Citrix Microsoft Crisis 1997 – USA Today Article

The included article by Kevin Maney written in 1997 does a great job capturing the elements of what happened during the 1997 Microsoft/Citrix crisis. There is a real sense of urgency for survival. As I have said before, it should not be forgotten.  It is dangerous to be idly complacent.

Tiny tech firm does the unthinkable

USA TODAY

Date: June 11, 1997, Wednesday, FINAL EDITION

Byline: Kevin Maney

Scott Kinnear rushed to get to work by 9 a.m. on Wednesday, Feb. 26. The director of software development for Citrix Systems had a job candidate to interview.

That morning, Citrix, a small, booming company that makes a computer networking product called WinFrame – hummed as usual. Kinnear and most of Citrix’s other 180 employees had no idea that by day’s end, Microsoft would nearly crush the life out of their company.

Microsoft threatened to create its own version of WinFrame, Citrix’s big moneymaker. The move had a familiar ring. Microsoft in recent years has plowed into markets for Web browsers, spreadsheets and many other programs, steamrolling companies in its wake. But this move was unusually shocking: Microsoft is a Citrix technology partner and owner of 6% of the company.

“It finally happened: They’d been Microsofted.” Says Kevin Compton, a Citrix board member and partner in powerhouse venture capital firm Kleiner Perkins Caulfield & Byers. “The market thought it was the strychnine drink.”

Citrix shares plunged. The company lost 62% of its market value in one day. “People (at Citrix) were devastated,” Kinnear says. Veteran employees had much of their net worth in Citrix stock.

A lot of companies might never found their way out of such a fix. But this tale took a twist. Scrappy, Fort-Lauderdale-based Citrix stood up to Microsoft and prevailed. Its stock as soared 110% the past month to $ 28 5/8 Tuesday. While the stock price is still far short of its high before the Microsoft ordeal, several Wall Street analysts rate the stock a “buy.”

Citrix needed heroics to pull off its upset. A team from Citrix secretly rented apartments outside Microsoft’s headquarters under assumed names and spent 10 frantic weeks working out a deal. The events, revealed here for the first time, offer a rare look at a corporate drama usually played out behind conference room doors.

Tuesday, Feb. 25, started as another routine day of talks between the two companies at Microsoft’s Redmond, Wash., headquarters. They were in the midst of negotiations over licenses and royalty payments for the Microsoft Windows NT technology that Citrix uses for WinFrame. But internally, Microsoft already was changing its thinking about its partner, setting the stage for its aggressive move.

The two companies have known each other for a long time. Their roots go back to Citrix founder Ed Iacobucci (pronounced yahk-ah-BOO-chi), who has a knack for landing at the center of some kind of Microsoft controversy.

Big and amiable, with a salty beard that doesn’t match his dark hair, Iacobucci, 43, is a brilliant engineer who worked for IBM from 1978 to 1989. Most of those years were in Boca Raton, Fla., where he designed architectures and operating systems for IBM’s PC division. In that job, he worked closely with Microsoft, which supplied the DOS operating system to IBM. That deal launched Microsoft on its way to the top of the software industry.

In the late 1980s, Microsoft and IBM went to work on a follow-up to MS-DOS — OS/2. Iacobucci headed the joint design team. The two companies disagreed about OS/2. They fought. They became alienated. They broke up Iacobucci’s team. Microsoft took its rights to OS/2 and used them to develop Windows. IBM continued to develop OS/2, which never made a dent in the computer industry. Microsoft and IBM to this day are at odds, stemming from the OS/2 rift.

Along the way, Iacobucci saw a way to make software that would enable networks of any type of computer to run OS/2, even if the machines weren’t built to do so. He told IBM and Microsoft but neither was interested. Iacobucci left, taking a handful of IBM engineers with him, and started Citrix. The company got funding from Kleiner Perkins and other venture capital firms, and through them acquired a CEO, Roger Roberts, a low-key, twangy veteran of Texas Instruments.

Citrix’s technology worked. It was way ahead of its time. The problem was, OS/2 was a dead end. By September 1991, Citrix was broke. Iacobucci looked up Microsoft and decided to rebuild the software based on Windows NT, a version of Windows aimed at corporations.

