DMG Case Studies

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DMG Case Study — Cielo Communications, Inc.

Industry: Manufacturing; Technology
Business Description: A manufacturer and developer of laser fiber optic devices.
Business Problem:

In July 2002 Diablo Management Group (DMG) was referred to Cielo by Van Van Auken of The Mayfield Fund, a board member and investor in the company. Cielo was engaged in the optical components sector of the telecommunications industry, developing VCSEL (Vertical Cavity Surface Emitting Laser) semiconductors and multi-laser modules.

DMG was retained to manage an orderly sale of company operations and intellectual property assets and conduct the settlement of outstanding financial and legal obligations.

DMG Focus:
  1. Manage the sale of company assets in a timely and organized fashion
  2. Effectively settle with all creditors and lessors
  • Completed sale of manufacturing operations and intellectual property within four month period
  • Gained significant return to creditors
  • Purchase price allocation was successfully negotiated with senior secured debt holders, equipment lessors and IMI and unsecured debt holders
  • Completed all remaining fiduciary responsibilities for business closure

Additional DMG Information
Cielo Communications, Inc.

As of July 2002, Cielo was burdened by approximately $5 million in senior secured debt, $2.2 million in secured equipment leases and $5.7 million in unsecured debt. Earlier in the year, the company had taken cost-saving measures and had engaged an investment bank, Soundview, to seek a buyer for the company. As of July, there were no active acquirers, little if any revenue from sales and approximately 45 days worth of cash available.

In August 2002, a term sheet proposing the acquisition of Cielo was received from Finisar, a company engaged in various aspects of the optical components industry. The term sheet was signed, and the due diligence process began. On August 26, the Board of Directors met, appointed Richard Couch a director and CEO and resigned. The management team was also terminated.

DMG immediately began the restructuring steps required given the rapidly deteriorating cash situation. All employees were terminated, with many being retained on part-time consulting arrangements in order to support the sale process. All employee-related payments were made. All other expenditures were suspended except for those necessary to keep the manufacturing process in idle but working order.

The general terms of the final Asset Purchase Agreement reached between the buyer and Cielo called to purchase substantially all of Cielo's assets and included a requirement that all equipment, furniture and fixtures in the business be included free and clear of all encumbrances. This required releases from all secured lenders and lessors as well as some selected unsecured parties, such as the landlord and Cielo's outsource manufacturing partner, IMI, in the Philippines. It also included that OCP would lease part of Cielo's facility, which contained the semiconductor process area.

This division of proceeds between Senior Secureds, Equipment Lessors, and Unsecureds was predicated on the notion that the Senior Secureds had the strongest security position. In fact, this turned out not to be the case. The Equipment Lessors, as a class, had stronger security positions. As a result, the balance of power shifted to the equipment lessors as a class, making negotiations much more difficult. This eventually necessitated an adjustment to the division of proceeds.

Following numerous negotiation rounds with the Equipment Lessors, it was determined that the planned payout was not sufficient. It was also determined that the landlord would demand cash compensation in addition to the OCP lease in order to agree to a lease termination. Finally, agreement was reached with IMI to forgive the debt owed in exchange for certain of Cielo's equipment.

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