Phil Deck: The fixer looks forward Anthony Reinhart March 29, 2012 Communitech TORONTO Bright morning light and a whiff of fresh paint hint at new beginnings inside the downtown Toronto office building where Phil Deck is mulling his future. Fresh from a decade spent retooling Waterloo software stalwart MKS, then engineering its sale to Parametric Technology Corp. (PTC) for a healthy $292.5 million last year, Deck has turned his eye to the way tech companies are financed, thinking there must be a better way. So it goes when you’ve “always been drawn to a mess to clean up,” as Deck says he has. When he’s not looking for the next mess, Deck scouts for small tech firms to invest in via his new holding company, Extuple Inc. He also serves on the boards of the Bank of Canada, the Canadian Opera Company and Communitech, which he came to know well during stints as CEO and then chairman at MKS between 2001 and 2011. We sat down to chat recently in a sunwashed office overlooking University Avenue in Toronto, where Deck is helping to foster a collaborative docking space for early-stage companies. Q – How did your career in tech begin? A – I was a financier and I was hired to sell a company called Mobius Encryption, and I couldn’t sell it, so I ended up investing in it. I ended up having to go in and run it to try and rescue my investment, and that was the company that eventually turned into Certicom. That was 1993. So we took it public in ’95, when the markets were willing to take virtually no-revenue companies public, and got caught up in the boom, and eventually moved the headquarters to California, in San Mateo. We built the company to about $25 million in revenue, which is where we were when the tech wreck happened. I left the company in ’99, because I couldn’t figure out how to make a $25-million company worth our market cap, which was a billion and a half dollars at the time. So I took a year off. Q – So you saw looming problem there? A – I think the way I saw it at the time was that there seemed to be a lot of people around who didn’t have any particular difficulty with that concept, so I left it to them. I seemed to be the only person who didn’t get it. Q – Was it simply an emotional thing, everyone riding this huge wave of euphoria over soaring valuations? A – I think (it was,) particularly in California. In California the market caps made sense to everyone, and in fact, there seemed to be an attitude that if you didn’t get it, then the problem must be that you’re from Canada. So, I accepted that and moved on. Q – So you came back to Canada then? A – I came back to Canada, and during the year I took off, the tech wreck happened. MKS at the time had done what a lot of companies in that period did, which was take on somewhat ill-advised expansion plans and growth plans based on business models that were probably not grounded in strong fundamentals. But as the tech wreck happened, they missed a financing, and started to run out of money, and by Christmas of 2000, were about to miss payroll. And so that’s when I was asked to come and have a look at it, and I came in to run it, and invest a few million dollars, on a few weeks’ notice. I came in in January of 2001, initially because it became very cheap, and it had a decent maintenance-revenue stream. And then after coming to the company and, you know, doing the first really easy parts of trying to cut some costs and reorganize things a bit, I decided there were some really great growth prospects and spent 10 years trying to lead it as a growing company. That ended in May of last year. In that time, we really put the existing businesses of MKS into decline, and declining software businesses are, of course, tremendously good cash generators, because you’re not spending much on sales and marketing, and you’re not spending anything on R & D, and the maintenance in this industry has been tremendously reliable. And so, we took all the cash flow that was coming off the declining businesses and invested it into the growing business, which was in application lifecycle management. And that business we grew from nothing to about a $70-million business, when we found ourselves in a very enviable strategic position, and ended up selling the company. Q – Sounds easy. A – Yeah, just 10 years. Q – So going back to before 1993, was that your entry into business? A – Well, I had initially started with a math and economics degree and had gone to work for Canada Life as an investment analyst trainee, and had spent a couple of years there, and had gone to the venture capital industry for a couple of years. And then I ran my own merger and acquisition and finance business, but not tech-focused. I ended up doing some tech stuff as tech started heating up, but it was only when I made probably what was a very ill-advised investment in a highly illiquid, five-person, no-revenue company that I got sucked right into the technology space. That would be Mobius. Q – So it was kind of an accident that you wound up in tech? A – Accident almost makes it way too generous, in terms of my judgment. Q – It’s funny how you can end up in a place; it’s not always a linear, logical track. A – But I’ve always been like that; I’ve always liked growth, so the idea of taking things apart and selling them off is never all that inspiring to me. I probably should have recognized that at MKS, that I went to kind of clean up the mess, but in the end, growth is really exciting, and it was really exciting. I think my highest and best use and most fun was in the first couple of years of really intensive change, and really having to rethink what kind of business we were going to be in. I think, to our credit, we never really changed the strategy after 2002 until the day we sold the business. We decided we wanted to be a one-product company and we decided on the sector we wanted to play in. We even decided on what the key attributes