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Losing a Virtual Fortune

The tech community is quietly awash in its own accounting scandals. But few firms tried to get away with more than Critical Path Inc.


The analysts and the media certainly thought so. Gartner Group, a much-quoted consulting firm, estimated that two-thirds of all companies soon would be outsourcing their e-mail to firms such as Critical Path. Forbes magazine put Hayden on its cover as one of a dozen "digital visionaries." Hambrecht & Quist analyst Dan Rimer said the only way Critical Path could be in trouble was "if people suddenly decide to go back to using fountain pens."

In a sense, however, Critical Path's growth from the beginning was artificial. It acquired rights to service many of those 1.4 million mailboxes by giving equity stakes to their owners; for example, online broker E-Trade Group Inc. and phone company US West Inc. received 21% of the company.

This was a perfectly legal gambit used by many Silicon Valley start-ups, but there was only so much of the company that could be traded away. Critical Path had to find new ways to grow quickly, one reason it went public as soon as it could. It needed to raise money to buy other companies that immediately would boost its revenue.

Critical Path's initial public offering took place March 29, 1999, at a moment when Internet stocks were at their most glamorous. Investors ignored the fact that the company had revenue of only $897,000 in the previous year. Barbra Streisand asked for--and got--so-called friends and family shares, which enabled her to buy in at the offering price of $24.

It was a good deal: The stock rose 174% the first day, giving the company a valuation of $2.5 billion. At the IPO party, three employees were so giddy that they streaked. Maybe it was the four bottles of Dom Perignon sent by Streisand.

Within a few weeks, the stock jumped to $135. The gap between reality and expectations had become a chasm. At $135, the stock was factoring in expectations that Critical Path would service, and make at least a small profit from, every e-mail box on the Internet.

Employees, whose number would swell from 182 at the time of the public offering to 1,042 at the end of 2000, naturally were thrilled to be working at a hot company. Many programmed their computers to constantly display the stock price.

Employees knew they suddenly were rich--Hayden's stake alone was worth more than $300million--but there were constant reminders about how fragile it all was. In May 1999, when a computer failure temporarily shut down many Critical Path mailboxes, the stock immediately dropped 7%.

Even before the stock was offered to the public, the board of directors had kicked Hayden upstairs. This followed another venerable tradition in Silicon Valley, where it's the founder's job to launch the company, not run it. Hayden used a little of his Critical Path wealth to buy, with television producer Norman Lear, one of the four surviving privately owned copies of the Declaration of Independence. The price: $8.1 million.

The task of turning Critical Path from a raw start-up into a truly successful company that would match its valuation fell to CEO Doug Hickey and to Thatcher, chief financial officer and, as of January 2000, president. Both were in their mid-40s, with sober backgrounds--Thatcher a former auditor for accounting firms Touche Ross and Price Waterhouse, Hickey a veteran tech executive--that would be reassuring to Wall Street.

It certainly started to seem like a real company, one former employee recalled. "Critical Path was started by a bunch of raver-hippie-engineer types, and they tended to hire their friends," said Mike Wertheim, a programmer. "Hickey was slick. He turned the company corporate. But people figured that was just what had to be done."

Hickey and Thatcher went on a spending binge, acquiring 10 companies from May 1999 to September 2000. Most of these companies had few real assets; in fact, four had liabilities that exceeded their assets. At best, they were developing exciting technology that might work out well. That was enough to make them hot properties: Critical Path paid a total of $1.8 billion for them, nearly all in stock.

The acquisitions, along with other efforts, boosted the number of mailboxes the company serviced to 6.7 million in fall 1999 and then to 55 million early in 2000.

"I don't know if we are naive or what it is, but I've got to tell you, we really think we can touch virtually every Internet user in the world," Hickey told one Internet news site.

Forbes ASAP magazine voted Critical Path its No. 1 "ramp champ," saying that out of 100 fast-growing tech companies, it had the highest score in management, market opportunity, finances and competitive position. This was not, the magazine said, one of those companies "that are growing so fast that they spin out of control and crash."

Still, the pace was frantic. Thatcher told Forbes ASAP he had worked all night half a dozen times in the previous six months and logged 30,000 frequent-flier miles in one 15-day span. Employees were on call 24 hours a day.

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