Is there an open-source / closed-source dichotomy in robotics?

Is there an open-source / closed-source dichotomy in robotics?

I just put up a new piece over at Robohub discussing how open-source and closed-source can live harmoniously in robotics–because all robots are services.

ExOne IPO Successful: Shareholders Contribute Random Passers-by

Before I start bashing bankers, I’d like to congratulate the ExOne Company on a successful initial public offering (IPO).  I haven’t seen much about ExOne [NASDAQ:XONE] on the robotics sites, but if we’re calling Stratasys [NASDAQ:SSYS] a robotics company, we should call ExOne a robotics company as well.  It is really good to see another public company in our sector.  Hopefully, this will encourage more investment of both capital and entrepreneurial energy in our industry.

Last time I checked 26 is a lot more than 18.

Last time I checked 26 is a lot more than 18.

By the criteria of the market commentators, the ExOne IPO was a huge success.  You can Google things like “3D printing red hot.”  The IPO was priced at the top of the range $16-18, it opened around $26 before shooting up over $33.  Almost a week later it is trading roughly at its opening price.

Now this is all fine and dandy as far as it goes, unless you were an ExOne shareholder.  Who, by the way were the ones selling in the IPO.  One shareholder sold 300,000 shares in the IPO.  This means that this one shareholder transferred a gain of $2.4M to some connections of the underwriters.  This shareholder is taking $5.4M, less fees and discounts, call it $5M from of the IPO, so $2.4 is not exactly a rounding error.  Presumably, this shareholder is also more inclined to build companies with the capital than whatever speculators are hovering over the IPO.  Similarly, the company lost out on $40M of capital that could be invested in projects.  Think about that.  The company is worth less than $350M and the IPO mis-pricing cost it $40M of cash.  Cash!  Cash that could be sitting on the balance sheet scaring off competition and waiting for the next expansion opportunity.

It is hard to explain an IPO price that is so far below the fair market value of the company.  I know that there are a lot reasons why bankers try to justify under pricing an IPO, but giving-up over 10% of the firm’s market value in a single transaction seems really hard to justify no matter what.  I’m not sure what part of the economic gains from listing publicly should be given to financial intermediaries and incoming investors to get a deal done, but over 10% of the company seems quite excessive.  These new shareholders have no restrictions on ownership and quite likely to flip their shares instead of taking an active roll in growing the company, which seems to further erode any claim they might have to extraordinary gains.

I’m not familiar with the track records of FBR, BB&T, and Stephens, the underwriters for the ExOne IPO, but I’d think twice or three times about hiring them if I was going to do an IPO.  They seem to have not only underpriced the IPO, but also floated too much of the company, almost 40%.  Underpricing the IPO might be tolerable if the bankers had only floated 5-10% of the company.  The company could have done a secondary offering later once the offering had an established market price, instead of getting ripped off during the IPO.  The large offering certainly did do one good thing for the bankers: it increased the underwriting fee.

If my company ever goes public, I hope I’ll have the good sense to hire Morgan Stanley–unless an underwriter is involved in litigation for overpricing an IPO, how can you be sure they’re any good?  Heck, they even give discounts–what’s not to like!

The Knowledge Economy Cash Anomaly, Part 2

This is a continuation of Part 1.

Option Value of Cash on the Balance Sheet

This theory of the cash anomaly posits that the returns from R&D are high, but also highly uncertain.  Every once and awhile, the R&D of a company will produce a really high value project that requires massive investment and possibly acquisitions to use in combination with the asset.  The problem with R&D as an economic asset is that it is very difficult to sell or even be exploited by organizations other than the organization that developed it.  Unlike discovering oil, it is not clear even after discovery of a project that another firm could develop the project to create economic returns.

