Itel struggles to stay on its feet in technological storm
It once glittered in the spotlight of success as the golden boy of West Coast computer leasing companies. Now, beset by lawsuits and a staggering debt of $1. 3 billion, Itel Corporation waits in the shadows backstage facing the grim possibility of bankruptcy.
The rise and fall of Itel follows the script of a classic melodrama. Itel's phenomenal rise as the first company to exceed $1 billion in revenues in 12 years, is in the best tradition of American success stories. Its plummet points to the danger of pushing success too far. It also points out some of the pitfalls companies must avoid if they expect to compete in the potentially profitable -- but equally risky -- growth of computerized offices.
The next six months will determine whether Itel will survive the worst financial crisis in its 13-year history. Its fate depends upon whether it can restructure its debt with more then 200 creditors and negotiate insurance claims that may exceed $250 million with the First National Bank of Boston, US agent for Itel's insurer, Lloyd's of London.
Itel announced on Nov. 20 that the initial debt-restructuring plan had failed and it would now be forced to create a new plan. And on Dec. 18 James H. Maloon , presiding as chairman, president, and chief executive officer, told grim shareholders that an even broader restructuring was being planned. This one, he said, would require heavy sacrifices by Itel's various debt and equity holders.
Sources familiar with the company as well as Itel officials are not optimistic the restructuring plan will succeed. Says one securities analyst who has met with Itel officials in the past, "I wouldn't bet a large amount on it, buy my guess is that the company will go under." Herman Howerton, vice-president and executive officer since 1972, says, "There can be no assurance that we can achieve the debt restructuring."
Founded in 1967 by Peter Redfield and Gary Friedman, two San Francisco businessmen, Itel radiated confidence from the beginning. The partners, with only $72,000 of their own, managed to raise $10 million in equity from Fireman's Fund Insurance Company. Their initial success was due to hiring aggressive young business people, taking risks that competitors wouldn't dream of, and seizing upon an idea that had just fermented in the business world -- leasing computers.
Mr. Friedman, manager of IBM's San Francisco branch before beginning the Itel venture, calculated that the new firm could make handsome profits by leasing $90 million worth of computers that it had bought on credit from IBM. Leasing was an attractive alternative to purchasing since Itel's customers not only accrued tax benefits but also avoided getting stuck with an outdated model in a rapidly changing market.
Itel made the leasing delas even more attractive. Spurred by their soaring profits of the early 1970s, Itel offered a package that included IBM System/360 computers and accessory equipment made for them by other companies.The accessories were less expensive than IBM's, enabling Itel to underprice the computer giant.
In 1977, when IBM introduced the more cost-efficient System/370 line, Itel flew into heavy winds. They value of the 360 models nose-dived.
Instead of phasing out the computer leasing program and concentrating on its other operations, which had expanded into seven divisions by the beginning of 1979, Itel doggedly remained in the fray. This decision, some observers claim, went along with an attitude of invincibility and overweening pride that helped lead to Itel's downfall.
In a decision that has since baffled financial analysts, Itel contracted National Semiconductor and Hitachi of Japan to build central processing units that were interchangeable with IBM's. Itel again underpriced its competitor, but this time found itself competing directly with the much more powerful company. Itel had moved into second place behind IBM with computer leases totaling $1.7 billion.
Even while losses were pilling up, to a total of $443.3 million in 1979, Itel was known as one of the flashiest outfits around. A single Caribbean cruise for the company's highly motivated salesmen set Itel back $1.5 million. Plush offices, decorated with Persian rugs and art objects, enormous salaries, and bonus incentives for its employees distinguished Itel from run-of-the-mill leasing companies.
This generosity also extended to departing executives. When Mr. Redfield and Mr. Friedman left Itel in 1979, they reportedly received more than $3 million as part of their termination agreements.
In its recently released "10K" form, the annual financial report submitted to the Securities and Exchange Commission, Itel stated that the heavy losses of 1979 were preceded by a net income of $21.5 million in 1978. This figure came as a surprise to financial observers, not to mention the SEC. Itel originally reported a net income of $47.2 million. It now claims the restatement is a result of a reduction in the residual value of the outdated computers it owns and is attempting to lease.
The SEC may conclude differently after examining Itel's books. It will decide whether Itel artificially inflated its 1978 earnings. Itel admits that "the necessity to restate is attributable to insufficient documentation, employee misconduct, and officer and employee inadvertance or oversight."
The original statement of the residual values in its 1978 10K is a "classic Itel manuever," according to one observer. "Itel was so anxious to boost its sales to the magic $1 billion mark that it was willing to deviate from normal conservative business practices."
Adding to Itel's woes, the Justice Department is reportedly conducting its own investigation for possible fraud connected with the restatement. A company official claimed he had no knowledge of an investigation.
Had overconfidence led Itel to make unwise decision?
Mr. Howerton, Itel vice-president, says not:
"I do think that there was a sense that we were a very successful company -- and we were. Nobody believed we wouldn't cope with IBM announcements and actions; we had dealt successfully with them in the past. Let's say we were confident, not overconfident".
Itel appeared to have good reason to be confident. Along with leasing its "Advanced System" computers to more than 300 companies in the United States and Europe. Itel had arranged what seemed to be foolproof insurance coverage with Lloyd's of London. From 1975 to 1977, the venerable under-writer agreed to insure for losses due to canceled contracts. The 300-year-old institution found itself insuring against technological change with the Itel contract. Simply put , Lloyd's was saying that the computers Itel leased would not become obsolete.
Speculation about the IBM 4300 series drove Itel's sales down in late 1978 and early 1979. Itel was not prepared for the spate of canceled contracts that followed. It was committed to long-term purchase agreements with the computer manufacturers. With a severely reduced cash flow, Itel could not pay its creditors
Losses were exacerbated by delay in insurance adjustments by Lloyd's. By August of this year, Itel had claimed $21.5 million and Lloyd's had paid only $8 .4 million. If claims exceed $250 million, the Itel contract will be one of the worst deals in Lloyd's history. The 10K states that negotiations to settle te rest of the claims "have revealed a difference of opinion." Itel has threatened to sue Lloyd's if a settlement is not reached quickly.