To do that, Citrix had to get licenses from Microsoft. Microsoft knew that if Citrix could successfully make NT work on networks of disparate computers, that might expand the NT market, which at the time was still tiny. Microsoft was so thrilled with Citrix that it bought the 6% stake and put Microsoft Vice President Greg Maffei on its board of directors.

In August 1995, Citrix shipped WinFrame. In Citrix’s lab sits an old 286 PC — a real clunker that could never handle Windows software on its own. Using WinFrame, the 286 can run Windows 95 and Microsoft’s Office 97 via a network connected to a server. Customers love the idea that they can use WinFrame to wire together a patchwork of computers to use the same standard software. At a time when it’s hard to be far ahead in technology, WinFrame was and is. “There isn’t anybody else out there with a proven solution,” says Michael Cristinziano, analyst at Gerard Klauer Mattison.

Microsoft, it seems, got jealous.

The breakdown

Microsoft watched as Citrix’s business took off. Revenue tripled from $ 14.6 million in 1995 to $ 44.5 million in 1996. By last fall, the stock hit a high of $ 56 3/4. The company started hiring an average of five employees a week and moved to a sparkling glass building next to a pond. Partners signed up to work with Citrix, including Sun Microsystems, a Microsoft rival.

Citrix increasingly found itself in the middle of a raging debate in the computer industry. Sun, IBM and others were pushing network computers, or NCs. The stripped-down computers connect to a powerful central computer and use software stored there. WinFrame is ideal for NCs. But Microsoft felt NCs were a threat to its traditional business of selling software for high-powered PCs. It denounced NCs.

On Feb. 20, rumors started circulating that tensions were high between Citrix and Microsoft. That day, Citrix shares plummeted from $ 39 1/2 to close at $ 29 1/8. CEO Roberts said the relationship with Microsoft was fine. Analyst Cristinziano told investors he was sure the partnership was “as strong as ever.”

In retrospect, what happened next doesn’t surprise anyone who knows Microsoft well. But it certainly shocked the socks off Citrix.

The hammer falls

By the time the representatives of Citrix and Microsoft sat together Feb. 25, Microsoft already had decided it wanted to build Citrix-style networking capabilities right into NT, says Jonathan Roberts, Microsoft’s director of product marketing for Windows. (Microsoft said the executives closest to Citrix — Maffei and Group Vice President Paul Maritz — were not available for comment.)

Citrix’s WinFrame has two parts. One is Citrix ICA. It’s a computer protocol that separates the graphics of a Windows application from the actual information. Only the information goes back and forth across the network, making the network much faster.

The other part is called Citrix MultiWin, otherwise called multi-user extensions. Those are changes to the actual Windows NT code. They tell NT that it’s OK for several users to access the same software at the same time, which is necessary for WinFrame to work.

With Microsoft’s permission, Citrix has been adding the extensions to NT, repackaging NT under the Citrix name and selling it to customers in a WinFrame box.

That became a sore point for Microsoft. With NT sales booming, the company no longer liked Citrix altering NT and reselling it. Microsoft wanted to regain control, even if it had to compete against Citrix.

A clause in the Microsoft-Citrix contract requires Microsoft to give Citrix six months’ notice if it’s going to unveil a competing product.

Microsoft had no such product in the works. Nonetheless, after a break in negotiations on Feb. 25, the Microsoft team gave Citrix official notice that it might decide to develop its own Citrix-like product.

Microsoft officials insist the notification was routine, not a negotiating ploy to force Citrix to give Microsoft whatever it wanted. Others say it was a mistake — an overly aggressive move by a midlevel Microsoft negotiator who wanted to cut a tough deal. “It became obvious that behind the room there was a lot of, ‘You did what?’ ” says Kleiner Perkins’ Compton.

Microsoft CEO Bill Gates, who kept in touch with the Citrix situation, counters: “We were very clear with them all along about what we were considering.”

Either way, the move exploded on everyone involved. Because of its power, a mere utterance from Microsoft can set off panic.

Citrix was obligated to make a public announcement explaining that Microsoft might enter Citrix’s market and end the partnership — a change that would “materially affect” Citrix.

That information was all the stock market needed to hear. “We were completely cognizant that if Microsoft was so inclined, it could take over this market right under Citrix’s nose,” says Christopher Galvin, analyst at Hambrecht & Quist.