Because exploitation relies on unique capabilities inside the firm that are only poorly understood outside the firm, their economic value is harder to forecast.  This violates the costless symmetric  information condition of efficient markets is violated, unlike the projects of old economy companies, where the market has a reasonable expectation that it will understand the value of the project.  This uncertainty introduces huge frictions if projects need to raise new capital. Therefore, if a company has R&D projects, the value of that project stream is greatly enhanced if the company also has a means of financing the projects that does not require subjecting those projects to the friction of market financing.  These frictions are both directly financial in the form of more returns to new investors and intermediaries, and also temporal.  In winner takes all markets, which many technology markets are, temporal costs are huge.

The option value of cash on the balance sheet could be huge, however, we would expect more tech companies to at least on occasion, expend all their cash and perhaps even borrowing capacity when they exercised options if this were the case.  This is common in growing technology companies.  Mature tech companies, rarely, if ever come close to expending their investment capacity.

I’m skeptical of this explanation.  Why does Google need to hold enough cash to buy Yahoo or Facebook in cash, if they are never exercise the option to do so?  When was the last time you heard that a company was undertaking a project with more than a billion dollars of expenditures in year one of the project?  These kinds of companies can make acquisitions with stock, invest over time out of future cash flows, and they even have relatively low cost borrowing capacity should it be required.

Cash Poor at Home

Recently, much has been made of the U.S. companies that are parking cash overseas to avoid the tax when they repatriate it.  Many companies are cash poor in their U.S. entity, but their consolidated balance sheet shows a lot of cash.  This cash can’t be repatriated for distribution without a large tax bill.  This is the worst of all possible worlds from a policy perspective, but it doesn’t seem to afflict tech companies as much as industrial conglomerates.

(BTW, Congress doesn’t need to capitulate to corporate demands for no tax on foreign earnings.  All it has to do charge the companies income tax on their cost of capital for any overseas investments, then true up when the companies bring cash home.  Particularly if the law slightly over estimated the cost of capital, or ignored the cost of capital on financial assets in the WACC calculation, so that repatriating funds usually triggered a small refund rather than a small bill, you could just sit back and relax and watch them all bring their cash home while still paying tax.)

Distress Costs

The final explanation I’ve heard offered is the idea that since most of the investments of a technology company are in workforce and R&D, the costs of financial distress are huge.  Not only that, but the costs of financial distress can manifest themselves long before bankruptcy is close.  If managers are cutting benefits or tightening R&D activites, and the costs are not properly captured by accounting frameworks.  New talent goes elsewhere, the best old talent leaves, R&D becomes less creative, less real economic capital employed stealthily decreases without the accountants noticing.  However, CFOs are smart, they know this–even if the accountants don’t.  They keep cash on the balance sheet, employee benefits generous, and 10% time meaningful.  This prevents the stealthy erosion of the real assets of the company, by the prospect of distress, which the intelligent and savvy workforce is acutely aware of even if they don’t conduct formal analysis.

But there is one more reason…

In part 3, I will outline how holding cash creates economic value, regardless of and in addition to, all these explanations.  Go to Part 3.

Why American women are too smart to become robotics engineers

The lack of women in robotics is quite palpable.  I’m not going to quote statistics about the lack of women in robotics because the readers of this blog have been in robotics engineering shops and have eyes—it is that bad.  This is a loss for all of us.  Not only do the women in robotics often have a disproportionate impact, but also the missing women are indicative of a deeper cultural problem that hurts both male and female participants in our industry.

Beyond the issues of opportunity, fairness, and attracting the best and brightest in our field, a lack of women is an indicator of a deep seated cultural problem that is impairing our efforts to make the world a better place.  This insular culture, which robotics shares with many other engineering-centric industries, harms and alienates many men too.  The lack of women in robotics should be viewed as a flashing red warning light of a much deeper problem that affects everyone, rather than just a women’s problem.

Another Knowledge Industry Grapples With A Similar Challenge

While I was at Deloitte, the firm was endlessly bragging about its Women’s Initiate, they called WIN.  Before the turn of the millennium, the partners realized that they had a problem.  At all the ‘working’ ranks of the firm, Deloitte was doing a great job hiring and retaining talented people of both genders.  However, when it came to senior managers and partner level positions, the women all disappeared.

