Blum Letters
September 6, 2005
Mr. Jack Messman
Chairman, President, and Chief Executive Officer
Novell, Inc.
404 Wyman Street
Suite 500
Waltham, MA 02451
Dear Jack,
We received your letter dated June 24, 2005 acknowledging our
letter dated June 20, 2005. The terse, one-sentence correspon-
dence thanking Blum Capital for our input led us to believe you
and the Board would not seriously consider the operating and fi-
nancial proposals we outlined in our previous letters, dated June
6, 2005 and June 20, 2005 (attached). Needless to say, we were
disappointed by your response (or lack thereof) as you stated in
your prior letter dated June 16, 2005 that "We seriously consider
your views when offered." For more than 20 years, Blum Capital
has worked collaboratively with all of our portfolio investment
companies, and we have most often waited for tangible evidence
indicating whether or not a company would employ our suggested
strategies to maximize shareholder value. In Novell's case, we
are disappointed in not only your failure to consider our propos-
als but also at the clear lack of urgency in implementing a
strategic plan.
Over two months have elapsed since your last response, and we
have been discouraged by Novell's recent progress towards what we
believe should be the company's goals. On August 1, 2005, Novell
announced plans to eliminate 120 to 150 jobs in Europe, the Mid-
dle East, and Africa in an effort to cut costs by approximately
$12 million to $16 million per year. While this is a step in the
right direction, it is de minimis on a total expense base of $1
billion. We believe that you and the Board do not appreciate the
immediacy or the magnitude of what must be accomplished for Nov-
ell to return to an appropriate level of profitability, and sub-
sequently an attractive level of growth.
To reiterate, we believe it is imperative that Novell must: (1)
reduce costs to an appropriate level necessary to operate all of
its businesses profitability; (2) divest non-core businesses; (3)
become a leader in Linux and identity management through joint
ventures and selective acquisitions; and (4) optimize its capital
structure to maximize shareholder value. The predominant theme in
this four-step plan is the employment of disciplined analysis in
allocating capital.
Addressing our first point, we believe operating expenses can be
curtailed while actually improving productivity if funds for R&D,
sales and marketing, and general and administrative functions are
scrutinized and deployed judiciously. We estimate that over $225
million of operating expense reduction could be implemented in
2006 prior to the incremental costs associated with any acquisi-
tions. As most of these cost savings are cash expenses, a key
benefit would be the reinvestment of funds into higher return
projects. In addition, our $225 million estimate may prove con-
servative as we have identified only the obvious targets for
costs savings, including the company's two corporate jets, an
overstaffed R&D department, the redevelopment of legacy products
such as ZenWorks and GroupWise, and the maintenance of over 400
Netware engineers. As it is, this plan would yield a run rate op-
erating profit margin of 22% during 2006, up from an unacceptable
2% estimated for 2005.
Secondly, the same argument can be made to sell non-core busi-
nesses to reduce unnecessary costs, monetize value, and redeploy
funds more productively. We estimate that Novell could generate
approximately $500 million of pretax cash (or equity value in
spin offs) as follows: $175 million for Celerant, $150 million
for Zenworks/Tally Systems, $100 million for Groupwise, and $75
million for Cambridge Technology Partners. If generated in cash,
the realized proceeds could further enhance liquidity, which
would further facilitate Novell's ability to pursue necessary
growth opportunities.
Regarding our third point, we believe we have identified key
product areas that management should pursue either via acquisi-
tions or joint ventures to position Novell as "The Open Stack"
for Linux and to capture more value "further up the stack." Com-
bining these products and services with Novell?s existing Linux
offerings would create a formidable player in the industry offer-
ing the most complete, secure stack for mixed open and propri-
etary IT environments. We are aware that Novell has announced re-
cent joint ventures that provide a small portion of these capa-
bilities. Our plan is likely directionally similar to manage-
ment's in this regard, but we feel the window of opportunity to
achieve this goal is much narrower than Novell's current percep-
tion. Furthermore, we believe that this "growth" initiative
should only be pursued concurrent with a well defined plan of
cost cutting, divestitures, capital structure rationalization,
and overriding investment discipline. Failure to do so will most
certainly result, at best, in suboptimal returns for sharehold-
ers, and at worst, a missed market opportunity and a deteriorat-
ing business.
