Today we have a lesson in Internet math.
What do you get when you merge a shrinking, unprofitable communications equipment company, the stock of which is selling for less than $3 a share, with another shrinking, unprofitable communications equipment company, the stock of which also is selling for less than $3 a share?
When those two companies are Netrix Corp. of Herndon and OpenRoute Inc. of Westboro, Mass., which merged last month to form Nx Networks, the answer is that three plus three adds up to a whole lot more than you'd think:
Nx Networks stock, trading under the former Netrix symbol, has jumped to $17.43 3/4, helped by a recent $10 million contract and its acquisition of privately held AetherWorks Corp., which provides voice and data switching technology.
Nx Networks Chairman Steven T. Francesco, who had been on the job as Netrix chairman less than a year, has earned a bonus of stock and options now worth more than $40 million.
Howard C. Salwen, who had been chairman of OpenRoute, has seen the value of his holdings soar to more than $17 million from less than $3 million.
The investors who bailed out Netrix with a $4 million cash infusion last spring have been repaid with stock now worth more than $24 million.
The outside directors of both companies have been given stock options that have soared in value to more than $850,000 each because of the deal.
Is this a great country or what?
Only in America, at the dawn of the new century, could a wedding gift of that magnitude be bestowed upon the marriage of such a down-at-the-heels couple.
For a long time, revenue at Netrix and OpenRoute dwindled annually while losses mounted. OpenRoute's revenue fell to $14.3 million in 1998 from $93.9 million in 1994. For the first nine months of last year, the company reported revenue of $10.6 million, down from $11.1 million in the same period a year earlier. The company last reported a profit in 1995, having since lost about $36 million.
Netrix had not been bleeding revenue quite as badly, but that company had lost more than $30 million since 1984. Revenue retreated to $31.5 million in 1998 from $53 million that year. The company reported that revenue was $21.4 million in the first nine months of last year, down from $23.4 million for the same period a year earlier.
By the time Francesco was brought in as chairman of Netrix last March, the company was running low on cash and scrambling for any business that would generate revenue, if not profit.
With sales of its basic telephone switches declining, Netrix was taking orders for custom products and swinging at jobs outside its core competency. As Francesco said last week, "When a lot of companies run out of money, they go into panic mode."
As chairman, Francesco moved quickly to refocus the company on its basic business, end the revenue-driven survival strategy and downsize the staff to cut costs, all while trying to find new capital.
Netrix raised $4 million in cash from a private placement of preferred stock that could be converted to common stock for $2.75 a share, the price that Netrix shares were selling for at the time.
The investors took advantage of the conversion provision last month and with the stock closing Friday at $17.43 3/4 a share, they are sitting on 1.4 million common shares worth more than $24 million -- a cool $20 million profit in less than a year.
"They took the high risk, they deserve the return," Francesco said. "We were a very high-risk proposition back in May." At that time, the company was running out of cash and its stock had fallen to less than $3, he said. Finding investors who would buy shares at the market price was no small accomplishment because only the most optimistic forecaster would have guessed the stock would be worth five times that much by the end of the year.
Francesco himself also landed a paper windfall from the rapid run-up in the stock price. His employment contract gave him options to acquire 1.6 million shares over four years -- 400,000 shares the first year at $1.50 each, then an equal amount at $2.75 a share for each of the following years.
Under terms of the contract, all those options could be used immediately if a merger resulted in a "change in control" of the company; if that happened, Francesco also would be given 1 million additional shares.
The provision was triggered in December after Netrix merged with OpenRoute because shareholders of that firm wound up owning slightly more than 50 percent of the stock of the combined companies. Legally, that amounted to a "change of control," even though Francesco kept his job as chairman of the new company, whose stock trades under the Nasdaq symbol formerly used by Netrix.
As a result, Francesco holds 1 million shares now worth $17.4 million, along with his other options on 1.6 million shares, which would produce a profit of $24 million if he exercised the options and sold the stock today.
"If you told me six months ago, seven months ago, I was going to have this, I wouldn't have believed it," he said. "I had no clue."
Nobody involved in these transactions has sold shares, according to Securities and Exchange Commission filings.
Netrix's stock did not move at all when the plan to acquire OpenRoute was announced last summer. In fact the stock fell slightly because a big investor was unloading a batch of shares.
In early November, however, Netrix won a $10 million contract for equipment that allows telephone calls to be made over the Internet, and the stock started climbing.
In this era of buzzword investing, "voice over Internet" is one of favorite phrases of investors who flock to technology stocks.
The enthusiasm for Internet phone calls has created a payday for others in the business, including founder Dan Simpkins and other shareholders of Salix Technologies Inc. of Gaithersburg. The 10-year-old firm, which has produced prototypes of a switch that handles voice traffic over the Internet, was bought last month by Tellabs Inc. of Lisle, Ill., for about $300 million. Netrix's merger with OpenRoute to create Herndon-based Nx Networks -- the Nx is pronounced Nex -- gives the company a broader, more versatile product line, Francesco said. The basic product of Netrix is a switch that controls where phone calls go while OpenRoute makes routers -- in layman's language, switches for the Internet.
Further enhancing the product mix is Netrix's expertise in another buzzword technology: Virtual Private Network, a system that protects the privacy of phone calls and data messages. VPN provides the same security as using a private network without the cost of actually building or leasing your own lines.
Nx Networks' first product combines the offerings of the two merged companies and was proclaimed "best in show" at a recent industry trade show.
The sales force is hawking the new product now and shipments are scheduled to start early next month. Nx Networks has not issued sales projections on its new line and it will take several months to determine whether Francesco's turnaround team can make the company competitive with the dozens of bigger, better-financed, better-known players in telecommunications equipment.
Yet the Internet chat rooms already have proclaimed Nx Networks a success, driving up the stock price and making Francesco, his financiers and Salwen far richer on paper than anyone would have guessed last spring.
Serious investors trying to assess the stock of Nx Networks will have a hard time finding any objective information.
Only one securities analyst has looked at the company -- Vic Grover of Kaufman Bros., a small New York firm. Grover likes the stock, but Kaufman Bros. is not a disinterested observer. Kaufman served as the adviser to Netrix in the merger with OpenRoute. Along with collecting a cash fee for its work, Kaufman received warrants to buy 100,000 shares of Nx Network stock for $3 a share.
The firm also was paid $50,000 for delivering an opinion to the Netrix board on whether the takeover was fair to shareholders. The answer was affirmative.
The directors had plenty to gain if the merger succeeded. Inside directors and officers of both companies were given the right to exercise their stock options immediately once the merger was completed, a benefit worth several million dollars to the group.
Outside directors of both firms got the same instant vesting on the 50,000 options each received last year for serving as board members -- an $870,000 plum.
CAPTION: A Look at . . . Nx Networks (This graphic was not available)