So Wall Street pulled the trigger.

A lot of technology stocks are caught up in momentum investing. A tech company gets hot and regularly beats earnings expectations. Big-money investors snap up the stock just because the company’s hot, not because they know much about the company. The stock soars, probably higher than it should. When bad news comes, momentum investors don’t wait to learn details. They dump shares.

Momentum investing bid Citrix up. When the Microsoft news hit, the stock got slammed.

On Feb. 27 — the day after Citrix’s announcement – institutional investors couldn’t sell Citrix shares fast enough. The stock lost 60%, closing at $ 10 5/8, down from $ 26 1/2. Citrix has 27 million shares outstanding; 13 million traded hands.

Devastation

The stock plunge made everything more difficult for Citrix. It put public pressure on the license negotiations.

It rocked employees’ sense of security just as they were finishing a critical new version of WinFrame. “My very first reaction was, ‘Guess I better find a job,’ ” says Scott Clark, 22, an engineer who joined Citrix in January.

It made customers nervous. Marketing chief Mark Templeton walked into a meeting with Citrix’s biggest customer, Sears, to find executives nervously tapping the table, waiting for an explanation.

The technology industry was riveted by the Microsoft-Citrix showdown. Many wondered where Microsoft would stop if it was “willing to cross swords” with a partner in which it owned an equity stake, says Terry Garnett, a venture capitalist who has backed a number of tech start-ups.

Iacobucci saw that he had to convince Microsoft it was wrong as quickly as possible — and he believed he could. He immediately flew to Redmond, got a hotel suite and took charge of negotiations. He assembled a negotiating team of about a half dozen people, pulling in some of Citrix’s best technical minds.

They weren’t necessarily there to talk about deep tech issues, but to win the respect of the highly technical Microsoft people. “A heavy technical content is unusual on most negotiating teams,” Iacobucci says. “But you have to do that with Microsoft.”

Jeffrey Krantz, a top Citrix engineer, got a call from Iacobucci to drop everything and join him. Krantz, 42, was used to sitting at a computer designing software code, not debating business issues. Upon arrival, he learned of the task before him. “It was a real emotional experience getting briefed,” he says.

Iacobucci wanted Microsoft to know he was digging in his heels. He rented four apartments in a building in Redmond. He hired Nancy Lee — a telecommunications consultant and Iacobucci’s fiancée — to wire the apartments together with high-speed data networks. Computers lined every wall. Four or more phone lines were run into every room. Iacobucci brought in a treadmill for keeping in shape, a DVD player for watching movies during breaks and cases of Diet Coke and Diet Peach Snapple, a team favorite.

The team moved in for as long is it would take, for better or worse. “Imagine a college dorm where everyone is over 40 and set in their ways,” jokes Krantz.

“It was like Animal House,” says Barry Dockswell, a Citrix vice president who was on the team. “We saw parts of each other we never thought we’d see.”

Talking in code

The team tried to be secretive to keep from setting off more rumors. The apartments were rented under fictitious names. In public, team members used code words. Microsoft was The Family. Gates was The Father. Windows was Walter.

Most of the work was done in the apartments. “We spent hours and hours with spreadsheets and business models,” Dockswell says. They explored every option, from selling the company to Microsoft to the two companies walking away from each other for good — and every tweak in between. “There was no easy answer out of our options. We’d burrow down and try to make one work and then try another until we could make one of them make sense. It was the hardest thing I’ve ever done. It was a 24-hour thing.”

The team members would come up with a deal they thought would work and march it over to Microsoft. Maritz, one of a handful of people who report directly to Gates and a man who had known Iacobucci for years, took charge of Microsoft’s team. It was an indication of how important the negotiations suddenly had become to Microsoft.

The two teams would gather in a conference room near Maritz’s office and debate the latest proposal. At first, neither side budged much. “I think they weren’t sure what to make of us,” says Dockswell, “because we wouldn’t give in and we wouldn’t go away.”

Back at the ranch

While Iacobucci worked the negotiations in Redmond, Citrix CEO Roberts tried to keep things on track in Fort Lauderdale. He traveled around the country, reassuring customers. His message: Citrix had $ 175 million in cash, enough to see it through a crisis with Microsoft. “If not for that, we would’ve been much more vulnerable,” Roberts says. No customer abandoned Citrix.

