Due Diligence: A Thriller

by Jonathan Rush

  “We didn’t just pull that out of the air,” said Rob. “We did a hell of a lot of work to get to—”

  “A lot of work,” said Menendez derisively. “I should show you what a lot of work is.”

  “I think if we’ve got a range—”

  “What? You got an issue?” Menendez stared at him. “We haven’t got time for this. You got a problem?”

  “I haven’t got a problem.”

  “You got something you want to say? You haven’t got enough work to do?”

  Rob looked at Menendez’s belligerent, pop-eyed face. “No,” he said.

  “Good. That’s about the smartest thing you’ve said all day.” Menendez turned back to Sammy’s computer. “Look at this crap here.” He pointed to something on Sammy’s computer screen. “Do what the Shark says. Right? Just fucking do it, Sammy.”

  Sammy nodded.

  “I’ll be back at eight. Make sure these guys don’t fuck everything up.” Menendez got up. He threw a glance at Rob and left.

  There was silence.

  Sammy sighed. “Rob, there are some things you shouldn’t question in front of Phil.”

  “Like anything,” muttered Cynthia.

  “You’re saying I can’t ask?” said Rob. “Sammy, if you’re telling me I can’t question anything, I think that’s an issue.”

  “You can ask what you like,” said Sammy. “I’m just telling you, Phil doesn’t take kindly to it. He’s not interested in questions from analysts. I’m not saying it’s right, I’m just telling you how it is. You can accept my advice or not, it’s up to you.”

  “Did we advise Leopard to go in at that price?”

  “Twelve-point-five?” said Sammy. “I don’t believe so. I believe the client favored a strategy of going in high to get immediate agreement. We suggested eleven-point-seven-five, twelve if he wanted to make the deal look really sweet.”

  “And he went in at twelve-point-five?”

  “That was his call.”

  Rob took the document back and looked at the offer page again. Twelve-point-five billion—4.2 billion in cash, the rest in stock.

  “I thought we were going a quarter cash. This is a third.”

  “Client’s call,” said Sammy.

  Rob was silent. Stock prices could move up or down. Cash in hand was certain. More cash in a deal was like an additional bump in the price.

  Sammy and Cynthia turned back to their computers.

  “If we think it’s worth eleven-point-seven-five billion max, our client’s throwing away three-quarters of a billion of his shareholder’s money.”

  Cynthia clicked at her keyboard.

  “We’re agreeing to that.”

  Sammy turned around. “It’s a valuation, Rob. We could be wrong. It could be worth thirteen. Maybe Leopard’s getting it cheap.”

  “What about you, Cynthia?” said Rob. “What do you think?”

  Cynthia entered a couple of numbers, scrolled down the page, entered a couple more numbers. “The offer’s crazy,” she said, eyes still on the screen. “But they want the deal, right? So they’re going high to make it irresistible.”

  “They want it so much they’ll throw away almost a billion dollars?”

  Cynthia shrugged. “It’s just our valuation, Rob. Who says we’re right?”

  Rob shook his head. “This is crazy. This is just wrong.”

  “It’s a negotiation tactic,” said Sammy.

  “You don’t negotiate like this. Come on, Sammy. That’s not negotiation. That’s surrender.”

  Sammy watched him.

  “Don’t you think something odd’s going on here? This guy goes in at a price that’s a full three-quarters of a billion over the top of our range. Why? He’s got so much money he can’t get rid of it quick enough?”

  “He wants the deal done quickly. It’s a tactic. You go in high, you get the deal.”

  “Yeah, but why do a deal if you’re going to destroy three-quarters of a billion in value?”

  “I told you, Rob,” said Sammy very quietly, very deliberately. “It’s just an estimate. His valuation may be better than ours.”

  Rob stared at Sammy. Then he shook his head. “You don’t believe that. You saw the work I did. Hell, Sammy, you did half of it yourself. You know what went into it.” He turned to Cynthia. “You don’t believe that. Do you believe that?”

  Cynthia didn’t reply.

  “Neither of you believe it! Come on, Sammy, what are we talking about here?”

