The Second Time Around – Commerce One’s investment in Covisint
IT LOOKED LIKE GREAT NEWS for Commerce One Inc. last December, when it proudly announced it was becoming a technology partner with Covisint LLC, the online auto-parts exchange formed by General Motors Corp., Ford Motor Co., and DaimlerChrysler. The procurement-software maker gave a total of 28.8 million Commerce One shares to GM and Ford in the deal–a 14 percent stake worth a total of $1.2 billion at the time. For its part, Commerce One received a 2 percent equity stake in Covisint, a share in Covisint’s revenues for 10 years, and consulting fees.
But some are questioning whether the deal is either great or new for Commerce One. While the deal has been hailed as a groundbreaking alignment with the auto giants, in reality its terms largely reworked an earlier, two-party arrangement between Commerce One and GM.
Some 13 months before, in a deal the Covisint announcement didn’t mention, GM had named Commerce One as a partner for GM’s 1999 online parts marketplace, called TradeXchange. For that opportunity, Commerce One–then a much smaller player in the procurement field–agreed to give GM alone 28.8 million shares, which then represented about a 20 percent interest in the company. (That deal never formally closed.) So the Covisint agreement actually halves the number of Commerce One shares GM was supposed to hold, while giving the other half to Ford. Of the total shares given to GM and Ford, 50 percent will be held in escrow until 2002–or 2004, if Covisint fails to meet certain performance conditions. The stock transfer is expected to occur only after Commerce One restructures into a holding company.
To some analysts, the new deal appears far less attractive for Commerce One than the previous deal in 1999, when an up-start software firm first grabbed a chance to work with giant GM. Says analyst David Mahoney, principal at Wit Soundview, the original deal made sense because it “kick-started” the company. But that was “before industry consortiums started coming together,” he says. “Now, it’s not all that advantageous to give up such a big chunk of your company to some players so you can sell software.”
The stock market has agreed that the Covisint deal leaves something to be desired for Commerce One, as if fails to give the software firm the same big bounce it experienced with the 1999 deal (see chart, page 34). The hot and cold investor responses, in fact, illustrate clearly that big partnership deals involving equity swaps aren’t nearly the Wall Street darlings they used to be.
From GM’s perspective, the advantages of this second deal are fairly easy to gauge. Halving its expected Commerce One interest reduces the exposure to Commerce One’s volatile shares, which shot up from around $50 to $137 after the first deal was announced (after accounting for two stock splits) and then plunged to around $35 just before the Covisint arrangement was announced. Jon Ekoniak, senior research analyst for US Bancorp Piper Jaffray, figures that GM promised the 14.4 million Commerce One shares to Ford essentially to “coerce” it into joining the Covisint partnership. “Overall, it’s a dilutive deal to [Commerce One] stockholders,” says Ekoniak. “If the deal were done today, it would not be a good deal.”
The new arrangement certainly enhanced the reach–and potential revenues–of the industry exchange, especially when DaimlerChrysler was added. Launched last October, the Covisint Web site handled $350 million of purchase transactions in the fourth quarter, and GM’s purchasing chief, Harold Kutner, predicts a 2001 transaction volume of $50 billion. Infrastructure for the exchange seems to be on track, and Covisint is fully funded for 2001, a spokesman says.
For Commerce One–which despite strong revenue increases has been downgraded by some analysts in the embattled procurement-software market–the situation is more mixed. Beyond the revenue benefits it will also enjoy, “the collateral effect has been obvious,” says Commerce One CFO Peter Pervere. “It has put us in a position to win a lot of business from other companies, and business from within those automakers’ other divisions.”
But the projected transaction volume reflects both “indirect” commodity-oriented products like fasteners, and customer-designed direct products, which some observers think are resistant to the move toward exchanges. (Direct products, like proprietary engine parts and on-board computers, come with extensive specifications–and far higher margins.) Further, the major cost-saving components of the site are supply-chain management and collaborative design functionality–a big draw for manufacturers and suppliers. Although Covisint has the software for these components, that isn’t worth much unless supply partners are wired to use it, which could take three to five years.
WHO WILL BUY?
Wit Soundview’s Mahoney predicts that Covisint will settle into a comfortable niche as the channel used for buying indirect products, while direct products are bought “in extranets and private networks.” He adds, “I don’t think humongous marketplaces will ever take off for direct materials.” For those, “quality is more important than price.” A recent all-industry study by Giga Information Group Inc. supported this assessment, forecasting that $5.2 trillion in B2B sales will go through a variety of channels by 2004, including electronic data interchange, direct Internet links, extranets, and private E-markets. “As business-to-business E-commerce matures, there will be no single magic channel that meets all companies’ needs,” says Andrew Bartels, a Giga vice president and research leader who follows the E-commerce market.
The biggest impediment for Covisint may be the cost pressures the exchange places on suppliers below Tier 2–those that themselves supply major auto suppliers. A recent KFMG LLP study listed the auto industry as the slowest to adopt Internet technology among the seven surveyed, with auto-industry suppliers especially wary of the security of online product exchanges. “Suppliers wanted to make sure their proprietary intellectual capital would be protected,” says Brian Ambrose, the study’s lead author.
Many of those suppliers also worry that the exchanges’ auction nature could help automakers slash supplier prices. And they fear making their inventory information available online to car companies, something necessary for the full supply-chain integration and collaborative planning envisioned as the Holy Grail of Covisint. While common among Tier 1 and Tier 2 suppliers, often directly wired to manufacturers, the requirement for open information may make smaller providers balk. Others simply lack the technological infrastructure to integrate inventory information in an exchange’s supply-chain management system.
Analysts are also concerned about when, if ever, Commerce One will gain that Covisint equity stake, if the depressed dot-coin market delays Covisint’s initial public offering. And there’s a question whether the automakers will continue to support Covisint’s development, given their own financial problems of late. Covisint’s take on that prospect, says its spokesman, is that “in a downturn, Covisint becomes even more important,” because carmakers “need to make use of every possible means of cost-cutting.”
Is Commerce One kicking itself just a little for giving away so much stock for its shot at the big leagues? No, says CFO Pervere. “It’s hard to value what value you get from this deal,” he concedes. But his company doesn’t expect to sign another pact like it, ever. “There’s only one Fortune One,” he says of GM. “We’ve entered into major agreements with other companies, and equity has come up, but that happens only once in a business’s lifetime.”
Commerce One stockholders may be relieved to hear that.
KRIS FRIESWICK (KRISFRIESWICK@CFOPUB.COM) IS A STAFF WRITER AT CFO.
THE CAST AT COVISINT
Some key players in the auto-parts partnership.
BUSINESS PARTNERS (SAMPLE)
Delphi Automotive Systems
SOURCE: COVISINT LLC
COPYRIGHT 2001 CFO Publishing Corp.
COPYRIGHT 2001 Gale Group