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Stacking the index
Sacramento tech alliance keeps only the region's top 50 companies on its index, tossing the poorer-performing companies. Still, many on the list like the prestige.
Sacramento Business Journal
June 3, 2005

Since the second quarter of 2003, the Sacramento Area Regional Technology Alliance -- a 3-yearold public/private partnership -- has put out a list each quarter that attempts to show the collective health of the best-performing public and private tech companies in the region.

It's like a quarterly all-star list of the 50 local companies with the most growth as charted by revenue, employees and capitalization. The point of the index is to lure venture capital to the area by showing Greater Sacramento's punch as a technology market. The original goal of the index was to attract $500 million in venture funding here by the end of this year. That goal still seems a few years away.

But because of the SARTA index's method of assembling company data, the local tech market seems to be going nowhere but up. There's a reason for that, and it has little to do with the strength of the entire market. It has to do with the way the index is tallied.

The list's membership differs from most public company performance indexes, such as those run by Dow Jones and Standard & Poor's. Those traditional indexes, with a few exceptions, keep indefinitely the companies that initially qualify for the list, whether their performance goes up or down. The SARTA index, meanwhile, routinely drops companies off its list if they forget to reapply, don't show high enough numbers, or leave the area.

With that formula, companies without strong enough numbers are ejected from the list, begging this question: Is SARTA's list an accurate barometer of the region's technology economy? Or is it merely a numbers massage to help market the local tech economy as one much stronger than it actually is?

Rules are stated

Index experts at Dow Jones and Standard & Poor's say their indexes, which are geared to monitor the economic ups and downs of companies, require:

- A publicly disclosed list of the economic criteria that qualify a public company to make the list;

- Keeping a qualified company on the list whether it performs well or not;

- Refraining from mixing public and private companies on a list. They're considered to be too different to combine, and private companies' numbers are much less likely to be officially verified.

John Prestbo, editor of the Dow Jones indexes, says it is critical to disclose the criteria that qualify a company to make an index. Not doing that, he says, "is pretty dubious." While the Dow Jones industrial average and the Standard & Poor's 500 are "black-box indexes" affected by human judgment, "the vast majority of indexes used by investment professionals are rules-based," he says. "The rules are published and are known." Such indexes, Prestbo says, "are by far the most transparent and reliable form."

He called the quarterly practice of weeding out companies with lesser numbers "stacking the deck for a rising index."

Public-company indexes often have formulas that subtract stock held by founders and family members, Prestbo says. "The weighting schemes for components of an index are fairly well known," he says. "The idea that this index's (SARTA's) are so proprietary that they can't be disclosed is pretty far-fetched. If they want to have their index taken seriously, they've got to lift their skirts a little bit."

What's wrong with different?

Oleg Kaganovich, SARTA's executive director, makes no bones about the fact that the local list seeks only the top 50 growth companies every quarter, and includes additions and deletions if necessary. Since the third quarter of 2003, three months after the first index debuted, 22 companies have been taken off the list and replaced by companies with stronger numbers. Four have made it back on.

Kaganovich says the unorthodox mixing of public and private companies is reconciled by SARTA's undisclosed proprietary algorithm -- one that took a year to formulate, he notes. From each company, the index records numbers of employees, revenue and, for public companies, capitalization, and for private firms, raised capital.

Unlike a lot of other more established tech markets, Sacramento doesn't have many public technology companies. Most are privately held -- some are startups -- and smaller than their public counterparts. The SARTA list, says Kaganovich, uses year-end numbers from private companies because such numbers are typically audited, and are likely the most accurate available. Beyond that, he says, Ernst & Young randomly spot-checks the company numbers, to verify what was reported.

So far, the SARTA index base numbers have shown a collective gain for six straight quarters, from second-quarter 2003 through last year's fourth quarter. The index was given a starting value of 100 in the second quarter of 2003. That grew to 105.2 by the end of the quarter. The fourthquarter 2004 index totaled 149.79, up from 131.1 in the third quarter.

The latest index reflected a strong public stock market, with market capitalization rising by more than $1 billion to $2.06 billion; a rise in private company revenue to $483.1 million; and continued increases in local venture funding.

Private-company employment among index members dipped from 3,084 in the final quarter of 2003 to 2,950 late last year.

But Kaganovich says the index's growth trend won't necessarily continue.

"Several things can happen if the public markets go down to any extent," he says. "And if the local economy starts to downturn, private companies' revenue can decrease and it (the list's numbers) can go into negative territory."

Meanwhile, SARTA has launched a system to automate data collection, allowing index companies with a password to enter their numbers via the Web.

Yeah, but ...

SARTA's proprietary formula is pitched as something that makes possible a workable blending of private and public companies on its index. But Prestbo of Dow Jones says he's never heard of such a thing.