Our final point is perhaps the simplest to execute, but equally
compelling. Therefore, it confounds us as to why Novell has yet
to implement a major share repurchase program of $500 million. In
our prior letters, we outlined the potential for 20% returns giv-
en the current depressed stock valuation, while still leaving am-
ple liquidity for strategic acquisitions and customer assurance.
In addition, it bears repeating that should Novell employ all of
our operating and financial strategies, the market value of the
company's stock would most likely appreciate to a level that
would exceed the conversion price of the outstanding convertible
debentures, thereby generating an additional $600 million of cash
availability. Our analysis has the company repurchasing $750 mil-
lion of stock at $7.50 per share, approximately $500 million of
additional acquisitions, $500 million of divestitures, and still
leaves approximately $950 million of gross cash on the balance
sheet at year end 2006 ($350 million net cash if the converts are
not exercised), and a company that is again a substantial cash
generator.
Implementing all of our proposals, we estimate run rate 2006
earnings per share would be approximately 30 cents, growing ap-
proximately 20% per annum thereafter for the next several years.
As the preeminent company in the Linux field, with 22% operating
margins and surplus free cash flow, we believe the stock would
receive a premium multiple and a $10 per share price would be re-
alistic, with approximately $1 per share of value in net cash on
the balance sheet. That represents over 43% appreciation versus
today's current stock quote of $7 in a 12 to 18 month time frame,
and a sustained growth profile of a vibrant business capable of
compounding shareholder returns for many years in the future.
We are deeply concerned about the direction and pace you and the
Board are currently taking and have been dissatisfied with the
company's results. Given the company's recent weak operating
performance, we believe that the majority of Novell's sharehold-
ers share our discontent. Our conviction is firm in the future
promise of the company. The question is whether the current man-
agement and board will execute.
Sincerely,
Colin Lind Greg Jackson
/s/ N. Colin Lind /s/ Greg Jackson
Managing Partner Partner
cc: Albert Aiello
Fred Corrado
Richard L. Crandall
Wayne Mackie
Claudine B. Malone
Richard Nolan
Thomas G. Plaskett
John W. Poduska, Sr.
James D. Robinson, III
Kathy Brittain White
Ron Hovsepian
June 20, 2005
Mr. Jack Messman
Chairman, President, and Chief Executive Officer
Novell, Inc.
404 Wyman Street
Suite 500
Waltham, MA 02451
Dear Jack,
Thank you for your letter dated June 16, 2005. We appreciate your
feedback regarding our proposals as detailed in our letter to
you, dated June 2, 2005.
While we certainly respect differences in opinion relating to the
strategic direction of the company, we are compelled to dispute
several conclusions in your response based on our own understand-
ing of facts.
Regarding our proposal to curtail R&D expenses, you responded:
"To suggest that all our business efforts must be profitable to-
day, is to not fully appreciate our strategy or the need to make
the investments necessary to successfully implement the strate-
gy." We are well aware that some level of investment is required
to maintain future growth and profitability. However, our pro-
posal to reduce R&D expenses stems from Novell's historically
poor investments in both R&D and acquisitions that have yielded
sub-optimal returns for shareholders with little, if any, new
product sales of significance. As evidence, we point out Novell's
-5.4% compounded annual sales decline since fiscal 1994 through
the ten years ended fiscal 2004. During those same ten years,
Novell has spent approximately $2.5 billion in R&D expenses, $365
million in acquisitions, and $635 million in capital expendi-
tures. Since your assumption of the CEO duties in late fiscal
2001, sales growth has been just 3.5% through fiscal 2004 which
is certainly an improvement from prior years, but driven primari-
ly through acquisitions. Beginning in fiscal 2002, R&D has to-
taled $382 million, capital expenditures $94 million, and acqui-
sitions $353 million. We believe such a high level of investment
for 3.5% annual sales growth is not satisfactory. In addition,
the most recent quarter's (Q2 05) lackluster 1.2% revenue growth
is continuing confirmation that extraordinarily heavy investment
in the combination of R&D and acquisitions is not justified. Giv-
en this track record, we submit that the current strategy to sub-
stantially increase spending on growth initiatives carries a much
higher risk profile than management appreciates. To be clear, we
are not against R&D expenses and acquisitions per se. Quite the
contrary, we recognize that the judicious allocation of capital
to both areas is essential for the long term health of the orga-
nization, as long as it is within the means of the company's
ability to remain profitable and that it is subjected to a rigor-
ous analytical process. Therefore, under the current circum-
stances we believe that reducing R&D is not only appropriate but
also necessary to ensure all investment opportunities (being
viewed as a scarce and valuable resource) are subjected to a dis-
ciplined process whereby only the highest return projects sur-
vive.
