Cracking the Books: Manugistics' Mysterious Debt

When I examine a company, the number of unanswered questions typically declines as my analysis deepens. But since my initial columns on Manugistics (MANU Quote) last Dec. 19 ( Manugistics' Warning Flags) and Dec. 20, 2000 ( Manugistics' Results) -- in turn inspired by earlier work by Herb Greenberg -- the mysteries of the company just seem to expand.

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Take debt: In the second column, I pointed out that Manugistics had added $250 million in debt in the last quarter. I've been doing some digging since then, and what I've found has raised many serious questions -- questions that the company appears to be in no mood to answer, as my various emails and phone messages to five people at the company and its public relations firm over the past several weeks have gone unanswered.

In the meantime, the stock has been on a roller coaster lately, as seen in the chart below, but still trades at approximately 140 times analyst earnings estimates for fiscal year 2002 (ending February 2002):

Borrowing Binge

On Oct. 10, Manugistics issued a press release in which it announced its intention

"to issue up to $200 million aggregate principal amount of Convertible Subordinated Notes due 2007, with an option to issue up to an additional $50 million of Notes, in a private placement ..."

A week later, the company announced that the

"offering is expected to close on Oct. 20, 2000. The company has granted the initial purchasers an option to purchase an additional $50 million of Notes. The Notes will be convertible into Manugistics common stock at an initial conversion price of approximately $44.07 [adjusted for a recent stock split] per share."

The stock closed that day at $36.31. Three days later, it had jumped to $48, when the company announced that it had completed the private placement.

Finally, 11 days later, on Oct. 31, Manugistics announced that it had

"sold an additional $50 million principal amount of 5% Convertible Subordinated Notes due 2007 in its recent private placement, bringing the total amount sold to $250 million The sale results from the exercise of the overallotment option that the company had granted to the initial purchasers."

Gee, why am I not surprised that the buyer of these convertible notes exercised the overallotment option when the stock closed that day at $56.96 -- and the strike price was $44.07?

What It Means

As a general rule, I'm wary of debt, especially during times like these, with a slowing economy and a difficult capital-raising environment. I especially don't like it when technology companies with highly uncertain future cash flows take on meaningful debt.

In my view, $250 million is a large amount of debt for a company like Manugistics. To put it in perspective, Manugistics' trailing 12-month sales were $222.3 million. More important, after steadily losing money for more than two years, the company has only turned profitable -- barely -- in the past two quarters, and as I said in my last column, is struggling to generate any free cash flow at all.

Finally, analysts forecast that Manugistics will earn 27 cents in the fiscal year ending February 2002. With 66.2 million diluted shares outstanding, that translates into $17.9 million of net income. While we don't know the terms of the debt offering, simple math tells us that 5% annual interest on $250 million is $12.5 million, which would consume 70% of next year's anticipated profits. Any way you look at it, this is a lot of debt.

Talk About Dilution

Making the situation more problematic is that this is convertible debt. That means that the debt holders have the option to convert all or part of their holdings into stock at a certain price -- in this case, $44.07 (this is why they are able to pay a low 5% on the interest rate). Consequently, the number of fully diluted shares outstanding jumped 15.6% last quarter.

But this creates a heads-I-win, tails-you-lose situation for regular shareholders. If the stock does badly, shareholders suffer both directly from the stock price decline, and also from the added risk and interest payments that the debt entails. Conversely, if the stock does well, shareholders benefit, but will suffer from significant dilution as the debt holders convert their options.

Purpose of the Debt

Maybe taking on so much debt under such onerous terms would be understandable if the business needed the cash, but that's not the case. At the time Manugistics did the deal, it had $34.8 million of cash and marketable securities, and it generated $9 million of cash flow from operations in the third fiscal quarter. So clearly, the company had ample cash to fund its current operations, even including the expected losses associated with its acquisition of Talus.

The deal might also be understandable if management had announced exciting uses for the capital, but this is all the company has said:

"Manugistics expects the net proceeds of this offering will be used for working capital and general corporate purposes, including capital expenditures and research and development. The company may also use portions of the net proceeds to acquire businesses, products, and technologies that complement or expand its business."

Shareholders are supposed to judge whether the deal makes sense based on that?!

To find out more, I searched Manugistics' SEC filings -- which are common in a deal like this, even a private one -- but found nothing but a few 8-Ks that contained only the press releases. I also listened to the quarterly earnings conference call on Dec. 19, but management only briefly mentioned the new debt in passing -- boasting about how the offering was "well-received and was well-oversubscribed" -- and not a single analyst asked about it.

Unanswered Questions

So here's what we know: Manugistics took on a lot of debt, on terms that appear to be unfavorable to common shareholders, but has disclosed next to nothing regarding what the money will be used for -- or the terms under which it was raised.

To try to get answers to some of these questions, in late December I emailed Manugistics' CFO, director of investor relations and VP of corporate communications with the following questions (slightly modified from what I sent):

1. Why didn't the company issue stock to raise money? (This is certainly the most common route chosen by companies with stocks trading at extremely high multiples.) Was it the company's choice to do a convertible debt deal, or did market conditions preclude a stock or plain debt deal?
2. Why did Manugistics raise so much money? Why not a smaller amount?
3. Why was it done as a private placement? Who purchased the convertible debt? Is there, or has there ever been, a relationship between the buyer and Manugistics or its management?
4. What were the terms? Why weren't shareholders offered the right to buy this debt? How was the conversion price of $44.07 determined?
5. Is the 14.2% difference between basic and diluted shares outstanding at the end of the third fiscal quarter of 2001 (there was no difference at the end of the second quarter of fiscal 2001) due solely to this debt offering?
6. I went through every SEC filing since Sept. 1 and could only find 8-Ks that had a copy of your press releases. My understanding is the deals like this typically require fairly detailed disclosure with the SEC. Did I miss it, or wasn't there any? If not, why?

I am amazed that not a single analyst asked even one of these questions during the nearly hour-long Q&A session portion of the conference call after Manugistics reported earnings last month.

I will let you know if the company answers any of these questions.