  Sammy shrugged.

  “Sammy?”

  “We’re talking about our client.” Sammy’s tone was still patient, but there was an edge to it now that hadn’t been there before. “Our client has given us a mandate to advise him, and we’re executing it. We get an advisory fee because we advise. If the client doesn’t take our advice, that’s up to him. Valuation isn’t an exact science. We may be wrong. The client may be right.”

  Rob shook his head.

  “Rob, you were a lawyer before. This isn’t that different. You have a client. You serve his interests. You give him advice. You lay out the options. He listens, makes his judgment, gives you instructions. You follow them.”

  Rob gazed at Sammy. But there was nothing more to be read in Sammy’s eyes. They were steady, cool.

  He glanced at Cynthia.

  “All I care about is getting a good review on this project,” she said. “Just let that fat bastard Menendez give me a good review.”

  “Exactly,” said Sammy. “We’re all in this together. Every one of us wants the same thing, to get a good review. Rob, you’re doing a good job. Just keep doing that. That’s what Phil’s really saying to you. Focus on what you’ve got to do and don’t worry about anything else. That’s how you get ahead here.”

  Rob watched him.

  “No one gets a good review when someone on the team acts up,” said Sammy. “Everyone suffers. You understand what I’m saying, Rob? Everyone suffers.”

  Cynthia was looking at him.

  “I understand,” said Rob.

  “Good. Now, when this thing moves to the next stage, you’ll go to London to do the due diligence. You done that before?”

  “Only as a lawyer.”

  “Okay, this’ll be another learning experience for you. That’s what you should be getting out of your first assignment, as much learning as you can get. So, can you keep doing the proofing?”

  “Sure.” Rob turned to the next page of the document. It showed a history of Leopard’s share price. There had been a sharp dip at the start of the year, then the price came back.

  “What caused this?” he said to Sammy.

  Sammy glanced at the page. “Nothing. A revenue writedown. Don’t worry about it.”

  * * *

  Emmy came out of the bedroom, bleary-eyed.

  “What time is it?” she said.

  Rob glanced at his watch. “A quarter past two.”

  Emmy yawned. “When did you get back?”

  “A couple of hours ago.”

  She looked at him in surprise. “What are you doing? You still working?”

  “There’s just a few things I need to check.”

  “What?”

  “Nothing. It’s just work.” Rob looked at her. Emmy’s hair was mussed, and she was in a long T-shirt. “Stand there like that much longer, and you’ll force me to act.”

  “Will I? And what action will you need to take?”

  “You don’t want to know.”

  Emmy rolled her eyes. “I’m going back to bed.”

  Rob nodded. “I won’t be long.”

  “Don’t wake me,” she said over her shoulder. Then she stopped and turned back. “I meant to tell you, I bumped into Greg today. You know that bookshop on Sixty-third? The one that does the readings? I saw him as I was coming out. Rob, he didn’t look too good. I think things are pretty bad with Miss Snookums. You haven’t seen him since Wednesday, have you?”

  “When would I have had the chance to see him,
Emmy?”

  “You should give him a call. Have a beer with him. You know, just you two.”

  “If I can make the time.”

  Emmy raised an eyebrow.

  “I know. You’re right. I’ll make it.”

  Emmy nodded, then headed for bed.

  Rob watched her go. He looked back at his computer. The screen showed a page from the Louisiana Light annual report.

  He had realized something that afternoon after he had dared to question the Shark. He knew virtually nothing about Louisiana Light. He could cite chapter and verse about fourteen different electricity companies around the world, and more than chapter and verse about BritEnergy, but about Louisiana Light he could say hardly a thing. He thought it was about time to find out.

  They were up to their eyeballs in debt. That was immediately obvious from the most cursory examination of the financial pages in the annual report. But that didn’t prove anything. Many of the companies he had analyzed were carrying a lot of debt. The electricity business was a hugely capital-intensive industry, and if you were going to grow—as Louisiana Light had done so spectacularly—you were going to suck in capital. Debt wasn’t bad as long as you had the revenue to service it.

