How the Directors Brought a Dot-Com Back From the Brink
from
January/February 2007
by Colin Leinster
Audit committee chairman Kenneth K. Klein made it official at the November 2001 board meeting of Homestore Inc., a high-flying company set up to sell real estate online. He and his two fellow committee members, he told the rest of the board, believed somebody was cooking the books.
What the directors did next—as the suspicions became facts and the facts exploded into multimillion-dollar fraud—makes for a constructive tale of how a board took control of a seemingly doomed company and got it back on course. “We saw the need to dig very deeply,” says outside director Joe F. Hanauer. Among other things, that meant 50 meetings over the following six weeks for the audit committee’s Klein, who is a builder of homes and commercial properties; Barbara T. Alexander, then a UBS Securities senior adviser; and William E. Kelvie, a former chief IT officer at Fannie Mae. The committee hired its own lawyers and forensic accountants and made it a point to keep the Securities and Exchange Commission, the Justice Department, and other regulators informed as the unpleasant discoveries piled up. Ultimately it turned out that revenues for 2000 and most of 2001 had been inflated by $160 million, or nearly 30%.
Not knowing whether chairman and CEO Stuart Wolff or CFO Joseph Shew had been part of the fraud, the board voted to make Hanauer vice chairman, giving him daily oversight of the company’s operations and the final sign-off on any significant decisions Wolff and his team might make. Wolff had already been talking about leaving, recalls Klein, and the board wasn’t about to stop him at that point, even if his hands were clean. (They weren’t, it soon turned out, and nor were Shew’s.) So Hanauer also led a search to find a replacement, and by mid-January of 2002 a new CEO, W. Michael Long, was in place.
Since then, Long, Hanauer (now chairman), and the rest of the board have worked closely together to retune the business model—ditching some operations and buying others—and to settle a number of major bills. These included $200 million that the company owed Time Warner’s AOL, which provided a portal to the site, and $700 million it owed Cendant Corp. for various acquisitions paid for with now-worthless stock. The company settled a class-action suit with the many investors who’d lost millions to the fraud, including the California State Teachers’ Retirement System pension fund, which picked up a board seat as part of the deal. The cash-strapped company also forked out a relatively puny—but spectacularly galling—$22 million toward the legal costs incurred by two defendants, Wolff being one of them.
But all this effort seems to have paid off. Move Inc., as the Westlake Village, California, company is now known, was set to make an operating profit for 2006, its first, on estimated revenues of more than $300 million.
The story isn’t quite over. The share price, which peaked at $138 in 2000 and then dropped to 14 cents after the scandal broke, was still hovering at about $5.45 in mid-November. And more competitors are banging on the door. Move leads the market in online real estate advertising, but the Web still represents a small piece of a category that continues to be dominated by print classified advertising. As a result, says CEO Mike Long, 54, “we’re the biggest pygmy in the jungle.” A challenge for Long is to make sure his core customers—realtors, homebuilders, and rental outfits—remain committed. When he first took the job, this meant convincing them that online was the place to be; these days he has to explain which of Move’s various sites is the place to be.
|Selling the concept of online advertising was the big challenge when the National Association of Realtors first came up with the idea for the site in the mid-1990s. (With about 700,000 members then and 1.3 million now, the NAR is the biggest professional organization in the country.) The association’s leadership saw the Internet as an obvious threat to realtors’ livelihood. An increasing volume of industry data—chiefly what was for sale, where, and for how much—was showing up online, where home-buyers could mine it for free. Who’d need real estate agents as middle guys if this went on? Even though not all the members saw it this way, the association put together a website subsidiary and posted its members’ listings. The original plan was to collect revenues from advertisers looking to reach relocating families, and from the listings themselves. The latter started at $25 each, though that soon dropped, first to $1 and then to nothing, as competitors began to offer similar sites.
The cost of setting up the technology, meanwhile, and hiring staff to run the operation proved crushing. So many members complained about the growing losses, which totaled nearly $15 million by 1996, that the association agreed to fold the business and picked three members of its executive committee to do the job.
The lord high executioner was to be Joe Hanauer, now 69, an industry veteran who’d sold real estate ads for the
Chicago News
and
Sun-Times
and served as chairman and CEO of both Coldwell Banker Residential Real Estate and Grubb & Ellis Co., another huge realty firm. Hanauer had also been involved on his own behalf in all kinds of successful investments in commercial and residential developments (and still is, as principal of Combined Investments LP in Laguna Beach, California). In a word, he knew real estate.