"The pricing of private companies is not as transparent a process as for the companies on the stock exchange," he says. "Pricing a private equity firm is an art, not a science." Private companies, when reporting their numbers, "like to have their best interests at heart."

But to get the most accurate numbers from a private company, he adds, "you'd have to hire an appraiser to come up with some reasonable range" of value -- such as a middle range -- evenly applied to all the private companies getting appraised.

As for trying to chart a small technology economy like Sacramento's, Prestbo said having the index skewed toward positive numbers works as a marketing tool.

"I can see the PR value of it," he says. "But the rules of the index should accommodate the fact that nascent growing industries sometimes stumble, so they'd be expected to be more volatile."

Srikant Dash, index strategist for Standard & Poor's in New York City, says an index's qualifications criteria should be made public. If not, he says, "I don't know how you can use something like that."

Dallas has it

The Greater Dallas Chamber of Commerce last year bought the license to use the SARTA tech index's data- collection methodology. (The price has not been disclosed.) Meredith Dowling, director of technology business development for the chamber, says the job of setting up a technology index for Dallas/Fort Worth has been "contracted out to SARTA."

The chamber was interested in it because "rather than reinventing the wheel," having a readymade system was seen as a key to a quicker startup, she says.

The Dallas-area tech market is quite a bit bigger than Sacramento's, with 18 big tech companies based there.

Sacramento has about 20 public companies in all industries based here. Dallas has an estimated 350, she says, and another 1,300 or so private companies, with technology companies on each of those lists.

The SARTA index is being "customized quite a bit," for Dallas, she says, and a launch is scheduled for autumn.

The goal of the index, she says, will be to show which tech companies and startups are in the area.

"A lot of people don't know what we have here," she says. "We want to let folks know it's not just cowboys and horseback riding."

'Where are the downs?'

Technology companies both on and off the SARTA index generally agree that the listing provides valuable visibility that they wouldn't get without qualifying for it. Others seem to be in the dark about how the thing actually works.

Paul Tupin, CEO of LifeWave Inc., a Roseville startup that makes noninvasive medical diagnostic devices, initially made the list, but was later taken off.

"We're a startup," says Tupin. "Revenue is a dream of ours. I was kind of surprised we got on the list in the first place."

Perry Martin, of the McClellan Park-based Materials Technology Laboratories, says his firm filled out the application for the list and made it, but was pulled off for the fourth quarter of 2003.

"They seemed to want us to participate in stuff," says Martin. "They hold seminars. I haven't got time. I'm not looking for investors."

Martin says the information a company supplies to SARTA "tells any story the company wants to tell. There are no accountants verifying everything."

He says that alone raises questions about the index. But it doesn't bother him. He sees it as "a visibility platform," and though his company isn't seeking visibility, he adds, "Anybody that would be dumb enough to invest in a company because it's on an index wouldn't have enough money, because they're not smart enough."

David Cuttler is president of Roseville-based Affinity Global Solutions, which makes budget software for state government. He says he wasn't miffed in the least when his company got booted off the SARTA list for third quarter of last year.

"In many ways, you're better off (off the list) because you don't get bugged by so many people," he says. Besides that, "There's no credibility to the index if they keep changing what the composition is."

Mike Jones is general manager of Barco Folsom LLC, a 100-employee local display company bought in January by a Belgium concern. Jones says the company is still growing with strong revenue locally, but because of the time demands of the merger, it let its application to the SARTA list lapse. It came off the list as of last year's third quarter.

Dave Piper, founder of Evit Labs Inc. at McClellan Park, which makes medication inhalers, saw his company come off the SARTA index for the first quarter of 2004. The index "is a positive thing," he says. "It gives additional exposure and a way for us to communicate with investors and other people who may have an interest in the medical field."

But Piper figures the index ought to record downside numbers instead of keeping only companies with growth to report. "If you want to know all the action in the Sacramento area, you want to know the ups and downs. Where are the downs?"

Piper says the SARTA list is weighted mostly by the fortunes of the public companies on it, which are much bigger than the more plentiful private companies.

He adds, however, that its benefits outweigh any of its faults. "I'd rather have a list with some limitations than nothing at all. You can't let the best be the enemy of the good."

Amit Mazumdar is CEO of VisualCalc Inc., an El Dorado Hills data-analysis software company. His company was dropped off the SARTA list for the fourth quarter. While noting that private companies providing their numbers to SARTA are essentially on the honor system for their accuracy, he doubts if companies "pad" their numbers to get on or stay on the list.

"It's a limited indicator," he says. "It gives a sense of who did well last quarter."

Beyond that, he adds, "If you're not on the list, you're not a nobody."

Henk Keukenkamp is CEO of ScopeIT, which makes software that gives cost estimates of information technology projects. His company was dropped off the list for the third quarter of last year. He's not familiar with the index's methodology. But he too sees it as a good marketing option for his company.

"I'd like to be on the index," he says. "The visibility is good for us."