  That was the thing that had gotten him thinking. The revenue writedown in January that Sammy had mentioned.

  Following the writedown, the share price had dipped by around five dollars. That was about ten percent of the stock price, or close to a billion in value. A search of the Louisiana Light filings on the company website had quickly revealed the reason. An announcement of a $208 million writedown of revenues that had been booked in their Hungarian operation. The announcement said it was a one-off due to exceptional market conditions brought on by the credit crunch. Could be. But that $208 million writedown caused a billion-dollar dip, which suggested the market wasn’t so sure it wasn’t the tip of a fivefold-bigger iceberg. Yet eventually the market must have bought the line. Within a couple of weeks the stock was back up to where it had been.

  How did you write down revenue? Writing something down meant you were revising a figure you’d already claimed up front. But you were only supposed to book revenue as you earned it, so you wouldn’t need to write it down later, because you actually had it. Or that’s what Rob thought. He was no accounting expert, but he had taken corporate finance as part of his MBA and he had the basics. But he also knew accounting rules were riddled with so many exceptions that even experts had trouble following them. And the less developed the jurisdiction, the more profuse the exceptions.

  Maybe in Hungary you could book revenues ahead if you had certain kinds of contracts. Maybe that explained it. But then, if you were going to understand the numbers in the report, you’d need to know about that.

  That got him thinking. If you went back to the time when they booked that revenue, would you have known they were claiming it even before they’d earned it?

  He started going back through earlier annual reports. Louisiana Light had entered the Hungarian market with an acquisition in 2004. Through one report after the next, Rob tracked the revenue statements. There was nothing anywhere about booking revenues up front.

  If it was only $208 million, compared with Lousiana Light’s total revenues it didn’t really matter. But what if there was more? How would you know? There was nothing to indicate the $208 million that had been booked. Maybe there was another $208 million, or $408 million, or a billion. If you couldn’t distinguish the $208 million from the rest of the company’s revenue, how could you trust a single number you saw in these reports?

  Rob closed the computer and thought about it. Surely it couldn’t be that obvious. He must be missing something. If he could reach that point within a couple of hours of looking through the filings, if he could conclude that you couldn’t trust a single number in those reports, anyone else could. There were analysts who did nothing but spend their whole lives looking at companies in the electricity sector. Rob looked at the share price chart again. A billion in value off. Mike Wilson must have had some explaining to do to the market. Whatever he said, it must have worked. The share price came back up and stayed up. Obviously no one was worried. Why should he be?

  And surely if something at Louisiana Light was really wrong, the credit crunch would have exposed it. Anyone with shaky foundations, he thought, would have been swept away by now.

  But it still didn’t seem right. The Leopard was up to its neck in debt and within the last year had written down revenue that had been claimed sometime in the past. And now it wanted to do this deal and was throwing three-quarters of a billion above the top of the range at the target to try to get them to agree. Not to mention paying forty bips to its investment bank along the way. That had seemed like some kind of a coup for the bank before, but now it seemed suspicious.

  Red flags. That’s what they were, and they were everywhere.

  During induction, there had been an hour’s session on ethics from one of the MDs. He talked about something called Know Your Client, which was a set of guidelines to help you understand your client’s situation so you could give the best, objective advice. It was also supposed to help you figure out if your client was doing something wrong. Red flags, he called them. Things to watch for, indicators that there were problems. One of them, Rob remembered, was if your client wanted to pay you in a foreign currency. “If he wants to pay in rubles,” said the MD, “you know something’s wrong.” Then he said, “If you’re dumb enough to take your fee in rubles, you don’t belong at Dyson Whitney.” And everyone laughed, which is why everyone remembered it.

  Another red flag they had been told about was when a client accepted your terms too quickly. Rob didn’t know how quickly Leopard had accepted Dyson Whitney’s terms, but how much negotiation could there be if you walked away with forty bips?

  And offering above the valuation range? The MD hadn’t mentioned that one, but it seemed like a red flag to Rob.

  Yet Sammy and Phil Menendez claimed not to think so. It was just a range, they said. The client could do what he wanted. He could go above or below. It was just a range.