What Deloitte discovered when they looked into this problem was not discrimination.  The problem was that all the top women that the firm wanted to promote were leaving, even though they were being offered the same deal as the men.  Becoming a partner or principal at Deloitte today is arduous, but before WIN it was grueling and brutal.  Basically, becoming principal at Deloitte requires a huge commitment to have consulting be one’s life, but before WIN there was pretty much one way this commitment could look.  Women knew what was required and were more than capable, but they were saying, ‘Screw this, I don’t want to put up with your abuse just to sit at the top of the pyramid and perpetuate it, I want a family (or an impact in the world, or a life).’   So they were leaving the firm.

Deloitte took a hard look at the firm and decided that the path to becoming partner was counterproductively rigid.  They launched WIN and made the workplace much more humane for everyone.  The firm started retaining more talented women and they have thousands of women principals today.  But more interestingly, they also started retaining more of the talented men who had been leaving too, but ‘just weren’t cut out for consulting.’  Deloitte fervently believes—and their impressive growth in the last decade testifies—that they created a much more effective organization.

What had showed up as a women’s problem was actually a firm-wide culture problem.  It turned out that many more men were willing to compromise their performance and risk losing their marriages, families, and personal lives over the firm’s culture problem.   There was nothing ‘wrong’ with the women, nothing they needed to be taught or given to help them get ahead.  They were just not willing to put up with such an unnecessarily inhumane system, while many men were willing to live with it.  As a result, the firm got sub-optimal performance.

The question that Deloitte should have been asking was not, ‘What’s wrong with our women that they’re not making partner?’  Or even, ‘What’s wrong with our men that they don’t help the women make partner,’ it was really, ‘What’s wrong with our men that they’re willing to make partner under sweatshop working conditions?’   I fear that we’re at a similar impasse with respect to the engineering fields.

The Deeper Cultural Problem In Robotics Engineering

Isn’t it odd that we don’t need to make a special effort to interest women in law, accounting, medicine, or the like?  These fields have similar intellectual requirements and levels of drudgery to engineering.  Yet despite comparatively massive efforts to interest women in engineering, they are not entering the field in anything like the numbers we would expect.  And why are American students—including men—not enrolling in engineering fields at the rate that foreign students do?

There is strong social signaling in undergraduate schools that discourages most women and many men from even attempting the study of engineering.  Perhaps they realize that getting an engineering degree can be a long, unrewarding slog when compared to the experience that most undergraduates have.  Perhaps, they have a sense this narrow technical view is carried on beyond undergraduate.  I do not believe that being willing put up with this kind of experience is necessary, and is perhaps counterproductive, to being a great robotics engineer.

Engineering courses are used to screen out anyone who is not willing to devote long hours studying tough courses that do not reward students just for their interest in the subject.  Those who are considering law, business, or medicine as an alternative career may not want to risk their GPAs even trying engineering courses.   No one would bother becoming a robotics engineer unless she had an innate sense that she had a special calling in robotics.  This sense of calling is common among the engineering superstars, both male and female.  Though the current method of engineering education may be adequate for the superstars, this method of education likely alienates many people who could make great contributions to engineering.

We now realize that training medical residents more than 80 hours a week is not productive—engineering isn’t different.  Silicon Valley is starting to see sunlight, humane schedules, leadership opportunities, and pleasant workplaces that promote social interaction as the minimum conditions for engineering productivity.  Colleges such as Olin which have experimented with new (read more people centered) ways of teaching engineering have seen many women enroll.  These are all signs that there is another way to do engineering.  We are starting to see that engineering can be altered to treat engineers and students like social beings, without sacrificing technical rigor.

By attracting people to engineering who are sensitive to the way that others treat them, we will also attract people who are sensitive to their colleagues, customers, and business partners.  Without these engineers who understand their impact on others, engineering will forever be solving the wrong problem.  Engineering education and culture are far too important to all our futures to be left only to left-brained males.  If we let engineering be a secret club that no woman without an extreme commitment would want to join, we will fail to harness engineering’s full potential to improve our society.

