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To: Glenn Petersen who wrote (223)2/9/2003 1:55:56 PM
From: Glenn Petersen  Read Replies (1) | Respond to of 246
RoweCom purchase haunting Divine

Buyer infected by problems it couldn't cure

Rob Kaiser, Tribune staff reporters
Published February 9, 2003

For a flamboyant dealmaker like Divine Inc.'s Andrew "Flip" Filipowski, it would be hard to find a less sexy business than placing libraries' subscriptions to obscure journals such as Tetrahedron, a must-read for chemists.

Yet Divine's opportunistic CEO was determined in late 2001 to buy just such a business--RoweCom Inc., a troubled Massachusetts public company.

Filipowski's chief financial officer counseled against the deal, as did at least one outside financial adviser, according to one person who participated in the discussions.

But Filipowski wanted to buy RoweCom for two reasons.

Despite its losses, RoweCom's $348 million in sales would build Divine's revenues, helping Filipowski make good on his boast to shareholders to create a $1 billion in sales company from the ashes of the dot-com disaster that killed his Internet incubator.

Filipowski also was convinced he could turn RoweCom into a marketing machine. He envisioned selling Divine's software to leading libraries and publishers in the rarefied world in which scholars and scientists exchange ideas.

RoweCom not only would turbocharge Divine's sales. It would also put a glossy sheen on the patchwork of financially strapped companies that Filipowski's team was buying to create a software company in the turmoil following the tech collapse.

What ensued did not come close to Filipowski's plan.

Bankrupt RoweCom's problems now threaten Divine's future and spotlight the Chicago company as a culprit in a high-profile financial mess.

"This is unquestionably the biggest financial collapse America's libraries have had to deal with," says American Library Association Executive Director Keith Michael Fiels.

The unfolding scandal left hundreds of libraries without important periodicals and out more than $65 million collectively in subscription fees Divine allegedly failed to forward to publishers, according to RoweCom's lawsuit against Divine.

The suit, in a Delaware bankruptcy court, seeks the return of at least $74 million to RoweCom--a sum that almost certainly outstrips Divine's cash.

Librarians around the country are calling state watchdogs about missing money and periodicals.

Illinois Atty. Gen. Lisa Madigan launched an investigation last week. More suits are likely following a civil fraud action against Divine in December by New York's attorney general on behalf of a university in upstate New York. That suit seeks $50 million in damages.

Survival threatened

The mess not only has left a stain on a high-profile venture that was supposed to place Chicago on the high-tech map. It also reduces the odds of Divine's survival,

Sources close to Divine say the company needs a cash infusion or a buyer, as well as favorable terms in settling RoweCom's claims.

Divine says RoweCom's suit is "completely without merit" and that it would prevail if it were forced to litigate.

"We expect the RoweCom situation to be resolved shortly through the completion of the sale to EBSCO" Industries Inc., a financially sound competitor, Divine said in a statement Friday.

"With the sale nearly completed we are focusing on our core businesses and customers and are excited about some of our new business initiatives," Divine said.

RoweCom's sale to EBSCO would go a long way toward resolving the library crisis because EBSCO can afford to work with publishers to keep subscriptions going while continuing to negotiate claims against Divine.

Yet Divine's problems go deeper.

In a severely depressed software market, the company still has too few sales and too many employees--2,244 worldwide, including 376 in Chicago--to turn a profit.

Divine burned through $27 million in the third quarter, leaving it with $63 million in unencumbered cash as of Sept. 30. It had drawn about $10 million on a $40 million line of credit from LaSalle National Bank, according to Securities and Exchange Commission filings.

Divine's fourth-quarter report is scheduled for Feb. 25, when it is expected to take a large writedown of goodwill--a non-cash charge.

Meanwhile, the company's stock has sunk again into penny stock territory, trading in the 70-cent range, below the $1 minimum for Nasdaq listing--nine months after a reverse-stock split boosted the price to about $5 per share.

Total market value has fallen to about $19 million--less than one-third the $61 million equity infusion last year from Oak Investment Partners, a well-regarded private equity firm.

Oak, which has two seats on Divine's board and controls the company through its preferred stock holdings, is Divine's most likely savior in a cash crisis.

Fred Harman, Oak's lead partner on the Divine investment, was unavailable Friday, and Filipowski did not return telephone calls.

"They're not just going to throw good money after bad," said a former Divine financial adviser. "[Oak] will have to be very well satisfied there's a good potential return."

Still, investors who know Filipowski, and his sale of Platinum Technology International Inc. when that firm was financially troubled, say it's not smart to count him out.

"I find it very hard to believe [Divine and Oak] are out of bullets this early," says a private equity investor.

RoweCom was an unlikely acquisition for a software company.

Kent Mulliner, collection development coordinator for Ohio University in Athens, recalls Divine/RoweCom's large booth at a library conference last summer in Atlanta. Divine was demonstrating software to let librarians and patrons chat online.

But Ohio's university libraries already were using a competitor's software.

"I told them, `This sounds like a great product,'" Mulliner recalls, "`but you're late to the party.'"

RoweCom's main business is subscriptions. The company is a distant third among the industry's top three agents, which pool millions from libraries to place orders for thousands of magazines, mainly scholarly and scientific journals.

RoweCom's $348 million in 2001 gross sales was largely subscription money. Net sales--the portion RoweCom keeps to operate its business--totaled less than 10 percent.

Agents must tightly manage cash flows. Historically, libraries forward money to agents at the end of their fiscal year, in June or July, while agents typically don't pay publishers until late fall.

"It's a nice opportunity to make some money off the float for those few months," says industry analyst Leigh Watson Healy of research firm Outsell Inc.

But agents also must plan for a year-end cash squeeze because money that isn't paid in advance arrives in January or February.

RoweCom, which had incurred losses due to poor investments, was facing a cash crisis when Divine bought the company. At the time, Divine closed the gap with bank financing. But a year later, when RoweCom was caught in a similar crunch, Divine--whose own cash had dwindled--could not arrange financing.

Looking for buyer

Anticipating the crisis, Divine had been scouting a buyer. But when it could not close a sale or arrange credit to pay publishers, it notified libraries in late December that it would no longer support the business.

Librarians and publishers formed a committee to negotiate with Divine and EBSCO, which finalized an agreement last week to buy RoweCom's European operations. Talks continue over the more troubled North American operations.

Divine's actions raised "concerns for the whole industry," says Mark Seeley, general counsel for publisher Elsevier Science Ltd., a leading journal publisher.

Copyright © 2003, Chicago Tribune