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San Francisco, November, 2007
The Tipping Point-It's Here

The previous national economic expansion (March 1991 to March 2001) lasted a record 120 months - a full ten years. However, the average length of the nine post-World War II economic expansions in the United States - excluding the current one - is 59 months, or just one month shy of five years, and slightly less than half the 120 month record.

The current expansion, which started in November 2001, is now 71 months in length, or just one month shy of six years. It is already 12 months longer than the post-World War II average. Thus, the current expansion is no longer youthful and, in fact, is now quite mature. Based solely on statistical averages, we may be living on borrowed economic time.

In our previous May 2007 white paper, “The Black Swan Pushes Events to the Tipping Point - Maximizing Enterprise Value in the Upcoming Crisis”, Gerbsman Partners discussed its observations of the then economic times and potential issues to maximizing value in the upcoming crisis. Six months later, we are revisiting our presentation and are asking ourselves “Is the Tipping Point here?”

As time passes, we have become increasingly struck by our inability to predict events on a macro scale and by the fundamental randomness of such events. We also note that most professionals whose business it is to make such predictions, such as security analysts, marketing strategy consultants, economists and mutual fund managers, have an abysmal record. It is very educational to look back five years at their predictions and compare such predictions to what actually occurred. Most of these professionals simply project forward existing trends and miss "Black Swan" events, such as the Crash of 1987, the Savings and Loan crisis, the September 11 attacks, the current Sub-Prime Mortgage, or more positively, the impact of the Internet.

In the past few months, a number of conflicting trends have emerged that make it even more difficult than usual for us to predict the future. On the (mostly) positive side, there has been the 3/4 point decrease in interest rates, the continued low unemployment rate, the rally of the stock market to a new record and the continued health of the IPO, merger and acquisition and private equity/venture financing markets. There still seems to be a great deal of money chasing anything that is a quality deal.

On the (mostly) negative side, we appear to be experiencing far more inflation than is reflected in the official government figures, as evidenced by the decline of the dollar against the Euro and the Canadian dollar, oil prices above $90/barrel and record high gold prices. At the same time, we see continued weakness in the real estate market, continued fall-out from the Sub-Prime mortgage crisis, much tightened credit and, very likely, disappointing corporate earnings in Q4 2007 and Q1 2008. For example, I have heard from the President of a major building products company that sales and very weak. This news is not surprising. More interesting is that I have heard the same thing from a major manufacturer of high technology capital equipment.

Although we do not anticipate a general meltdown in the short term (barring an U.S. attack on Iran and an interruption of oil supplies), there will likely be fallout in specific areas. For example, recently we sold the assets of a failed venture-backed company. This company had been in existence for 10 years, had raised and burned some $90 million and was still not generating significant revenue (as often happens in a medical device company). Its product was approved by the FDA and on the verge of shipping. It failed in raising $20 million in new equity and its senior secured lender declared its debt in default and swept all of its cash, leaving the company with no option but seeking to maximize value through a sale of assets. As the general tightening of credit and slow-down in growth percolates through the economy, we expect to see similar situations in the near future. Marginal companies will miss revenue targets, run out of money and fail to raise equity or debt financing. We also expect to see lenders be increasingly aggressive in protecting their debt.

Once a company is in a cash crunch with minimal prospects of obtaining more cash, there is very little one can do to maximize enterprise value but to run a controlled mergers and acquisition process. It is very difficult to predict in advance when the tipping point in any situation will be reached, but history has shown that, once it has been reached, events proceed very quickly. Given this situation, we urge all of our clients to be pro-active in identifying and involving professional resources earlier in the cycle of potentially troubled situations before such situations become terminal. We have seen over and over again that troubled companies can best maximize their enterprise value when they have more cash, and hence, more time to develop alternatives.

Our Advice?

Before such an event occurs:

As a board member, investor or stakeholder:

  1. Implement tight cash flow, receivables and inventory reporting so that you are alerted to problems early.
  2. Focus on the control, preservation and forecasting of CASH on a weekly, monthly and quarterly basis.
  3. Require “bottoms up” forecasting for all aspects of revenue and expense. Have the CEO and CFO defend ALL numbers.
  4. Hold the CEO responsible and accountable for performance. If you are off the business plan/forecast, re-forecast based on the reality of “what is” today.
  5. Communicate frequently with all parties at interest. Check that the CEO is providing leadership, motivation and morale to the management team and employees.
  6. Review all companies in your portfolio. Identify and define action plans to fix weaknesses now.
  7. Utilize professional resources to assist in maximizing enterprise value, when appropriate.

When such an event occurs:

  1. Face up to reality and act quickly. When things are going bad, waiting seldom improves them. We have never seen a board of directors act too quickly when faced with a crisis. We have all too frequently seen a board act slowly or not at all.
  2. Call for assistance early. The earlier professionals can get involved in the process, the better the potential outcome in maximizing enterprise value. Many times boards request assistance only after a company has run out of cash. Many more options exist to maximize enterprise value if a company has some running room.

About Gerbsman Partners

Gerbsman Partners focuses on maximizing enterprise value for stakeholders and shareholders in under-performing, under-capitalized and under-valued companies and their Intellectual Property, as well as assisting Mobile 2.0 companies with strategic alliances, M&A, distribution of content and licensing.

In the past 60 months, Gerbsman Partners has been involved in maximizing value for 36 Technology and Life Science companies and their Intellectual Property and has restructured/terminated over $720 million of real estate executory contracts and equipment lease/sub-debt obligations. Since inception, Gerbsman Partners has been involved in over $2.1 billion of financings, restructurings and M&A transactions.

Gerbsman Partners has offices and strategic alliances in North America, Europe and Israel.

Gerbsman Partners
211 Laurel Grove Avenue, Kentfield, CA 94904
Phone: +1.415.456.0628, Fax: +1.415.459.2278
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