prelude

The leaders in the race for the Republican presidential nomination are both deeply flawed business people.   Both are brilliant marketers.  Both are, paradoxically, running–successfully–on their “records” in business, something that alternately bemuses and appalls the financial community.

The Trump case is complex: excessive use of leverage that all but destroyed the family real estate business in the late 1980s, followed by a successful decades-long struggle to rebuild what was lost.

The Fiorina record is less so:  her tenure at Hewlett-Packard is best summed up by the fact Fortune magazine points out that HPQ stock gained almost $3 billion in market value the day she was fired.

As her poll numbers continue to rise, however, attention is beginning to shift to Fiorina’s tenure at Lucent, a spinoff from ATT that included Bell Labs and ATT’s telecom infrastructure business.  Lucent was a stock market darling in the late 1990s, but collapsed in the early 2000s under an accounting scandal surrounding vendor financing.  Fiorina, who became CEPO of HPQ in 1999, was long gone by then.  But the question is beginning to surface as to what role she played in promoting vendor finance at reckless levels before she left.

So I figured I’d write about what vendor financing is.

vendor financing

I’ve found that a good way of gauging competitive strength is by looking at how quickly a company gets paid for its goods or services.   On the positive end of the conceptual spectrum is the firm that gets paid in full before it makes or delivers stuff.  On the far negative side is the outfit that either gives its products/services away or pays you to take them.

Vendor financing falls much nearer to the negative pole.  It isn’t simply giving customers 180 days to pay.  Vendor financing is long-term loans given to customers by a firm to induce the purchase of that company’s very expensive capital equipment.  In Lucent’s case, vendor financing involved multi-billion dollar deals for telecom infrastructure equipment.

At first blush, there’s nothing wrong with this.

The company providing vendor financing may have a lower borrowing cost than a customer.  So one could argue that this is a relatively harmless way of providing a product discount.  In addition, the fact that a customer doesn’t have to line up bank financing makes it easier for a super salesman to close deals–and lock up clients–in a very short time.  In the land rush to stake out territory in the fast-growing mobile phone infrastructure, it became a staple of dong business in Europe and emerging markets in the 1990s.

Even in its most benign form, however, vendor financing has issues.

It makes company profits look better than they otherwise would be.  Let’s say, for example, my list price is 100, on which I earn an operating profit of 50.  If my customer asks for a discount of 10 to seal the deal, my sale would be 90 and my profit 40.  If I counter with 100 plus cheap long-term financing, then I still show sales of 100 and a profit of 50, even though I’m giving a discount.  The loan I provide simply sits on the balance sheet and has no effect on profits.  So I’ve hidden the discount and inflated my profits.

Like most financial things, vendor financing didn’t remain in its benign form for long.

Telecom vendors soon began offering financing to firms that wouldn’t be able to arrange commercial bank loans.  Then they began to offer loans that would be impossible for customers to repay  …and/or for more equipment than they could ever possibly use.

Lucent was eventually charged by the SEC with accounting fraud.

In an extremely carefully written article on the front page of the New York Times yesterday, Andrew Ross Sorkin reports that Fiorina was involved with a multi-billion dollar Lucent vendor loan to a company called PathNet that had less than $1.6 million in annual revenue (shades of Solyndra)–something that came up in her unsuccessful Senate run in California.