the Bakers, in over their heads when it came to M.& A., signed a five-page engagement letter drafted by Goldman. In it, Goldman pledged to provide “financial advice and assistance in connection with this potential transaction, which may include performing valuation analyses, searching for a purchaser acceptable to you, coordinating visits of potential purchasers, and assisting you in negotiating the financial aspects of the transaction.”
Goldman also sent a letter indicating that they would be doing due diligence.
The team providing these services was not exactly the A Team. Maybe not even the B or C team. It was four guys, three of whom were in their twenties and thirties, who were pretty much operating unsupervised, and seemingly making things up as they went along. Which is, as we (now) know how plenty of smarter-than-thou, BSD* wannabes operate. And at a mere pittance payment of $5 million from Dragon, the deal just wasn’t worth the BSD-ness of the alpha boys, the real BSDs. (The guy who’s been fingered as the supervisor has DK’d any personal involvement in this deal.)
Fast forward and the due diligence wasn’t all that done or all that diligent. In fact, at one point, Dragon received an unsigned letter from Goldman suggesting that they have Dragon’s accounting firm, Arthur Andersen, do the due. (Goldman, L&H, and Arthur Andersen. For ultra-smart folks, the Bakers sure could pick ‘em.)
Meanwhile, the D-team was kinda-sorta conducting due diligence. They also set up a call with a Goldman analyst who, ahem, followed L&H so that he could talk to the Bakers – at Dragon’s request – about why L&H shares were “gyrating wildly.” The analyst:
…assured Ms. Baker that investors were worried about the market in general, rather than L.& H. in particular. He also said he expected the stock price of the combined companies to rise substantially once a merger was struck.
As it turned out, the analyst had not really been following L&H. The guy who had been doing so had left Goldman, and Goldman stopped its L&H coverage. But the analyst who agreed to talk with the Bakers – shamefully – was willing to fake it.
He wasn’t the only one. No one warned the Bakers that the all-stock deal on the table was risky. (There had been an earlier half cash-half stock offer out there, although whether L&H would have had the cash to cough up is questionable.)
At the Dragon board meeting where they voted on the deal:
No one from Goldman gave a presentation, but minutes from the meeting, taken by Dragon’s outside lawyers, indicate that the Goldman bankers expressed confidence that the combination of Dragon and L.& H. would produce a market leader.
Dragon agreed to a $580 million all-stock deal and, within a couple of months after the deal closed, L & H was toast, its stock price at zero. And Dragon got, as Tony Soprano might have had it, stugots.
As it turned out, Goldman had – on Dragon’s behalf – accepted at face value L&H’s claims about customers when L&H was pulling “sales figures out of thin air.” Goldman, however, had done a bit better on the due diligence they’d done for themselves when they’d been considering an investment in L&H. Which they decided to take a pass on, for obvious reasons.
The coup de grace was that the technology that the Bakers had considered their third child ended up in the hands of another competitive of theirs whose IPO was being handled by none other than Goldman at the same time they were “advising” on Dragon’s sale to L&H. (Did I mention that Boston technology is a small world? A few months before this all started going on, I had actually interviewed and gotten a job offer, which I didn’t take, from that rival company that IPO’d.)
Meanwhile, remnants of the Dragon technology may have made its way into Apple’s Siri. (Maybe John Malkovich or Zoey Deschanel can ask Siri a question about whether Goldman screwed Dragon.)
Yes, the Bakers may have been naïve, but you can’t blame them for thinking they were in the hands of the ne plus ultra of investment banks, getting the best advice that money can buy. Except that, come to find out, $5 million doesn’t buy you very much.
Anyway, did we really need another reason to dislike Goldman Sachs?
Forget dragon slayers: this is one where you want the Dragon to win.
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*For those who haven’t read Liar’s Poker, that would be Big Swinging Dicks.
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Not to defend Goldman, which appears to regularly screw its clients left and right but somehow come up with new ones all the time, but L&H was a fairly sophisticated fraud as these things go. There were some complex deals involving a private S. Korean company that was supposedly distributing its products in Asia, which was the source of much of L&H's imaginary sales and earnings. The hedgies and short sellers were all over this one, but as usual the mainstream brokers recommended the stock and sloughed off the short sellers' points on the grounds that the bears were just greedy people trying to trash the company to make money (as if brokers and their customers aren't just as greedy.) Tons of major institutional investors, the ones that brag about all the hard work they supposedly do to protect their investors' money, were also long the stock when it collapsed.
ReplyDeleteMy point is that Goldman was not uniquely lazy and incompetent. Everyone hates short sellers when they attack some stock that one owns, but they, and other skeptics like that fellow who kept trying to get the SEC to investigate Madoff, do better work than the cheerleaders that dominate the investing world.
The most lazy and incompetent people here appear to be the Bakers themselves. I am sure they consult Consumer Reports and study their options to get the best deal on dishwasher soap, and then they sell their entire company for stock in some other company on the basis of a flimsy OK by some junior analysts?
I must admit that the Bakers do appear to be pretty naive - definitely in the category of "dumb smart" people. But techies are often like this, and I think they are correct in believing that Goldman screwed them. (My favorite was the analyst who didn't even follow L&H pontificating on them. Were/are there no controls/supervision in place at GS at all?)
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