Regarding our proposal to divest Celerant Consulting, you wrote:
"Although Celerant is a non-core asset, it would not be prudent
to rush a transaction through, thus creating a risk that the key
assets of Celerant, its highly-valued employees, could become
dissatisfied with the end result, thereby destroying value that
is due to all shareholders." We are open to discussions with man-
agement and the Board on this issue, and look forward to pursuing
this idea further. However, we offer the following opinion on
this matter: a spin-off of Celerant to Novell shareholders as an
independent,publicly traded company in our view would retain em-
ployees who would see their direct efforts reflected in equity
value appreciation over time. Today, as part of Novell, Celerant
employees' fortunes are tied to the overall enterprise's operat-
ing performance which has led to a decline in equity value de-
spite solid results within Celerant. In addition, surplus cash
generation could be reinvested in Celerant's own growth initia-
tives rather than Novell's other operations where there has been
no value creation historically.
Regarding our proposal to implement a $500 million share repur-
chase program, you said, "To date, our analysis has indicated
that the current time is not appropriate for a stock buy back."
It is our firm belief that your analysis is incorrect in that we
cannot imagine a better, risk-adjusted rate of return offered
than buying back stock given the current valuation. Had Novell at
the beginning of 2002 not deployed the $353 million it spent on
acquisitions plus the $53 million it spent on long-term (venture
capital) investments and instead invested that capital in a share
repurchase program, using average stock prices for fiscal years
2002, 2003 and 2004, shares outstanding would be almost 20% lower
today. Assuming that the combined acquisitions and venture capi-
tal investments resulted in a net neutral contribution to earn-
ings, and assuming the same price earnings multiple that the
stock price currently trades at, per share market value would be
20% higher today. We note that our assumption of a neutral con-
tribution from acquisitions may be optimistic given the $158 mil-
lion write down of goodwill and intangible assets since fiscal
2002, but that only strengthens our analysis in that current
earnings would be higher than our estimate.
Applying that same analysis, should the company repurchase $500
million of the outstanding shares at today's market price, it
could retire approximately 80 million shares or more than 20% of
the company. Again, assuming the same price earnings multiple,
the stock price would be more than 20% higher. The same com-
pelling opportunity that existed over the past three years avails
itself today.
We are curious that management and the Board believes the current
time is not appropriate for a stock buy back given this high re-
turn profile and that Novell continues to fund long term invest-
ments in various private, venture capital investments. At the end
of fiscal 2004, Novell had a carrying value of $54 million in
such long term investments (recently writing off $1 million in
the past quarter), with further commitments of $33 million in the
future. In examining Novell's financial statements, it appears
the rate of return on these investments has been far below the
level a share repurchase program would have yielded historically
. We would be willing to share our analysis with you and the
Board in more detail to facilitate further discussion.
Finally, you stated your "need for cash as a demonstration to
customers of our market staying power and viability," and that
customers need comfort that they will be "supported by us for
many years to come," and a "strong balance sheet is an undisputed
way to give customers that comfort." We believe that our proposal
of leaving $500 million of cash on the balance sheet is suffi-
cient to allay any customer concerns, particularly if Novell were
to adopt our operating proposals to run each division profitably
such that the overall company generates significant free cash
flow. The ability to generate substantial free cash, in our
opinion, is of higher priority than a large, but wasting cash
balance in convincing both customers and shareholders that Nov-
ell's economic future is sound.
We look forward to additional constructive dialogue in the near
future. We thank you and the Board for taking our proposals se-
riously, and responding to our concerns and suggestions expedi-
tiously.
