Lipman Electronic Engineering Ltd (LPMA) (LPMA)

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Lipman's liabilities
02.10.2005 | 15:06
Uri Ronnen

The Wall Street Journal revealed further escalation in the battle between Overstock.com (Nasdaq:OSTK), short-sellers, and unkind analysts. Short-sellers are speculators who think a share price is too high. They borrow the share from a shareholder and sell it, assuming the price will drop. Then (if all goes well) they buy it back at the lower price to return to the lender, and pocket the difference.

About 50% of Salt Lake City-based Overstock's floating stock has been sold short. Overstock sued Gradient Analytics and the hedge fund Rocker Partner, for alleged collusion. It claims Gradient, ostensibly an objective source of analysis, wrote downbeat reports at the behest of Rocker, which had gone short on the stock. Rocker is a Gradient customer.

Since January, Overstock stock has dived 50%, a fate the company insists is unwarranted. It is all because of a conspiracy between the independent agency and short-sellers, it argues.

It all sounds rather other-worldly to our local market players, not the sort of thing that could happen over here. Israel has very little tradition of short selling, and independent research not written by investment banks is a rarity.

The Wall Street Journal story had another thing we deal much in here. Almost as an aside the paper wrote that the first negative report from Gradient expressed concern about Overstock's accounting policy and the independence of its board of directors.

Independence of its board? How many Wall Street traders really believe that the composition of a company's board changes the probability of its stock soaring or tanking?

Certainly, nobody here has any such convictions.

The Wall Street Journal ran its story on Tuesday. On Wednesday, Lipman stock plunged 23%. Here is the question: would Lipman's stock have behaved any differently if other people had been sitting on its board of directors?

Lipman stock in Tel Aviv




Expand the empire

Lipman's share price dived because the management admitted that Dione, its British acquisition dating from October 2004, had surprised it by underperforming expectations. 'Surprise' is to points it mildly.

When buying Dione, Lipman's management had expected it to produce $80 million sales in 2005. Now they're looking at half that sum. Investors have good reason to wonder how thoroughly Lipman performed its due diligence.

Managers like to expand their empires, even at a high cost. The board is supposed to stop them when the cost or risk to shareholders are too high. Experts in corporate regimes say that lavishing stock options on directors ruins the balance of interests between the shareholders and directors.

Shareholders benefit from the rising value of an investment in the long run, but directors who get options for free benefit from short-term fluctuation in share price, and may support adventurism by the management.

Moreover, a director glutted on options loses his ability to supervise the management from the outside.

In 2003, Lipman gave its chairman, Jacob Perry, a mega-burst of options that according to Black & Scholes, were worth NIS 3.4 million. No wonder that Perry, an insider, chose to join chief executive Isaac Angel and the controlling shareholders – Mivtach Shamir Holdings (TASE: MISH ) and First Israel Mezzanine Investors - in selling shares four months ago, at 40% more than the share prices today. Perry alone made $1.5 million on that exit.

Activist American institutional investors tend to vote against any appointment to the board of a person unlikely to devote sufficient time and attention to the company's affairs. The September 2005 edition of TheMarker 100, listing the hundred most influential people in Israel, needed a whole page to list the high-ranking jobs Perry presently holds, from chairman of United Mizrahi Bank (TASE: MZRH) to chairman of the Israeli Cinema Fund.

During the little time he has left for Lipman, Perry is supposed, says the company, to "develop its business connections inside and outside Israel" – which again begs the question of whether Perry fulfills any supervisory role on the board.

Lipman also lavished options on other people, from which it also seems to expect less supervision than advice and services. Usually a company's board supervises while it pays good money for such services.

Present for Nephew

Of all the possible worthy candidates, Lipman appointed one Yitzhak Davidi as an external director on its audit committee.

Yitzhak Davidi is the uncle of Ishay Davidi, who runs FIMI, which is one of Lipman's major shareholders.

Formally speaking, Uncle Itzik fulfills even the strictest requirements of Nasdaq regarding independent directors on the audit committee; he is a highly worthy director, too. But how can Uncle Itzik be 100% objective when it's his nephew in the controlling group?

How often as doting parent or aunt, or uncle, have you bought a toy for a beloved son or nephew? A toy the child demanded to have, though you knew full well it would last maybe a day before the little genius hammered it into powder? Maybe the nephew had a powerful hankering for Dione and Uncle Itzik had the feeling it wasn't the smartest thing to buy – would you expect him to lead the board or audit committee to vote against it?

In the three weeks before Lipman stock crashed 23%, its stock was busy losing 20% of its value. Stock market sources view that as the result of leaks and wonder why the management maintained opacity for so long, without admitting to the facts.

The answer may lie in the composition of the board and the manner of its remuneration. Rot starts at the top.

It is too soon to say when and how Lipman will recover from the blow. Before its starts to recuperate, it should look closely at another Israeli company that went from bad to worse after making an acquisition. Its board is headed by a very busy man with myriad contacts and business in Israel and abroad, who was also heaped with options before the crash. The man is Jacob Frenkel, the former Bank of Israel governor. The company is Lumenis (Nasdaq:LUME.PK) and the acquisition was of Coherent, in April 2001. The great exit was in June 2001 and the collapse, in early 2002.

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