General partners for
The complaint, filed in U.S. District Court in Seattle in mid-December, alleges that the management and directors of Isilon made untrue statements and omitted facts in its communications to shareholders as Isilon stock fell more than 80% from its highest point of trading at the end of December 2006 when it went public in a $108 million offering. “By misrepresenting Isilon’s financial outlook, the defendants presented a misleading picture of the company’s business and prospects,” according to the lawsuit.
The lawsuit claims the defendants “engaged in acts, practices and a course of business that operated as a fraud or deceit.”
The VCs named in the suit are Barry Fidelman, a partner at Atlas Venture, Matthew McIlwain, a managing director at Madrona, and Greg McAdoo, a partner at Sequoia. Fidelman and McAdoo currently sit on the Isilon board.
It’s important to note that none of the three venture firms, the largest shareholders in Isilon, has sold any shares in the company. The most recent ownership statements on file show Atlas with 14.78 million shares, Sequoia with 11.65 million and Madrona with 10 million—the same positions they held following the company’s December 2006 IPO, according to Thomson Financial (publisher of PE Week). It appears that Madrona distributed a big chunk of its shares to its limited partners in June, but PE Week was unable to reach Madrona for comment before going to press.
Had they sold at Isilon’s 52-week high of $25.50, the three venture funds could have raised a combined $929 million. That would have been a hefty return on investment, considering Isilon raised about $71 million in total venture funding from 2001 through 2006 before it went public.
The only venture firm that appears to have attempted to sell Isilon shares is
Besides the GPs at Atlas, Madrona and Sequoia, the suit names a number of Isilon executives, including Chairman William Ruckelshaus; former Isilon CEO Steven Goldman; former CFO Stuart Fuhlendorf; and founder Sujal Patel, who stepped up to the CEO role in October 2007. An Isilon spokesman was unavailable for comment. McAdoo, McIlwain and an Atlas spokesman also did not return requests for comment.
Attorney Matthew Handley declined to talk about the details of the case on behalf of law firm Cohen, Milstein, Hausfeld & Toll, which represents the plaintiffs. He said that an updated version of the complaint is due to be filed in the next few weeks.
Class action lawsuits are not unusual when publicly traded companies experience a sharp decline in share price though this suit is noteworthy since Isilon was once a high-flying IPO. The Seattle-based company went public in a $108 million offering on Dec. 6, 2006. The company’s stock, which debuted at $13 a share, rose to more than $27 a share within a few weeks of its IPO.
The stock steadily fell in early 2007, though the share price remained above the debut price, until the third quarter. That’s when the company reported that its quarterly revenue would be in the range of $23.2 million to $23.7 million, down between 6% and 8% from its previous quarter, and below the $25 million to $27.5 million guidance range it had given in July.
Wall Street analysts were disappointed. “We see no reason to buy Isilon shares—even at currently depressed levels—as another miss pushes out operating profitability until calendar 2009 and adds to concerns about Isilon’s ability to manage growth and handle stiffening competition,” Goldman Sachs analyst Laura Conigliaro wrote on Oct. 4. “Several execution miscues, including softness in Isilon’s European business, zero orders from a key customer (Kodak) in what is usually its biggest quarter, and a still-ramping salesforce, caused Isilon’s revenue growth rate to drop.”
Twenty days after the company missed its quarter, the board made changes at the executive ranks and promoted company founder Patel to CEO and Controller Bill Richter to CFO. The company announced it would delay its Q3 earnings call indefinitely.
“We believe Isilon’s board of directors was likely as surprised as the Street by the lack of execution in fiscal Q3,” analyst Thomas Curlin of RBC Capital Markets wrote on Oct. 25. “The issues are largely related to poor sales and service execution rather than a technology or product challenge.” Curlin estimated that Patel and the three venture firms hold share ownership interests of about 5% and about 60%, respectively, and that they “should be capable of marshalling a new executive team to right the ship.”
The investment banking arm of Curlin’s firm is currently a defendant in the class action lawsuit. Curlin did not return a request for comment.
Isilon may not be able to rebound from the beating it has taken in the public market. Wall Street analysts have suggested that the company may be shopping for a strategic acquirer. Wachovia’s Aaron Rakers suggests Hewlett-Packard and EMC as potential buyers. The company could be worth as much as $350 million in a sale, according to Friedman Billings Ramsey & Co. analyst Clay Sumner.