Incubator Or Incinerator?
Chicago's relationship with Internet incubator Divine interVentures (DVIN) began as a heavenly affair. Riding high on the popularity of business-to-business Net companies last year, Divine was the belle of Chicago's dot-com ball, and the company's enigmatic chairman and CEO, Andrew J. "Flip" Filipowski, was praised as the city's Great Wired Hope. When Chicago Mayor Richard M. Daley laid out his blueprint for turning the city into "the high-tech hub of the 21st century," he chose the site of Divine's planned seven-acre campus on the city's North Side to deliver his speech. Daley chipped in a $14 million tax subsidy to help the project along and tapped the company to manage a planned $100 million venture fund for local tech startups.
These days, Filipowski is looking anything but divine. His fall from grace started earlier this year when his company's much-anticipated initial public offering turned into a fiasco. Divine suffered a four-month delay in its offering that included the dumping of its lead underwriter, Credit Suisse First Boston, and a run-in with the Securities & Exchange Commission. The latter was triggered when Filipowski gave financial information to the media that conflicted with Divine's own IPO documents. When the offering was finally completed in July, the company raised $128.6 million, instead of the $460 million it had hoped for. Divine's troubles have only worsened since then. After selling shares in its IPO for $9 each, the company has seen its stock plunge to about $3. "The stock performance looks like a disaster," says analyst George Nichols of mutual fund researcher Morningstar Inc. And Divine's plan for a tech campus? It has been put on hold.
As the company's fortunes have changed, so have feelings among local politicos about Filipowski's role as Chicago's dot-com front man. "There is much less a desire now to involve Flip in projects promoting Chicago as a tech center than six months ago," says Shaye Mandle, president of the Illinois Coalition, a nonprofit organization that promotes the Illinois tech economy. The idea of Chicago's Net future being tied to Divine no longer sits well with the mayor's office, either. "It's not `as goes Divine, so goes Chicago,"' says Katherine Gehl, Daley's technology adviser. "I want to see that impression change."
All this backpedaling isn't going over too well with Filipowski, a brash, outspoken 50-year-old who sports a ponytail and favors black turtlenecks. He concedes that Divine's IPO was rough and that the tumble in tech stocks will make it more difficult to incubate hotshot startups. But he argues it's too early to pass judgment on Divine. "We haven't had time to really establish our portfolio companies," he says. "That's where our future success will be."
With much less money in hand than anticipated, Filipowski is scaling back his plans. Divine had $327 million in cash and securities as of mid-August, but it lost $75.4 million in the second quarter on $12.1 million in revenues. To cut back the burn rate, Filipowski is focusing on his existing companies, rather than trying to make more acquisitions and fund more startups. Divine also decided in May to lay off 29 of the incubator's 89 workers. Still, he admits that there won't be enough money to keep financing all 52 companies. "Will we continue to fund some of our companies? No," Filipowski says. "We will be emphasizing the brightest stars."
It's tough to find much evidence of a bright future for Divine, however. The stocks of the two public companies in its portfolio have been hammered in recent months. Shares in B2B medical products service company Neoforma.com Inc. (NEOF) have plummeted 95%, to $3, since their peak in February, and the stock of Web application software maker Sequoia Software Corp. (SQSW) has dropped 75%, to about $5, since July.
The prospects for many of Divine's private companies appear bleak. Most of the companies are so new that they have no revenues, and the vast majority are losing money. Several, like the public relations firm Buzz MSP and the headhunting firm Talent Divine, appear to have no competitive advantage over similar firms. Some outsiders question whether Divine's companies ever had solid business models. "Divine made 50-plus investments in about six months," says Chris Girgenti, managing director at the venture capital arm of rival William Blair & Co. "It's impossible to have done complete due diligence in that amount of time." Filipowski says he did conduct thorough due diligence and Divine's board got a full review of each deal.
Just as worrisome, Divine is getting started just as the whole model of a public incubator that finances and nurtures tech startups is being called into question. Internet Capital Group, for example, has seen its stock pounded down 95% from its peak, to $11. Critics say that venture capitalists and other private financiers have more experience in funding tech startups, and they don't have to answer to public investors the way incubators do. "Startups with good ideas can get funding in the open market, so why go to an incubator?" asks Forrester Research analyst Charles Rutstein. Others are more blunt about incubators. "They're incinerators--for cash and for peoples' careers," says L. John Doerr, a partner at Silicon Valley venture firm Kleiner Perkins Caufield & Byers.
Divine's particular brand of Internet incubator may be more problematic than most. Filipowski describes Divine as an Internet zaibatsu, a reference to family-controlled corporate combines in Japan. Divine pushes the companies it controls to cooperate with each other and to buy many services from Divine, such as marketing, human resources, and public relations. Privately, several execs at the portfolio companies complain about the cost and quality of Divine's services and say that the Soviet-style planned economy is stifling to more independent-minded executives.
So how did Filipowski become the flagbearer for Chicago's Net community in the first place? Through a combination of experience and enough chutzpah to light Wrigley Field. Last year, he sold his software company, Platinum Technology International Inc., to rival Computer Associates International Inc. (CA) for $3.6 billion and reaped $290 million himself. He quickly founded Divine last May and raised $400 million from such investors as Microsoft (MSFT), Dell Computer (DELL), and Compaq Computer (CPQ). "The Midwest was springing up as an important area for business and industrial exchanges, and Flip had a record of success," says Harold F. Enright Jr., Compaq's vice-president for corporate development, who adds that he thinks Divine's prospects are still bright.
When Filipowski wasn't reeling in investors, he was attracting a virtual Who's Who of Chicago-area businesspeople to Divine's board of directors. A bountiful 41 people sit on Divine's board, ranging from telecom equipment maker Tellabs Inc. (TLAB) Chairman Michael J. Birck to former Chicago Bulls basketball star Michael Jordan. Divine says it has a large board so directors can bring in potential investments.
The only problem is, the board is loaded with possible conflicts of interest. According to company documents, 33 of the company's 41 directors have some potential conflict. Those board members are executive officers of Divine, execs at portfolio companies, investors in portfolio companies, suppliers to those companies, or officers at competing companies. For example, board member Robert Bernard is chairman and CEO of MarchFIRST Inc., an information technology firm that also funds e-commerce startups. The thicket of conflicts has corporate governance experts scratching their heads. "You want expertise and perspective on your board, but you don't want people with blatant conflicts," says Walter D. Scott, a professor at Northwestern's J.L. Kellogg Graduate School of Management. While acknowledging the conflicts, Filipowski says Divine is diligent in making sure that the interests of the company come first and foremost.
What lies ahead? Some say Divine may not last long as an independent company because of its limited financial resources. CMGI (CMGI), which owns nearly 5% of Divine, may be a likely buyer for the incubator or several of its portfolio companies. Filipowski admits that he may have to sell out but says he has no plans to do so. He thinks the stock market will improve so some of Divine's companies will be able to raise money. "The current conditions won't last," he says. After all he has been through, Filipowski is keeping the faith.
For a Q & A with Divine CEO Flip Filipowski, visit ebiz.businessweek.com.