Kinnear rallied the engineers to finish WinFrame 2.0. Templeton worked on morale, buying T-shirts and throwing beer parties for employees. The message was that one way or another, Citrix would survive.

Then came lawsuits from angry shareholders. In late January, when Citrix stock was near its high, Roberts sold 25,000 shares for $ 1.3 million. Compton sold 10,000 shares. Other executives — Bruce Chittenden and James Felcyn — sold, too. A month later, the stock collapsed. The lawsuits claim the executives knew what was coming. Citrix executives won’t comment because the charges are pending.

In April, the stock floated a bit higher. Several Wall Street analysts advised investors to buy Citrix. They said the technology was solid, customers were happy and the fallen shares were a bargain. They believed Microsoft would cut a deal with Citrix.

But in Redmond, there were no breakthroughs.

Parting of the clouds

Negotiations dragged on. Citrix team members — including Krantz, who has two young children — hopped red-eye flights to Florida for birthday parties and family events and came back the same day. Lack of sleep took its toll.

In the Redmond apartments and Microsoft’s conference room, no single idea caught fire. “It was weeks of continuous small steps,” Iacobucci says.

Outside the negotiations, a couple of developments were influencing Microsoft’s stance. In April, for the first time, Gates made speeches signaling that Microsoft might embrace NCs. If so, it would probably want to go there quickly, analysts said. Citrix had proven technology for linking any kind of NC to Windows and was already a Microsoft partner. Developing similar technology at Microsoft would take months or years. The closer Microsoft moved to NCs, the more it needed Citrix.

The other development was that Microsoft was trying to soften its corporate image. The company has a long history of playing hardball. In the past, Microsoft has hurt little companies such as Stac Electronics and been accused of using its 80% market share in operating systems to freeze out competitors, from unknown start-ups to Lotus Development. In May, competitor Borland sued Microsoft, accusing it of systematically hiring away 34 of Borland’s top engineers in a plan to cripple the company. (Microsoft denies it.) That’s not an image Microsoft can afford anymore.

“They are realizing they will do better in the future open architecture of the Internet by having friends,” says Scott Kurnit, CEO of The Mining Co. “They may well be adopting a new, warmer corporate attitude.”

Microsoft gave in a little. Citrix gave in a little. On May 12, they struck a deal.

A win-win, for now

As part of the deal, Microsoft will license the multi-user extensions from Citrix and put it into future versions of Windows NT under Microsoft’s name. Terms of the license were not released, but Microsoft will pay Citrix $ 75 million now and up to $ 100 million more depending on software sales.

Citrix will continue to make WinFrame as a separate program that sits on top of NT and ties together the networked computers. And Microsoft and Citrix will jointly develop and market networking products for future versions of NT.

Everybody calls it a win-win. Citrix stays independent and won’t face competition from Microsoft. It can still work with Sun and others to market products for NCs. And Microsoft’s endorsement should bring Citrix more customers.

Microsoft gets the control it wanted over NT, keeps Citrix’s help in the NC market and improves its reputation as a kinder, gentler company. Yet Microsoft doesn’t feel it backed down. “Our strategy is unchanged, except that instead of working in opposition with Citrix, we’re working with them,” Microsoft’s Roberts says. Gates, asked about Citrix at a recent event in Washington, seemed genuinely enthusiastic about the deal.

Citrix’s stock price bounced up after the deal was announced. It closed May 12 at $ 32 5/8. Citrix employees gathered around speaker phones to listen to Iacobucci and Maritz explain the deal in a press conference. “There were a lot of high-fives and a lot of laughing,” Kinnear says.

The Citrix team caught the first non-stop flight they could from Seattle to Miami and celebrated with an on-board glass of champagne.

Three days later, at Citrix’s May 15, annual meeting — a meeting that could have been ugly had the deal not been done — a shareholder rose, asked for and got a round of applause for Iacobucci and Roberts.

The future looks good for Citrix. At the annual meeting, Roberts confidently said Citrix could be twice its size in a year.

But there’s one nagging catch. As Cristinziano notes: “The company is still dependent on Microsoft.”