“I was told to shoot it,” says Hanauer of his assignment. But his experience at Grubb & Ellis suggested an alternative: “IBM had wanted to outsource running its property and did so by way of forming a joint venture with Grubb & Ellis. The joint venture handled IBM’s real estate interests, managing employees, contracts, and so on. We thought we could do a similar thing.” The realtors’ association bought into the idea and in 1996 went ahead with a joint venture, retaining a 15% interest in the new company and selling the rest to venture capitalists, among them Allen & Co., a big media investor. Subsequent investors included Silicon Valley’s legendary John Doerr.
Everything soon hit high gear. The site began taking listings from homebuilders, institutional owners of apartment buildings, and others with property to rent, and ads from mortgage brokers, moving companies, and various concerns wanting to hook up with home-buyers flowed in. The company also grew by acquisition as CEO Stuart Wolff went on a buying spree, snatching up such businesses as Hessel Group, which prepared taxes for people being relocated. Sure, his outfit was losing money, but it was a dot-com, for heaven’s sake, and this was the beginning of the bubble. The company went public in the summer of 1999, raising some $450 million. Investors, including major institutional shareholders, still couldn’t get enough. Within two years the market cap reached $10 billion.
For a while it seemed as though Homestore, as the company was then named, was bulletproof. It had got through the technology crash of early 2001 relatively unscathed and even seemed to be riding out the real estate recession that followed the terrorist attacks that September. In fact, this degree of success stirred the neck hairs of the audit committee members. “We knew we were good, but were we really that good?” director Bill Kelvie remembers wondering.
And, of course, they weren’t. The audit committee began to pick up on some specific clues. “One was the number of transactions that rushed in at the end of the quarter,” says Kelvie. “Another was, we asked management to put together an internal audit function, but they never did. We kept asking, but nothing seemed to happen.” They also discovered that the company was padding revenues in various ways. For example, one complicated deal involved trading ads with a media company and booking their value as sales; this formed the basis of later criminal indictments.
Could the audit committee have seen what was going on earlier than it did? Did it miss some glaring clues? “That’s something all of us asked ourselves more than once,” Kenneth Klein says. “But at the end of the day, if the outside auditors tell you everything is as it should be,
if you ask top management the right questions and you get the right answers, the director has done his job. There’s not much you can do if people downright lie.” He does admit that boards need to be more curious than they sometimes are if they’re presented with too long a string of ever more successful quarters.
The 2001-02 Christmas and New Year holidays went by almost unobserved by the board as the nominating and audit committees buried themselves in their new assignments. Terry McDermott, CEO of the National Association of Realtors and a Homestore Inc. director, worked hard to keep his members supportive, as did his NAR colleague Alan Yassky, who sat in on some board meetings in a monitoring, nonvoting role. The association’s endorsement was critical. “Without it,” says Long, “the company would not have survived.”
All along, the board made sure to keep the SEC and other regulators informed of what had happened and what the company was doing about it. “At first,” Klein recalls, “I wasn’t so sure this was what I had signed up for. Others doubtless felt the same. But then we all determined to see it through, and our only option was to do everything according to the best practices the SEC had laid out for such events.” These included appropriate treatment for the perpetrators—Wolff, Shew, and nine other employees. The audit committee was not about to budge on this. The conspirators, says Klein, would get “no vesting. No long-term options payouts. No forgiven loans.” All 11 ultimately faced charges ranging from insider trading to fraud. Ten pleaded guilty to a variety of charges and are awaiting sentencing. Wolff went to trial and was convicted of 18 counts, including conspiracy, filing false reports with the SEC, and lying to company auditors. He was sentenced to 15 years in prison and ordered to pay a $5 million fine. He has said he’ll appeal.
The fervor with which the company investigated the frauds and its openness with the regulators helped keep it from being charged with anything illegal itself. Indeed, then-attorney general John Ashcroft later made that very point in a speech announcing the indictments of three Homestore executives. He commended the company’s directors and Long’s management team for having done it right. “The nature and extent of a company’s cooperation is always a significant factor in deciding whether to charge the company itself,” Ashcroft said.
Hanauer’s nominating committee had worked hard to find a new CEO and had considered more than a dozen candidates. Whatever his or her background—finance, technology, the Web—the right person would have to be prepared not only to take the helm of a deeply troubled company but also to work with an outside chairman, Joe Hanauer, which is how the board wanted it to be.
It was director John Doerr who came up with the name of Mike Long, somebody he’d recruited for another top job four years previously. That assignment had ended nine months earlier, Doerr knew, and Long just might be looking for something to do.
He was. A farmer’s son from North Carolina, at 25 Long had left for Austin, Texas, to join a software company. “Software” was a surprise to his father, Long recalls. “He thought I was going into the women’s-underwear business.”