 

Avenues for further investigation:

How can robotics companies accelerate the production of an inclusive engineer culture?

What benefits and employee flexibilities have measureable results on engineering output?

How concentrated among the ‘usual suspects’ schools is robotics engineering hiring?

Does hiring outside of the engineering department’s immediate network improve or degrade performance of the engineering organization?

Do robotics engineering organizations with more women tend to do better?  (Hypothesis:  There is positive correlation, but not to be confused with causation.)

Newsflash: Business School Professors Wrong, Delaware is Not Always the Answer

I’m working on incorporating a start-up and I discovered something very interesting, Delaware is NOT necessarily the best place for initial incorporation of your start-up.   If you are profitable, public corporation, Delaware is almost a no brainer.  However, there is no tax liability associated with moving to Delaware and most start-ups are not profitable or public.

Being incorporated in Delaware adds complexity and several fees and expenses that you might not incur when incorporating in your home state.  Especially if your state follows the model corporation act, you might consider incorporating there.  If you are not profitable, the corporate income tax rate of your state is irrelevant, you save a bunch of fees, the complexity of having registered agents, and having to qualify as a foreign corporation in your state.

The advantages of being in Delaware are in legal provisions that only apply once you have many classes of stock, the taxes on profits once you have them, and the power of officers and directors, particularly once the corporation is public.  None of these matter if you are pre-seed stage and may not matter at all until an IPO.  If the VCs demand that you be a Delaware corporation, okay, no big deal it can get done in less time than it will take them to finish their paperwork, but in the meantime, you’ve saved some money and most importantly some headaches of dealing with a state that is constantly trying to put its hand in your pocket.

I had been told by several entrepreneurship professors that Delaware is the only choice for incorporation of a start-up.   I was surprised to learn that this is not necessarily the case.  Others seem to think so as well.  Pass it on and consult with your counsel to  make a decision that is right for your circumstances.

Is a dollar worth a dollar on a tech company’s balance sheet?

Previously, dear reader, you and I have discovered that robotics companies are firmly entrenched in the knowledge economy and their assets look like other knowledge economy companies’s assets.  Robotics companies only hold only a limited amount of real assets but lots of financial assets.

As a related question, what is the value of the cash (and financial assets) on the balance sheet to investors?  There might be several issues with holding so much cash.  Particularly, money in a company should be employed making more money, ‘earning or returning’ as the saying goes.   Are there valid reasons to hold so much cash?  And if so, how should we value the cash that knowledge economy companies hold?

Cash Is King! (Or at least a founding father)

Bottom line up-front:  Valuations are always wrong.  What’s interesting is how they are wrong.  Assuming a dollar is worth a dollar is as good a rule as any, but is almost always wrong.  Nobody is really sure which way (too much or too little) it is wrong.  Below, is an elaboration of some of the issues with valuing cash which may come into play when valuing particular companies.  (And you thought that at least cash of all things had a fixed value  —  don’t we all wish!)

There are various criticisms of excess cash on the balance sheet, below are some of the most common.

1)  Holding the extra cash reduces returns, i.e. to buy into the business you have to buy a pile of cash beyond what is ‘necessary’ to run the business.  Further, the rate of return on cash has been essentially zero and certainly below inflation lately, so holding the portfolio the stock represents of a highly profitable business, plus cash must necessarily produce a lower expected return than just the business.

2)  Because of agency problems, management may be incentivized to use the cash to reduce volatility or ‘save’ the business if it falls on hard times, even if the investors could get a markedly higher rate of return in the market.  From an investor’s point of view this would be systematically wasting money.  Employees, customers, management, and trading partners might have a very different view.

3)  Holding lots of cash is said to signal that the company does not have profitable investment opportunities commensurate with the cash that it is generating and the company’s growth may slow in the future.  Further, holding lots of cash signals that you don’t know, or are ignoring, the traditional Anglo-Saxon business administration.  English speaking investors generally expect management to maximize monetary returns over the forecasting horizon and put shareholder interests ahead of all others.