of our technology platform were going to be: a totally unified model for software development. So, if you looked at how we talked to our own employees about what our strategy was going to be and what we were going to be known for, that would have been virtually identical the day before we sold the company. So it was a very focused push at one thing to grow it, but trying to come up with that, and conceptualizing that and deciding how to go from the kind of wreckage of the ‘90s into something that could be a growing business based on really strong fundamentals, was a fantastic couple of years. And I think I’m probably a far better turnaround, change-management person than I am at growing a company. As the company grew and became more successful, there were other people who were probably better at building the company than I was. Q – Why did it make sense to sell the company and not build it further? A – Well, it’s the price relative to what anyone could reasonably expect to get in any reasonable amount of time. It was a very high-priced deal; four times revenue, and depending on which quarter you measured, close to 30 times EBITDA. The job of the board is to look at an offer, which came in unsolicited, to say ‘How many years would it take us, on a risk-adjusted basis, to get anything like this?’ And it was quite a few years. So it made sense for the shareholders to do it, and in some ways – and maybe as we’re seeing in a much larger way in Waterloo now – there are huge, tectonic changes in the software industry, and if you find yourself in a place where the technology you have, the positioning you have, is fundamentally essential to some much-larger player, if you don’t go down that road, they’ll find another way to fill the need, and you may find that you don’t have a similar opportunity later. So, in this case, PTC was really the only company that had the kind of need for a merger with MKS, and they would have found another way to fill the need. This one was far better for them, and far more attractive, and they were willing to pay a very high price for it. But they found themselves in a position where they really needed to be in our space, and the only two companies that were doing well at it were us and IBM. So, it was a tremendous opportunity for them, and they paid up in a significant way, and so it really was the right thing for everyone to do. Q – Shifting gears now, what can you tell me about your new company, Extuple? A – Well, Extuple is so far just a myth. Q – Do you really want me to print that? A – Well, there are a lot of good things about myths. Right now it’s just an idea. It’s just my own holding company, which is well-capitalized but has no business plan, really, yet. Q – Where did the name come from? A – A tuple is a mathematical concept, and some of the things I work on are still a bit mathematical. And my roots with Certicom are math-based. And the domain was available, which is what defines a lot of companies these days. I’ve started investing in software companies, and for sure I’m trying to bring together both parts of my background, which is finance and software. I think a lot of software people look at me and say, ‘You must be a financier’, and financiers look at me and say, ‘You must be a software person’. So I’m somewhere travelling in between those, and I think there’s a lot of change in the way software companies are funded. There’s no more venture capital companies, really, in the traditional sense, and I don’t think there will be, because I think the idea of putting money for upwards of a decade into some illiquid fund is not very attractive for people right now. So, I don’t think they’re suddenly going to come back; I think the reason they’re gone is that we’ve had a decade of falling valuation, and when you are investing money for 10 years in a decade where valuations are lower every year, then it’s hard to make a great return. I think that process is largely finished, because now, tech companies – and I think this is a huge opportunity – tech companies are valued like any other business now. They’re valued by their revenue, and their earnings growth, and their dividends if they have them, and their ability to produce cash. And so, there’s no tech premium any more, and that’s a good thing, because you can finance them on a reasonable basis, and you don’t have to count on hundreds of percent of capital gains all the time to make everything make sense. And while certainly there’s going to be outliers in the really radical, front edge of the industry, the majority of the industry is now just about producing cash flow like any other business. But there’s a lot of work to do in trying to figure out how tech companies get financed; there’s lots of angel financing at the early stages, and for startup companies, in some ways, things have never been better. But in those middle years, before you’re at a size where you can do a public offering, there’s not nearly as much financing. There is a huge demand in the public markets for technology companies, but not a lot of supply right now, and hopefully we’ll start to see some of those. I’m a big fan of public software companies, and I’ve found that the institutional investment community in Canada is very welcoming to tech stories, as long as you understand what investors need, and as long as you treat them with respect and you run a company in a transparent way and really keep your shareholders well—informed. If you do those fundamentally important things about having a public company, then I think tech is really welcome. So I think there’s a lot of potential to finance software companies better, and provide better capital for software companies, and so somehow I’ll get involved in that. So far, it’s just starting to make investments, but there’s lots of appetite for investment in tech companies. I’m not going to raise a fund, but there’s a