The Cedar house rules

By Chris Hughes <i>Rule No1: </i>Beware of analysts bearing books of accounting regulations <i>Rule No2:</i> Especially if they come from fastidious stockbrokers Collins Stewart <i>Rule No3:</i> Because it might just, in the words of Cedar's Mike Harrison(above), "screw up" your business
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The Independent Online

In 48 hours, Mike Harrison hopes to complete a deal which has seen his company's share price collapse and has also left egg on the face of one of the world's most prestigious investment banks, but which he believes brings Cedar Group, a small software company housed on a Surrey A-road, to a turning point.

In 48 hours, Mike Harrison hopes to complete a deal which has seen his company's share price collapse and has also left egg on the face of one of the world's most prestigious investment banks, but which he believes brings Cedar Group, a small software company housed on a Surrey A-road, to a turning point.

In the three years he has been Cedar's managing director, Mr Harrison has tried to transform it into the one British member of that élite group of software firms capable of upgrading a multinational's computer network without ripping out the existing system that houses all its data. It is a business known as "knowledge-based enterprise systems", and focuses on linking back-office computers with customer call centres and the Web.

Mr Harrison's tenure at Cedar has been characterised by the timely use of share issues to fund earnings-enhancing acquisitions that have diversified Cedar's product range from purely financial software and brought HSBC and General Motors onto its books. As each acquisition has boosted Cedar's share price, it has been easier to repeat the trick.

But on 5 October, Mr Harrison's luck ran out. Collins Stewart, the stockbroker renowned for its obsession with dodgy accounting practices, took the axe to Cedar. Two weeks earlier, Cedar had unveiled its largest deal to date, an acquisition intended to make the company capable of standing on its own two feet at last. The $72m (£48m) purchase of Enterprise Solutions Group, a computer services consultancy, would fill the geographical and product gaps in Cedar's offering and give it a foothold in the North American IT services market. ESG would take Cedar's headcount from around 300 to more than 1,500.

To fund the purchase, Cedar launched a £66m rights issue at 600p per share, a 15 per cent discount to the previous closing share price. Rights issues inevitably put downward pressure on the share price of the company involved, by offering a large amount of cheap stock to shareholders. But in the wake of the technology market turmoil generated by profits warnings from Intel, Apple Computer and Dell Computer, Cedar's shares were particularly vulnerable.

Enter Tim Steer, an analyst at Collins Stewart, a broker usually thought too small to be able to nudge the capital markets. Collins Stewart did not cover Cedar, but the ESG deal attracted Mr Steer's attention. He arranged to visit Cedar's Cobham offices and put questions to Michael Hosie, the finance director, one Tuesday afternoon. Nothing controversial in that, you might think.

"The analyst came with a copy of SOP [a book on accounting regulations] under his arm, which is not what you expect to see," says Michael Hosie, Cedar's finance director. That Thursday, Mr Hosie found out why.

While giant US investment banks, including Credit Suisse First Boston and Merrill Lynch, penned punchy research notes urging support for Cedar's rights issue, Mr Steer's note, entitled Timber!, said Cedar recognised sales too far ahead of receiving cash from customers, and faced a potential cashflow crisis. It claimed Cedar had overpaid for many acquisitions, and investors should sell the shares.

This came as no surprise to many in the City. Collins Stewart's fastidiousness is well known. The firm is headed by Terry Smith, who was sacked from his role as head of research at UBS, the giant investment bank, for publishing sell notes on its clients and accusing them of massaging their accounts. Mr Smith settled with UBS out of court, and later told investors how to spot questionable accounting in his book, Accounting for Growth.

Cedar hit back at Mr Steer, saying its accounting policy is exactly the same as that used by its British peers, if not as strict as US standard. Mr Steer had overlooked the value of the people and products Cedar's acquisitions had brought into the group, it said. The overall impression created was misleading.

Many in the City agreed. "[Collins Stewart's] criticisms would be valid only if there's a question about customer acceptance of Cedar's software," says Beeson Gregory's Ian Mitchell. "The company has grown quickly creating demand for additional working capital, but that's the same with all companies. The position looks worse than it seems."

But a nervous stock market sided with Mr Steer, and Cedar shares fell below the price of rights issue. That left Merrill Lynch and a host of other underwriting institutions obliged to mop up the shares at a 30 per cent premium to the market price on Friday last week. Ironically, Merrill Lynch used to employ Mr Steer as a smaller-companies analyst.