Some countervailing points that you will often hear are along the following lines. 

A)  Although holding cash reduces returns, for a volatile security like a fast growing knowledge economy company, having cash on the balance sheet dramatically reduces volatility.  If investors want more exposure to the underlying business for the same initial investment, lever-up.  Since we are talking about cash holdings, buying on margin is almost a perfect antidote to management’s lackadaisical cash management policies if you feel that way.  [But seriously, who is their right mind thinks you need to lever-up when buying tech stocks?]

B)  Although management might ‘burn’ cash saving a failing business, which would be better redistributed to investors, more likely, they are going to have the flexibility to engage in acquisitions and new ventures without having to deal with the whims of the security markets.  [Has anyone seen a rational market lately?  Please let me know.]

Or has anyone read the Wall Street Journal?  Tech companies are routinely attacked for having their fixed life fund investors exit—Groupon and Facebook each got front page hatchet jobs over the past two days with nary a mention that these funds had been planning to sell now for, oh say, 8-10 years!  Talk about journalistic malpractice.  Would you want to go to the public markets in that environment?  I sure wouldn’t.  If I was management, I’d say that if investors are that irrational, I’ll keep the cash and do what they should have done with the money.

C)  Finally, although cash on hand may sometimes signal that the companies are running out of investment opportunities, it certainly signals to would be competitors that the said company is in a position to stick around for a long time and bitterly contest any erosion of their market position.  This may greatly enhance the value of the underlying business asset.

D)  This is a successful tech company.  It is run by the founders, for the founders (i.e. management).  If you don’t want the privilege of investing and taking whatever returns the founders deign to give, please step aside and allow the next investor to purchase stock.  But this isn’t really a justification.  Founders are investors too, especially once the company goes public, with theoretically the same motivations as other investors since their stake is highly liquid.

Further research on technology companies and their cash management policies should address the following issues:

I)     Are there structural reasons beyond the creation of new businesses and defense of existing businesses for technology/knowledge companies to hold lots of cash?  It does not occur to me that there is anything about a maturing knowledge business that seems to require massive amounts of cash.  Law firms and accounting firms do not seem to hold too much cash, but they are also typically private and can make much more drastic changes than public companies.

II)   Are there frictions between the interests of various classes of investors?  Particularly when there is a founder controlled/managed company, cash on the balance sheet is probably as good to them from a control perspective as cash in the bank and better from a tax perspective.  Should investment banks or others creating the classes of stock have new mechanisms to deal with this?

III)  What are the true limits on investment opportunities?  My firsthand observation has been that the greatest constraint on growth of robotics companies is management attention.  It may be that most technology companies have massively profitable investment opportunities, but management attention is engaged on current projects and hiring into the management circle is not that easy.  What is the needed resource to change this?  How can cash be used to obtain this resource?  Can it?  Is passion required?

IV)  Are there ways that management could resolve some of the market frictions that require them to hold lots of cash?  The public markets seem to mercilessly abuse tech companies—no they don’t look like utilities, but the highs and lows that they are pushed to seems unjustified—there just doesn’t seem to be enough new information about their future prospects to justify either one.  Can management take steps to make access to public markets, particularly debt markets more reliable?  Could banks make money by providing massive, typically undrawn, lines of credit that would provide much of the same protections to management?

Which VCs are investing in robotics? Here is the list.

the instrument of venture investment

source: SEC.gov

My overview of the Firms Behind the Hizook 2011 VC in Robotic List has graciously been published at Hizook.

Bottom line:  We don’t have a cadre of dedicated robotics investors, but we can get investment from the industries that serve as our customers.

I wish you all luck in getting some of that VC Cash.  …on second thought, no, actually, I don’t–I  wish you all luck in signing up major partners who will give you progress payments to complete your product without diluting your investment.

But whatever your situation I hope that you use the appropriate capital structure to make lots of robots, lots money, and lots of good in the world.