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Wednesday, 22 October 2014

“Why so many government projects fail”. Ernst in discussion with Jeroen Gietema, co-author of the book series “The Project Saboteur”

Last Saturday,  I have written about the Dutch, parliamentary Ton Elias Committee and its investigation into the failure of numerous governmental ICT projects.

This extremely sloppy and superficial investigation only seemed to push paper around and did hopelessly fail at looking for the real reasons, why so many governmental ICT projects fail.

After I finished my article last weekend, I had on Monday a very interesting discussion with my colleague Jeroen Gietema; except for being an excellent and amiable ICT consultant with expert knowledge in financial business, he is co-author of the small, but interesting management book series The Project Saboteur. On top of that, he has years and years of experience with change processes at the government and in the financial industry.

Jeroen Gietema, Co-author of
The Project Saboteur series of management books
Click to enlarge
Today, I asked Jeroen to speak out frankly about the topic of change and explain why so many goverment (ICT) projects failed hopelessly in achieving their main goals.

The following article is an integral representation of our ‘interview’, for which I thank Jeroen very much.

Jeroen: In governmental ICT projects, you need to look at the context in which a software supplier is acting. That is always a personal context – for instance where the account manager of the supplier is involved – but also a corporate context.  

The main corporate context is always that a commercial company wants to make profits and wants to achieve continuity for a longer period.

Depending on how the national ICT market is, at the time of the assignment, the company will try to extend or not to extend the assignment. That has to do with direct yields from the project and other opportunities beside the current project, which could yield more money possibly.

State officials, civil servants and employees of commercial companies often go through organisational change projects. And then certain eternal truths are highlighted: the change project should almost always lead to diminished numbers of personnel. In nine out of ten times, the business case for a change project is personnel reduction.

Irrespective of whether you take McKinsey, PWC or KPNG, they all sing the same ole’ tune. Personnel reduction is the only real business case that these companies have. But as a matter of fact, this is exactly the business case which almost never gets realized.

These companies argue, however, that their business case does get realized in a profitable way indeed. Still, at the bottom line, one will see that the expenses of the McKinsey consultants and the costs of outsourcing of employees have almost never been added to the final financial result of the project. The reason is that the costs of outsourcing and firing personnel are dramatically high.

There is a simple calculation for that, to prove my point.

I suggest that we have two companies, which want to go through a merger. Both these companies have an ICT-department. One ICT-department has a 60 year old manager and the other department has a 35 year old manager. It makes sense that these ICT departments will be merged together and that one of the two managers has to step down, for the point of being superfluous.

The manager that probably will be forced to step down is the 60 year old manager, who has about five years to go before his retirement. How much money will this man cost the merged company, when it pays him until his retirement, do you think? This is what many companies do these days.

Say, that it will cost you a total amount of about €500,000 during five years. The cash value of this is about €480,000 (at the current interest rates).

However, when I want to lay off this man, I need a consultant from an outsourcing company. This guy will probably cost me €250,000 annually and this kind of guys always manages to get themselves a contract for a whole year: €250,000!

So I have to pay this 250 grand now and when I say goodbye to my 60 year old ICT manager, I have to bring a large bag of money too: perhaps 20 to 30 times his monthly salary. Including the fees of the outsourcing consultant, this lay off will at least cost me also 500 grand and probably a bit more..

When the ICT manager has worked at the company for a long time (more than 20 years for instance), his resignation will cost me between €500,000 and €1 million. This already happens to be a very poor business case, as it costs more money to fire the man than to keep him at the job for five more years, until his retirement.

And there is more: when I fire this man, quite a lot of knowledge walks away from the company.

Ernst: Perhaps you should hire him back as a freelancer then, after he has been fired?!

Jeroen: That could very well be. The second thing that happens, is that these people start their resistance against the project in the days that they have left, as genuine project saboteurs.

They resist against everything and silently refuse to share their vast knowledge – which is always very useful knowledge, gathered in years and years of experience – among their colleagues. This is a double whammy, which makes the merger inefficient, as you cannot disclose all available knowledge, in this situation.

In other words: the added value of the merger diminishes strongly, even when the merger itself is a success. Such success, however, is definitely not a no-brainer, as a merger of two departments often leads to the situation that the ICT systems of both departments all remain operational. Then you have a merger without merging the available computer systems. This costs double the money.

The solution for this conundrum starts with not hiring McKinsey, KPMG or PWC, as these people always come with an unachieveable business case.

The second thing that you should do, is to keep the “superfluous” manager (or personnel) in service. Instead of firing them, you use these people to prepare and train the other people at the department, through a master / student relation for knowledge transfering.

In the example of our ICT manager, you let him coach the other workers, making him important in the process, instead of futile. You could even make him projectmanager for the transition, with a guarantee that he can stay the full five year period until his retirement or that he can go with a solid early retirement arrangement, at the moment that his knowledge has been transfered successfully.