Sincerely,
/s/ Colin Lind /s/ Greg Jackson
Colin Lind & Greg Jackson
June 6. 2005
Mr. Jack Messman
Chairman, President, and Chief Executive Officer
Novell, Inc.
404 Wyman Street Suite
500 Waltham, MA 02451
Dear Jack,
Thank you for meeting with us at your offices on May 27. We very
much appreciated discussing the future strategic direction of
Novell, as well as the opportunity to express our own views re-
garding maximization of shareholder value. Toward that end, we
would like to reiterate the following proposals that we offered
at our meeting:
R&D expenses along with other investments should be curtailed
such that Novell's core software and services business produces
an operating profit, excluding interest income and subsidization
from Celerant Consulting. Our analysis indicates that without
Celerant and the interest income from Novell's large cash bal-
ance, the core software and services business currently runs at
an estimated loss of $50 million. In our opinion, shareholders
would be better served if each of Novell's business units were to
independently produce an operating profit. While R&D and other
investments are important for future growth and profitability, we
believe that the company could achieve these goals even with a
reduction in overall expenses through a more rigorous capital al-
location process. The most critically important discipline man-
agement needs to exercise is making every business unit within
Novell profitable and self-financing, even during a transition
period, in order to ensure the best allocation of the company's
resources. We believe it is a grave mistake to rely solely on fu-
ture revenue growth, which may or may not materialize, to return
the core business to profitability.
Celerant Consulting should be sold or spun off to Novell share-
holders. Novell has publicly stated that it will focus on two
key areas: identity management and SuSE Linux. We agree with man-
agement's decision to align all business objectives around these
two very promising markets. In our experience, companies focused
on a few key businesses tend to execute better yielding more fa-
vorable long-term returns for shareholders. We believe the di-
vestiture of Celerant would increase management's attention on
its core business and provide additional value for shareholders.
Our preliminary analysis suggests an estimated $300 million value
for Celerant.
Novell should adopt a disciplined return on invested capital
methodology in evaluating all capital allocation projects. We
agree with management that the opportunities facing Novell in
identity management and SuSE Linux look very promising. However,
it is unclear to us if Novell has analyzed all available invest-
ment opportunities, prioritized them, and then allocated capital
accordingly. In particular, the decision to not repurchase any of
the company's stock in favor of making acquisitions indicates
that there is no discernable process at Novell that rationally
guides the deployment of cash to maximize returns for sharehold-
ers.
Novell should implement and execute a $500 million share purchase
program immediately. As we emphasized in our meeting, a share
repurchase program should be thought of as another opportunity to
increase shareholder value, not as an artifact to prop up a com-
pany's stock price. Given the current low valuation of the compa-
ny's stock, we find it highly unlikely that the company could
find an acquisition or other investment opportunity that would
offer a higher rate of return for Novell's shareholders than buy-
ing back stock. Our analysis suggests a $500 million share repur-
chase program at the current market price would be more than 20%
accretive to earnings per share by the end of 2006. Moreover,
with $1 billion of net cash on the balance sheet, a stock buy
back program would address Novell's inefficient capital structure
as well. Even if our suggested share repurchase is implemented as
outlined above, the Company would still have $500 million net
cash on the balance sheet and sufficient flexibility to execute
the 10 to 20 acquisitions ranging from $25 million to $50 million
in purchase price that you articulated in our meeting (assuming
such acquisitions with higher return potential than a share re-
purchase become available).
We have been on boards of many public companies. We clearly un-
derstand the duty of directors to ensure that the long-term fi-
nancial flexibility of a company is not compromised. Under our
proposals not only would the Company retain $500 million in net
cash on its balance sheet (gross of $1.1 billion) but it would
have the opportunity to create further material liquidity through
the divestiture of Celerant (estimated $300 million of value).
Additionally, the enhanced operating discipline resulting from
implementation of such steps should result in an appreciated
stock price making the outstanding debentures convertible and
thereby freeing up an additional $600 million of net cash.
We would be happy to answer any questions you may have regarding
our proposals. As significant shareholders, we look forward to
working with you, other members of management and the board of
directors in exploring all possible avenues to maximize value for
all shareholders.
Sincerely,
/s/ Colin Lind /s/ Greg Jackson
Colin Lind Greg Jackson