lot of work to do. And in the process, we’re setting up this office. Part of the process of me figuring out my business plan is just to create a lot of traffic, and the whole idea of this space is not so much for companies to be incubated here, because it’s not that much space and we don’t have room for that many people, but if we can create a lot of traffic with companies that are in Toronto seeing this as a place to come and connect and collaborate – and particularly talk about how they’re approaching financing – then it’ll be successful. And there’s Communitech companies in Toronto all the time, trying to work through their financing options, and hopefully we can help some of them and they’ll pursue all different kinds of avenues. This is where we really want to focus on that aspect of their development. Q – During your time at MKS, what did you learn about yourself as a CEO? A – Well, I’m a change guy, I like to change everything. And there’s times in a company’s life where that’s really necessary, and times where it’s not. At MKS, as it turned out, the time for change was in the first couple of years of my tenure, and the need for change after that wasn’t very high. In fact, in some ways, our greatest virtue was that we didn’t change; we really stayed focused. So, my contribution in the later years was partly on the finance side. We developed an extremely supportive relationship with our shareholders. We had a dividend; we had a relationship that allowed us to have a good valuation and a successful public company by having a focused strategy and having a way of talking to shareholders. But I’m not the kind of manager that’s going to be nearly as good as many others, including my COO, Mike Harris, at actual day-to-day management, you know, that weekly sales meeting and making sure the operations are humming all the time. I think sometimes I get more impatient to change things, even though my better judgement will say, ‘Well, they don’t need to be changed.’ Q – Is that something you learned while you were there, or did you know going in that you really loved and had a knack for instituting change? A – Maybe not consciously, but I’ve always been drawn to a mess to clean up. And certainly at Certicom it was a mess to clean up. Even now, I tend to find I’m much more attracted to turnarounds than startups. In startups, sometimes I feel like the only pessimist in the room, and in turnarounds, I sometimes feel like the only optimist, and I much prefer the latter. So, I find I’m attracted to things that are lower valuation than they should be, rather than high valuations, but they could get higher. And I’m not afraid of a mess, so I think that tends to make me more of a turnaround guy. But then, once you’ve cleaned up the mess and you have a company that’s growing, I’m not sure my skills are as critical. In the MKS case, though, I was full invested; I’d put a huge amount of my capital in it, I’d brought in a lot of other investors who were counting on me to see it through, so it was essential to complete the project, and I wasn’t going to leave before it was completed. Q – Do you think it’s crucial for a CEO to have skin in the game like that, as they say? A – I think it’s important to have large shareholders on the board, and I think it’s important that the major board decisions be made by shareholders. I think there’s a terrible trend to somehow seeing something unseemly about large shareholders; that that somehow reduces their independence. In fact, I think it increases their independence significantly if the only interest they have is in the share price, not their directors’ fees, not their salaries, not their stock options, but that 98 per cent of their interests are in just seeing the right risk-adjusted result, in terms of shareholder value. It doesn’t have to be the CEO, and in fact, by the end of the MKS project, Mike Harris was the CEO for the last year. But it was essential that, on the board, there was someone with a large shareholding who could really drive shareholder interest, because I think it gets lost all the time, otherwise. Some of the best corporate managers and corporate leaders are people who, just by personality, aren’t interested in being shareholders. The entire team at MKS, for instance, had 10 years to dine out on what was often a very low stock price. But there are a lot of people by personality who aren’t very comfortable with that, and that doesn’t make them bad corporate managers; in fact, I’d say the majority of great corporate managers are people who will never put a very significant part of their net worth on the line, and that’s okay. But someone on the board had better have a completely unvarnished interest in doing it. Q – When you arrived to work in Waterloo at MKS, what were your first impressions of the broader tech ecosystem? A – I’d say the CEO community, for instance, was extremely welcoming, because MKS had a real historical significance in the community, and I don’t think anyone wanted to see it go bankrupt – and that really was the imminent thing. So, people from (Dave) Caputo to (Jim) Balsillie to (Tom) Jenkins to the whole community was extremely appreciative, and offering help, and going to lunch, and just expressing the fact that everyone wanted to see MKS survive. So that was heartwarming. They didn’t have anything they could really offer in any tangible way, and not many really became customers very quickly, but I think there was a real sense that people wanted to see MKS survive. I mean, Jim Balsillie was one of our auditors when he was a young accountant. There’s people all over the community; there’s not many significant tech people in Waterloo today who haven’t, at some point, either worked for MKS or been around MKS. It was in the community for 25 years. Q – Do you think that’s a unique attribute of Waterloo, that you got that kind of a welcome and that kind of a