Long spent the next 18 years at Continuum Inc., a producer of packaged back-office software for insurance companies, first as a sweat-equity second-in-command and finally as CEO. Since the big U.S. insurers were reluctant to deal with a small outfit, Continuum began by building up an international business. “We had to become a global company in order to become an American one,” says Long. Over the following years Continuum became a giant, at home as well as overseas, though its growth meant that Long was almost continually on the move, spending weeks on end in Asia and Europe. To make sure they secured some time together, the Longs and their children started to go on adventure vacations, heading off a couple of times
a year to trek through exotic spots such as New Zealand’s South Island, Ireland’s Dingle Peninsula, and Costa Rica’s rain forest.
In 1996 Continuum was sold to Computer Sciences Corp. for $1.7 billion, leaving Long with a nice payout. He stayed at the combined company for a year before opting to move on. John Doerr, whom he met at an IBM conference on technology, recruited him to head a company Doerr’s firm had invested in. That company bought WebMD.com and took its name, and Long became chairman. He was excited at the opportunity: If it worked out as envisioned, WebMD would do nothing less than reengineer America’s then-$1.6 trillion health-care system by building a network of patients, hospitals, doctors, insurance companies, and pharmacies that would help manage people’s health care throughout their lives. Long chose to commute between Austin and Silicon Valley, where the new company was based, rather than uproot his family. To make this easier and “so I didn’t miss piano recitals and ball games and other things a parent has to be there for,” he treated himself to a plane, a Dassault Falcon.
But after four years, he recognized that the WebMD he dreamed of was not going to happen. “It was a disappointment,” he says. “We saw a way to simultaneously improve the quality of care and take out some $300 billion in waste. The company met a lot of resistance. What we saw as waste others saw as income.” WebMD is still around, mainly as a consumer-friendly encyclopedia of health-care information. Long quit in March 2001, when Homestore was still flying high.
For the first time in his life, he found himself with time on his hands. He filled a lot of that with daily horseback-riding lessons. He’d joined a hunt club in Virginia, where he and his wife now spent much of their time in a home that had been in her family for generations, and he was determined to be among the first riders behind the hounds, not the last. And though the kids were now grown, the Longs were keeping up their tradition of family treks. In late 2001 they were packing for a visit to Belize. Then John Doerr called with another job offer. How would Mike like to be CEO of Homestore? Doerr allowed that the company had “accounting issues,” says Long, and sketched out some of the details. Long flew to California, met with the board, and promised to think it over during his vacation. He said he’d have an answer when he and his family returned to the U.S. in the new year.
The family hadn’t even got all the way home before Doerr and Long were on the phone again. This time Doerr found his candidate at a Houston airport where the Longs were changing flights. Did Mike want the job? “I said yes,” Long recalls. He started work on January 7, 2002, barely six weeks after the board first began the company’s turnaround.
Long had few doubts about what faced him and what needed to be done. “For one thing, the company had $40 million in cash and was burning $50 million a quarter. And just maybe, there was no D&O [directors’ and officers’ insurance coverage],” he says, adding, “If I’d been planning my reentry, I might have picked something different.” Some concerns were especially serious: “I did wonder, Had I lost my touch? Could I run a company again?”
To help him do so, he reached back into his past to bring two previous colleagues aboard. Lew Belote, now 51, who had been vice president of finance at WebMD, signed on to fill the CFO spot under Long. Jack Dennison, 50, former general counsel at Continuum who’d also gone on to WebMD, became Long’s chief operating officer. Long needed a chief counsel as well. He picked Michael Douglas, 53: “To handle all our lawsuits, I knew I’d need somebody with ice in his veins, and asbestos work gives you that,” a reference to a $4 billion insurance settlement Douglas had negotiated while serving as the general counsel of Fibreboard, now part of Owens Corning, which used asbestos in its products. Allan Merrill, 40, already working at the company, also joined the top team. “His specialty was mergers and acquisitions. I’d need him to sell a lot of things very fast,” Long says. Completing his inner circle was Allan Dalton, a real estate executive whom he entrusted with cementing the relationship with the National Association of Realtors.
The scandals at Enron, WorldCom, Adelphia, and others had done a lot to keep Homestore largely out of the national spotlight. But for its 2,800 employees, the company was the only story. Morale was understandably low, headhunters were snaring the best, and Long knew that stopping the talent exodus was a top priority. On his first day on the job, a particularly sunny one even by the standards of Southern California, he assembled some 700 employees in the parking lot outside the Westlake Village headquarters, stood in front of a microphone at the top of the steps, and started talking. He didn’t pull his punches. “I told them the company had big problems, which they knew. I said we were going to address those problems,” recalls Long, who ended the day with a serious sunburn. “I told them there were no guarantees. If any of them had financial worries or responsibilities and no financial cushion, if they didn’t want to take a risk on us, they should move on. I’d understand. I asked for everybody’s help.” Some did opt to depart, and others left in later months as businesses were sold.