Cedar's share price may now be two-thirds off its high, but, thanks to the rights issue's underwriters, the firm has its £65m and is ready to complete the purchase of ESG. "The only thing we have learnt is that some people in the City can screw things up," says Mr Harrison. "What offends is the implication that we are doing something improper."

Mr Steer is unrepentant. He says he would not change a thing in his note. "The stock is where it is for a reason. Cedar is building a product and it's a bit like building a house. That's why US software firms account for sales in the same way as long-term construction projects. Cedar needs to issue a statement clarifying its revenue recognition policy."

The weakness of the stock price makes Mr Harrison unhappy for his shareholders, but he insists it does not make the company vulnerable. Cedar may be cheap, but he can't envisage a takeover - the business is lost without its present management, he says. And Cedar will find it much easier to raise debt to make acquisitions - ESG is cash-generative - and is less reliant on share-based fund raisings.

ESG marks the beginning of the second phase of Cedar's expansion. Cedar can supply a global offering for the first time. "I've always wanted to build a British company that plays well in the enterprise systems market place," says Mr Harrison. "We've crossed a threshold now. We expect this to be a FTSE company one day."

Three years ago, when Mr Harrison arrived at Cedar's offices, then in New Malden, he was alone in imagining it would be able one day to make such a claim. Cedar was run by a technologist who, in Mr Harrison's opinion, paid too much attention to the product and not enough to marketing. "The sales force didn't dare bring clients to the office because it was so grubby," he says.

But the product was good. In 1982, CedarData, as it was called, had gambled that Oracle financial software was going to be big-time. By 1997, that gamble had paid off and Cedar was profitable. But the management realised it needed a more experienced leader to take it further. Mr Harrison, a 52-year-old former managing director of Oracle's UK operation who had 22 years' experience of the US software industry, was a friend of Cedar's board. He accepted the challenge.

After all, he had long believed UK software companies were uniquely positioned to become world-beaters in enterprise systems, an area dominated by the likes of multibillion dollar firms such as Oracle and J D Edwards. US technology firms were handicapped by being obliged to report quarterly, a requirement forcing them to focus narrowly. "Business processes are complex, and doing things over time is not easy for US companies," he says. Cedar benefited from English-speaking staff between the US and Europe. But Mr Harrison felt alone in seeing the opportunity.

"When I arrived, there was £1m in the bank, which shouldn't be the case in a fast-growing company. I rounded everyone up and forced them to brainstorm possible ways to grow the business. I tried to get them to look beyond the day-to-day. When they worked it through, they were surprised by what they could achieve."

Mr Harrison defines enterprise systems as everything a business needs to make the latest software and internet applications compatible with the ageing back-office computer systems that store com- pany data. "If you are in the e-world, you are only one click from oblivion," he says.

Three years and 13 acquisitions later, Mr Harrison reckons Cedar can now do this for multinational companies. The next phase of growth will be about proving it, by winning big contracts with big companies. But the work is just beginning. While Collins Stewart agonises over accounting minutiae, others in the City are more concerned that Cedar will not harness the opportunity before it.

"Software companies are moving into services, and services companies are moving into software," says Beeson Gregory's Ian Mitchell. "Cedar has got a great deal in ESG. The challenge will be bedding everything down. They've got so many opportunities that it could be hard to manage. They have to make sure potential customers understand what they have on offer, because it seems so disparate."

Indeed, there are few areas in which Cedar is not involved. It recently launched ASP (application service provider) products, renting software online instead of providing one-off installations. Already, Shell is one of Cedar's ASP clients. But this has led to the charge that Mike Harrison is no more than a canny spotter of investment trends who pitches Cedar as a B2B software company one day and an ASP another, depending on stock market fashion.

Mr Harrison protests. "We've always said we're a B2B company. In fact, some people criticise us for being too open about what we want to do."

But he agrees the key challenges Cedar faces are organisational, not technological. His priority is to sustain a harmonious workforce. He is big on weekend breaks aimed at developing what he calls "personal awareness" and "producing a good buzz". He says it comes, in part, from being a fanatical rugby player who likes to be on the winning team. But it's also a lesson from Mr Harrison's experience establishing Oracle's subsidiary in Britain through the Eighties.

"It's not drinks in the pub or games or rounders," he says. "It's not OTT happyclappy. It's about doing things together and realising that giving customer satisfaction is a shared activity. All technology businesses are founded on people."

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