  It didn’t seem right. You could explain one red flag as a coincidence. Maybe two. But he had three.

  If he could spot them—a rookie six weeks on the job—then so could everyone else. All Cynthia cared about was getting a good review. And he didn’t expect anything from Phil Menendez, who was clearly pathological. But for some reason he expected more from Sammy. But why? What did he really know about Sammy Weiss? A week on a team working together under such intensity can make you think you know someone, but you don’t really know them at all. The only thing he could really say about Sammy Weiss was that he was obviously a star producer, someone that even a psycho like Phil Menendez grudgingly respected. And what makes you a star producer in a place where an associate is supposed to focus on his work and not bother anyone with questions?

  Rob knew what Sammy had been saying to him that afternoon. Focus on your work, and the collective animal that was the team would protect you. Ask the wrong questions, and you were on your own. No one would shield you.

  But that didn’t take the red flags away. They were still there, all around, brighter, redder the more he thought about them.

  They pointed to one clear conclusion: Louisiana Light was desperate to do this deal. Why would they be desperate? Because a deal was the only way out. Of what? What could be so wrong that a deal was the only thing that could save you?

  Rob thought about it. Who were these people at Louisiana Light? He opened the computer again. At the start of the report was a message from the chairman. Some guy named Edward Leary. His face was at the top of the page. An old guy with kind of a flat, almost bald head. On the next page was the message from the president, Michael T. Wilson. Rob skimmed it. All about how great they’d done in navigating through the downturn. Managing their costs, but not being blind to opportunity. Using it to position the company for the next stage of its growth by investing selectively in high-p
otential assets that came to the market.

  Over the past week, Rob had heard Wilson’s name about a thousand times. There was a picture of him at the top of the page. Healthy, fleshy face, full head of silver hair. Usual kind of corporate shot, half left profile, middle-distance gaze.

  Rob turned a couple of pages. There he was again, with his executive team around him. Arms crossed, chin up.

  He didn’t look desperate. He looked confident and strong.

  But what if, behind that facade, he was desperate? What would be his next move?

  Louisiana Light was filing its quarterly results later in the week. Anyone doing a deal would want to put out a good set of results. But if you were desperate, thought Rob, you’d put out a set that were extraordinary.

  No. That would be too obvious. It would raise suspicion on the part of Buffalo. You’d put out a set that were good, above trend. Not extraordinary. Solid. Enough to keep the stock price up, maybe bump it a little.

  He looked over Louisiana Light’s earnings results for the past few quarters. Growth of a very attractive six to eight percent, excluding the Hungarian writedown.

  Nine percent, thought Rob. If Mike Wilson was desperate, that’s what he’d want to put out.

  13

  Ed Leary sipped his coffee, trying to concentrate. He was sitting in the Houston boardroom of SRK Exploration, and John Sadower, CEO of SRK, was giving his management update to the board. Sadower droned on, showing charts with columns of dense little numbers that no one wanted to have to look through.

  SRK was an independent petroleum exploration outfit that did most of its work on contract with the oil majors. The S in the name stood for Sadower, who was one of the founders. The other two, Bill Robertson and Hugh Koch, had cashed out of the business years earlier. John was seventy-one, but he showed no signs of leaving or even thinking about succession. For the board, that was becoming an issue.

  Sadower was a small, neat man with a trim, white beard. Originally from Minnesota, he had turned himself more Texan than John Wayne, string ties and cowboy hats and big buckles on his belts. Not only was he the CEO of SRK, he was also the chairman of the board. This made getting the succession question on the agenda a doubly tricky proposition. A couple of the other directors had called Leary up before the meeting. They wanted to force the issue. Ed agreed that it needed to be raised, but he wasn’t going to go out on a limb to do it. Eventually, they concluded that one of them should talk to Sadower privately after the meeting to make sure it was on the agenda next quarter. Ed didn’t volunteer. In the end, Doug Anderson, another nonexecutive director, agreed to do it. Doug had arranged to stay over in Houston and have dinner with Sadower after the board.