That request for help was a message Long was to repeat often over the following months, not only to employees around the U.S. and Canada, of whom there are now about 1,750, but also to core customers and advertisers. The leadership of the realtors’ association was crucial. “A loss of their support would have killed us,” Long says.
He preferred to deliver his message in person, and before long was back to the kind of hectic travel schedule he’d subjected himself to at Continuum, often hitting three or four cities a day. Now, though, he was traveling in his Falcon—“my RV with wings,” as he calls it. While the board might have shied away from buying or leasing a plane—it could have looked bad for a company professing to be broke—compensating him for its use was deemed both fair and good business.
Long also had to deal with AOL and Cendant, both of which were due money the company simply didn’t have. Once again he chose the face-to-face approach. He went to see Richard D. Parsons, chairman and CEO of Time Warner, AOL’s parent. Homestore had had an exclusive deal to manage AOL’s real estate channel but now found itself unable to meet a so-called make-good payment of $200 million. “We laid out to Dick Parsons the very high-quality services we were providing AOL customers, which would be difficult to get elsewhere, and asked for relief from the payment. We didn’t have the money,” says Long. “Dick authorized the AOL team to negotiate a deal with us. He was a real gentleman and chose to look to the future rather than wage war over the past.” Long was equally successful with Cendant and with a group of investors led by the California teachers’ retirement fund. This gave him time to get the company on track rather than taking it into Chapter 11.
With the help of Allan Merrill, Long also set about unloading many of the businesses the company had acquired after its IPO. But some they kept, including an outfit called Move.com, a site specializing primarily in rental property that had been among the companies Wolff bought from Cendant.
Long and the board had discussed changing Homestore’s name. Not only was it associated with fraud and a plummeting stock, but it made the company sound more like a competitor of Bed Bath & Beyond, they thought. Like others before them, the directors put their faith in consultants, believing they could come up with a grabby new name, something that would describe the company better. “Residot,” suggested one. “Avenue R,” proposed another. Those ideas ended up costing about $100,000, says a rueful Long.
The company finally adopted Move, a name Long and the board felt best captured the image they wanted, of a company that promised to help prospective buyers not only find and finance a new home but also check out neighborhoods and schools before they made the big decision—and get to know the neighbors after they moved in.
The same set of Cendant acquisitions had included Welcome Wagon International Inc. To some people’s surprise, Welcome Wagon turned out to be not an American tradition of friendly folks from down the street just dropping by with an apple pie and the name of a good plumber, but an actual corporation founded some 80 years ago. Long believes that lining up what he calls local mavens to contribute their know-how about services and facilities in various neighborhoods across the country, and making that information available, delivers extra value.
As the company continues to change under Long, so has the board under chairman Joe Hanauer. Audit committee member Barbara Alexander resigned in 2002, for example; her committee place has been filled by Paul Unruh, a former vice chairman of the construction giant Bechtel Group. Terry McDermott retired as CEO of the realtors’ association; he was succeeded by Alan Yassky, who also took McDermott’s seat on the Move board. Yassky’s nonvoting, monitoring role at board meetings has been assumed by his NAR colleague Bob Goldberg. Part of the settlement with the state teachers’ fund allowed it to nominate a director; Geraldine Laybourne, CEO of Oxygen Media, took that seat. In 2006 Elevation Partners, a private equity group that recently bought into Forbes.com, paid $100 million for a chunk of Move’s preferred stock and got two seats on the board.
The newer board members will soon see why their longer-serving peers enjoy such a close working relationship with Long. “A lot of CEOs I talk to devote a lot of time to managing the dynamics of their board,” he says. “I don’t. I don’t lobby individual members. I speak to them individually, of course, but not to persuade them. Instead, I try to get each of them the same information I have, whether it’s about the market, a new product, a strength, or a weakness. Then I make my recommendation. If we all have the same information, it’s reasonable to expect we’ll come to similar conclusions. Of course, I’m at this 24/7 and the directors have other lives, so it’s up to me to translate the information I have efficiently. This doesn’t mean we haven’t had different opinions, but the differences always lead to our finding an agreement among us as the next step. I’ve never left a board meeting where the directors have been divided.”
The scorecard? The company is on the mend. Its valuation, though well shy of its peak, is up to $787 million. It was $19 million when Long took over. Move is the leader in its category, attracting 11 million-plus unique Web visitors a month, more than twice as many as competitors like Yahoo real estate. Does anything keep Long awake at night? Yes, and as it happens, Joe Hanauer has the same dread: that another company will see the same opportunities and adopt the same strategy, but somehow implement it faster.