supportive reception? A – I think Waterloo is small enough that that can happen. It wouldn’t happen in Toronto because it’s just too big and diverse and spread out. And there’s not a sense of community in the same way in Toronto that there is in Waterloo. In some ways, tech is what Waterloo is about, and the tech community really sees itself in a leadership position, as it should. It has funded a lot of things in Waterloo and it’s responsible for a lot of the success, and so it’s just a fundamentally different kind of community, and a nice one in that way. I think that’s why a place like Communitech works, because it’s a tight community and people see a responsibility to contribute to the tech community that they’re all succeeding within. Having said that, it’s not a charity; people are there to make money. Q – What kind of change have you seen in Waterloo Region’s tech community in the years since you arrived at MKS? A – I’d say in the ‘90s we really didn’t have critical mass, and if you look at any other successful tech community in Canada, there’s always been some multinational leader there. In Markham it was IBM; in Kanata it was Nortel. You always have someone big because that’s where you’re getting a lot of technology spinoffs; that’s where you’ve got a critical mass of engineers to hire from; that’s where you have engineers leaving the big company and starting something small. So if you look at the Ottawa tech culture, it all kind of starts with Bell Northern Research, and if you look at Markham it all started with IBM, and all the companies around there have had something to do with IBM. And I think in the late 90s, when RIM hadn’t reached its full size, that was really missing in Waterloo. There was no dominant employer to take engineers from and for ideas to come off and to build around, and RIM became that. Q – And to draw world-class executive talent, as well. A – For sure, and I think that’s been harder, I think, for Waterloo to do than Ottawa, maybe because it’s too close to Toronto to kind of draw people away. But now there’s more critical mass; there’s enough critical mass to actually have a Communitech and to have a tech community, and it wasn’t clear that was quite there at the end of the 90s. So that’s better, and hopefully it’ll continue. Q – What do you think tech entrepreneurs in Waterloo who are new should be focusing their energies on in the next couple of years? A – What’s always remarkable to me and worth startups remembering is, companies are hardly ever successful at what they were founded to do. Usually when you start up a company based on an idea or a technology, it doesn’t work out, because you’re wrong about the market, but that first initial foray into the market that may prove unsuccessful is going to teach you so much about the market you stumbled into that you’ll have another idea. RIM wasn’t founded to make e-mail pagers, and Certicom was not founded to do cryptographic toolsets, and MKS was not founded to do application lifecycle management software. The acronym MKS was from mortising and kerning, because they started off making graphics software, and changing the distance between letters, which, back in ’84, was relevant. And that didn’t work, so they sold the toolkit that Alex White had developed so that he could use a cheap PC and get all his UNIX commands. This is the normal course, where the initial idea gets you going and gets some funding and gets a critical mass of engineering talent, and then, when you realize that your initial idea was wrong, you redeploy in some useful way. So, it’s worth remembering that your first idea is probably not the company-maker, but it’s a vehicle, a catalyst to get you there, and you’d better figure out how to fund it and lead it and manage it in a way that you can quickly adapt to the opportunities that you find there, that you might not have been aware of. Most of the time you really are not in a good position to judge what’s going to be a good business model from outside of a particular industry; it’s when you get into it when you understand it better and you can come up with your next idea. Or the one after that. But that’s going to take a while. Q – So, entrepreneurship is more a state of being and a state of mind than that one big idea that you can capitalize on? A – Yes. And I think that’s why universities haven’t been that successful at monetizing technologies. There are a lot of technologies that come out of universities; not many technologies turn into companies. Companies are sometimes founded to go and commercialize some technology, but that probably won’t be the one that they commercialize. And sometimes it’s frustrating for universities, who say ‘Well, we have all these technologies’, but actually, very few of them are going to be commercialized in that kind of form. So it’s important to not run out of money just because your first idea doesn’t immediately hit the market and take off. And that’s not really a sign of failure if and when it happens; it’s just unfortunately what was required to get you going, and you need to make sure you have enough money and adaptability to roll on to the next one. Pivot is what they say in MBA school; I don’t know, I never went to MBA school. Q – Anything else you’d like to say? A – I think people should not forget that the public markets are there, and they can be very welcoming to technology companies, as long as you treat your investors with respect and give them their due. It’s worth focusing on as companies get bigger, because there’s a ton of opportunity. It’s in some ways a unique advantage in Canada that we have a regulatory infrastructure that actually is quite kind to small public companies, where you could never do the same kind of thing in the U.S. It’s a tight community, it’s cheap, it’s reasonably low-burden in terms of the regulatory needs, and there’s lots of appetite out there.