What will happen? The process of the transition will actually accelerate, as this experienced ICT manager with 20+ working years, from the example, had always been the most qualified guy to hamper the transition process.

By making him important, he will stop doing so. This has to do with the Pyramid of Maslow. This Pyramid actually goes very deep in explaining the motivations of people.

Pyramid of Maslow
Chart courtesy of
Click to enlarge
People in the lower stages of the Pyramid have interests, like making money to feed themselves and their families and to let their children go to college. The upper stages of Maslow focus at self-esteem and self-achievement.

When you make someone important, by letting him transfer his knowledge to his colleagues, you add to his self-esteem. So I save serious money in the process by keeping this guy and actually making him important!

Summarizing: when you have a business case for change, you need to get the human factor out of it (i.e. personnel reduction), as making a profit on this is exactly the thing that you won’t achieve… ever!

However, you should take the human factor into consideration, in order to force yourself to investigate how you can mobilize these people in a positive way. Positive people are enthusiastic to participate in the change project. This is the conundrum that you need to solve.

Every change project where executives fail to do so, is dead-on-arrival. You see that happen at almost every merger and at all systems and departments which should be merged together.

This is my statement and this is where things go horribly wrong, nine out of ten times, at government change programs and large ICT projects. Employees have great interest in their jobs being continued. Executive managers should never forget about that.

I thank Jeroen for his elucidating insights in change processes.

Monday, 20 October 2014

“There is nothing cheap about penny stocks, when you lose your money on it”; telephone conversation with a reader

This weekend I had the pleasure of having a telephone conversation with one of my latest readers, who had recently discovered my website and the information on it. Let’s call him ‘John’ (not his real name).

Without disclosing much about his background, it suffices to say that John became one of the ‘victims’ of the Dutch technical service provider Imtech. He lost quite a lot of his own savings’ money on this tech fund under jeopardy.

While his personal background, as well as his shareholders ‘comfort zone’ lay in the oil and gas industry, he was attracted both by the extremely low price of Imtech stock and the earlier reputation of this technical service provider. He decided to give it a shot and invested heavily in Imtech stock, without doing proper research into this company. It was a choice John would deeply regret soon.

As so many other people, John thought that Imtech’s drawbacks, with respect to its loss-bearing subsidiaries in Poland and Germany, would be of a temporary nature.

The good reputation and specialized knowledge of the company with respect to their different service areas, as well as the healthy order portfolio, would deliver the necessary cash-flows to pay back most of the enormous debt position of Imtech. The sale of a few company parts would smooth down the remaining edges and supply the necessary working capital.

Eventually, the remaining parts of Imtech would become a healthy and mostly debt-free company again, he thought, with a good order portfolio and sufficient new opportunities. In that case, he would have hit the jackpot, as the stock rate could have exploded then. And hey, how much money can you lose on a stock of less than €1 per share, right?!

Unfortunately, this was not going to happen. When John would have checked the balance sheet and P&L of Imtech and would have followed the news, he would have found out that the enormous debt of well over €1 billion, in combination with the skyhigh interest rates of more than 8%, made debt reduction almost a ‘mission impossible’.

And then we are not even speaking about the obligation of the company to gather a working capital of €400 million in 2014, in order to meet the bank covenants to this respect.

Other worrisome factors were the large amounts of goodwill on the balance sheet of Imtech and the circumstance, that it is very hard to sell parts of a company for a decent price, of which the people and the knowledge base are the main (and almost only) asset.

In such companies, the net worth is almost equal to the reputation of the company. And Imtech’s reputation lay in tatters at that very moment.

What happened with Imtech, since my March 2014 article (see the aforementioned link), is history. Imtech had indeed mounting liquidity problems, due to the heavy debt burden, the huge 8+% interest and the ‘impossible’ goals in the bank covenants.

And after every presentation of quarterly data since March, the investors and shareholders felt that “the worst had yet to come” with Imtech: problems got bigger, losses increased and there seemed to be no light at the end of the tunnel, in spite of the soothing words of CEO Gerard van der Aast at every presentation.

Royal Imtech's year-to-date price development
Chart courtesy of
Click to enlarge
In order to stay afloat, the company tried to sell some company parts, but it nevertheless had to turn to its shareholders repeatedly. These took a few heavy blows on the chin, in spite of the recent news that Imtech got slightly more favourable interest rates from its syndicated lenders.

One month ago, the company created total confusion when it offered 60 billion additional shares, at €0.01 a piece, in a limited access primary offering (called a “claim emissie” in Dutch).

Shareholders had to decide between cutting their losses, while their share in Imtech would vaporize under this tsunami of new stock, and buying many more shares in it, in order to keep their interest in the company intact. It was truly like ‘being stuck between a rock and a hard place’. You could also justifiably call it a lose-lose situation.

Royal Imtech's last month's chart
Chart courtesy of
Click to enlarge
A trading day like a roller coaster ride followed, in which the price for Imtech shares and claims seemed to go through the roof. This was a consequence of the complicated price calculations, which nobody understood properly.

