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Loudcloud leaning on EDS deal

The company is betting its business on hopes that its licensing deal with Electronic Data Systems will be approved. But if the deal disintegrates, Loudcloud could face a cash crunch.

Loudcloud is betting its business on hopes that its licensing deal with Electronic Data Systems will be approved.

The company moved Monday to allay fears about the deal and to end concerns that it will face a cash crunch. Worries about Loudcloud sent shares tumbling after its auditor, Ernst & Young, issued a "going concern" warning and said the company will need more funding if the EDS deal isn't approved by shareholders.

The company said it expects the EDS deal to be approved, but it is still contingent on a shareholder vote. Shares continued their weeklong decline, however, falling 14 cents, or about 12 percent, to $1.08. The stock was almost $2 a share last Tuesday.

Loudcloud said last week that it would exit the Internet hosting business and change its name to Opsware.

Simultaneously, Loudcloud announced that EDS, of Plano, Texas, would buy its managed hosting business for $63.5 million and license its Opsware IT automation software for a total of $52 million over three years.

The problem? On June 14, Loudcloud bought $42 million of its own debt, triggering comments from its accountant, Ernst & Young, that the company could have trouble funding its business.

On June 17, Loudcloud announced the deal with EDS, which will provide it with enough cash, assuming it gets approved by shareholders and EDS doesn't back out.

In a proxy statement filed last week, Ernst & Young said the debt repurchase has put Loudcloud in a sticky situation. If Loudcloud doesn't receive estimated net proceeds of $61.5 million from the EDS deal and $9 million from a separate deal with Frontera, it could have trouble continuing its business, the accounting firm said.

Loudcloud said Monday that it is confident the EDS deal will go through, despite a pending shareholder vote. Loudcloud also argued that the debt repurchase that has created its auditors' financial concerns is part of a strategy to save it money if the EDS deal succeeds.

Gartner analysts Ronni Colville and Donna Scott say Loudcloud's switch from a focus on managed hosting to software gives it a chance to become profitable, but it still needs to overcome many challenges.

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The Sunnyvale, Calif.-based Web infrastructure business, founded by Marc Andreessen of Netscape Communications fame, was one of the few companies to go public in the middle of the dot-com decline. But the company's initial public offering was far from successful, and Loudcloud has struggled with its business model.

On Friday, Loudcloud Chief Executive Ben Horowitz told Reuters that the debt purchase was a strategic move that would save the company $22.6 million if the deal with EDS were to be approved.

"The asset purchase agreement requires that a majority of Loudcloud stockholders approve the transactions," the company said in a statement Monday. Since Loudcloud's management owns 43 percent of the company's outstanding stock, and the board of directors has unanimously approved the transaction, chances are the deal will go through.

"We are highly confident our transaction with EDS will close as expected in September and very excited about the future of the business," Horowitz said in the statement.

Assuming the deal does close in September, Loudcloud said it expects to have a cash balance of about $65 million at closing. After closing, the company said it will burn less than $10 million in cash for the remainder of the calendar year.

The deal will also bring the company to cash-flow breakeven earlier than expected, by the second quarter of 2003, Loudcloud said. As a result, the company said, its cash balance will be above $50 million at cash-flow breakeven, and cash levels will grow after that.

As of April 30, according to the company's filing with the Securities and Exchange Commission, Loudcloud had $77 million in cash.