That trading day brought a mixture of old stock, new stock and tradeable claims for sale and it was virtually impossible to set the correct prices; for traders as well as for the stock exchange itself. However, in the end – when the gunsmoke had lifted – the shareholders ended with virtually nothing in hand.

The lessons that many people and especially John learned with Imtech, are also very much applicable to other penny stocks:
  • A penny stock with a rate of less than €1 can still go down 99 times: one cent at the time. And please don’t think that this won’t happen, because the stock price is already very low;
  • The circumstances that turned a company into a penny stock, are the same circumstances that could kill the company eventually;
  • Throwing good money at bad money – with Imtech this happened during the claim emission – is the worst thing that can happen for an investor. So sometimes it is better to cut one’s losses, than to endure the full ride down the drain;
  • When someone invests heavily in a losing penny stock, he doesn’t lose pennies, but loads of hard-earned pounds.

So the next time when you want to invest in a penny stock for the sake of it, without doing your homework properly, please think about John. Then his losses could save you some serious heartache.

Sunday, 19 October 2014

Is hybrid financing indeed “the new lubricant in the M&A market”? Or is it yet another symptom of the dangerous influence of “virtually free money” in the European economies?!

This week, Het Financieele Dagblad printed a very interesting article with respect to a ‘new’ form of company financing, called ‘mezzanine’ or hybrid financing. Here are the pertinent snips.

Subordinated loans work miracles at the Merger and Acquisitions market (M&A). Deals that scare away the traditional banks, are brought to a successful ending with it.

Take for instance the merger of two offshore companies, initiated by Amsterdam-based investment company Value Enhancement Partners (VEP). Traditional financing is virtually impossible to get, as there is too much risk involved in the multi million euro deal. No problemo: the London-based credit fund Beechbrook Capital, funded with capital from institutional investors, comes to the rescue.
The contribution of the British company was essential”,according to VEP-partner Bob de Lange. The role of the bank is now limited to the financing of working capital.  

In the business, hybrid loans are known as mezzanine financing. It is an ‘sub-level’ form of financing between equity and debt. The receiver of the funds gets subordinated debt in hands, which only has to be redeemed in the mid to long run.

And very important: in contrary to the offering of preferent and common stock at the exchanges, the executive control of the company does not change by it. The owners of the company remain in charge themselves.

The mezzanine loan is gaining importance. In the London City, billions of euro’s have been reserved for this form of financing. Private Equity houses of repute have established separate funds for mezzanine loans. With $4 bln in cash, Blackstone Group created in 2012 the largest debt fund in the world, closely followed by ICG, KKR and Greyrock Capital.

Mezzanine seems ideal for companies, which cannot (sufficiently) finance their growing ambitions at regular banks. Mezzanine is meant to fill up the void.

This whole article is a must-read, in my opinion, as it offers an excellent insight in this relatively new, but very risk way of financing.

I can imagine that mezzanine seems like the goose with the golden eggs for founders and CEO’s of innovative and fast-growing companies, which have enormous ambitions, but still suffer from financial growing pains.

Yet, a little voice in my head whispers:
When these companies are indeed so promising and seem to be a reduced risk; why don’t the renowned business and general banks want to finance these companies themselves?!

And a second voice whispers:
“When this kind of financing is too risky for business and general banks, why isn’t it for British and American private equity funds and the institutional investors that supply their funding?!

Does that have to do with the fact that banks have very strict capital ratios (solvability and liquidity), which are required and regularly assessed by the national banks and the European Central Bank, while institutional investors and private equity funds don’t have those ratios?

And is this perhaps a new kind of gambling with ‘other people’s money’?!

The skyhigh interest rates of 10% - 12%, plus additinal profit-based arrangements, definitely seem to point in that direction.”

And how many companies will eventually be successful enough and will indeed be able to earn sufficient cash flows, in order to pay back the substantial interest payments of 10% per year on their subordinated loans?

Losses and defaults of borrowing companies must be substantial; especially as a consequence of these skyhigh interest rates and the amount of risk involved. It is a very expensive kind of financing and also very risky; both for the money supplier and the debtor.”

I cannot help but think, that this new and extremely risky kind of financing – it looks, feels and smells a lot like the junkbond investments from the eighties, which went horribly wrong in the end – is only caused by the perversely low interest rates of this moment.

The institutional investors are desperately looking for ways to get more “bang for their buck”, than would be possible with sovereign and corporate bonds and shares.

On the other hand, the private equity funds are feasting on the ubiquitous availability of litterally shiploads of cheap money, which can be borrowed against only 2% or 3% interest. When the difference between the yields and the funding costs of loans is almost 10%, it rewards the risk of taking a gamble. Because that what it is, to these eyes. 

These kinds of investments will probably yield excellent results, until one day they won’t anymore. That will be the day that a lot of common people can wave a substantial share of their invested pension and insurance money goodbye!