ESG's Friends & Family Deals

Since opening its doors in November 1999, the Enterprise Storage Group Inc. -- led by salty-tongued founder Steve Duplessie -- has established itself as the crme de la crème of research and consulting firms catering to the storage industry. But questions about some of the steps ESG has taken along the way are raising eyebrows.

The firm counts a significant portion of the vendors in the business as clients, from such giants as EMC Corp. (NYSE: EMC) and Cisco Systems Inc. (Nasdaq: CSCO) down to some of the smallest early-stage startups. ESG analysts are among the most widely quoted by IT trade publications (including Byte and Switch) looking for quick insight into market trends.

One of ESG's primary selling points is that it presents itself as an impartial, unbiased observer -- that its analysts will tell it like it is under any and all circumstances. "ESG's greatest strength is our integrity," reads the mission statement on the company's Website. "We always provide an informed opinion and we always tell the truth... With ESG you get the whole story, not just the 'safe' story. We may not be correct 100% of the time, but you can always count on our honesty."

But Byte and Switch has recently learned that ESG has accepted shares in 12 pre-IPO storage companies in lieu of cash in exchange for consulting and research work. On its face, it appears that this type of arrangement would give ESG obvious conflicts of interest, because the firm has a financial stake in the success of certain companies.

Duplessie, however, says ESG's ownership of shares in certain companies for which it provides consulting -- and about which it's supposed to be providing "independent" analysis -- is, in fact, really no big deal."We don't take equity positions that would make me a million dollars," he tells Byte and Switch. "Sometimes I take a little stock and I hope. But it rarely pans out." [Ed. note: Aside from Duplessie, no current or former ESG employees provided any information for this article.]

Duplessie readily acknowledges that ESG has received shares in certain companies. While he would not name all 12, he says that ESG had owned small amounts of common stock in Astrum Software (bought earlier this year by EMC), Pirus Networks (acquired by Sun Microsystems Inc.), and Nishan Systems (which McData Corp. recently purchased).

However, he says, every single client of ESG must pay $25,000 a year in cash -- no exceptions -- to receive the baseline service, which includes 12 hours of analyst time. Additional services cost extra; for example, ESG charges between $10,000 and $15,000 a day for speaking engagements. It is only for these extra services that ESG will take shares instead of cash, according to Duplessie.

Furthermore, Duplessie claims that ESG takes shares only in situations where startups simply do not have the cash on hand to pay for those additional services. "We always take cash when we can. If we feel there's legitimate opportunity to add legitimate value, we will consider accepting equity. Unfortunately, not every startup has the money. Sometimes we try to be nice guys."

He also notes that the shares ESG takes often end up being worthless. One of the few successful exits that yielded a return for ESG was Sun's acquisition of Pirus for approximately $160 million last year (see Sun Beams on Pirus). Duplessie would not reveal how much ESG received from that deal; an ex-Pirus employee, though, says ESG's piece of the pie was "not astronomical." By contrast, Duplessie says, when McData bought Nishan for $83 million, the $10,000 in Nishan common stock ESG held wasn't worth anything.Adds Duplessie: "I really do not think this is a story. Our finances are nobody's business."

Some in the storage industry, however, aren't sure ESG is completely above-board. "How can a consultant who wants press all the time have interests in the companies he is extolling the virtues of?" says Mike Workman, president and CEO of Pillar Data Systems, a storage systems startup backed by Oracle Corp. CEO Larry Ellison. "And if he has an interest in some, then is he really unbiased on the others?"

According to Workman, ESG -- specifically, Duplessie -- did offer to take shares in Pillar Data "many times, point blank, and in front of 10 people. Frankly, I was a little shocked."

Asked about Workman's version of events, Duplessie confirmed that he did offer to "take a split of equity and cash instead of all cash" because, he says, Pillar Data said it didn't have the budget to retain ESG. "Thought I was doing them a favor, but apparently not," Duplessie says. "I'd still like a piece of that company. I think they have a great shot to do real damage. We'll also continue to help a ton of other startups, and if that means taking a gamble on some stock, so be it. I like startups."

ESG, to be sure, has plenty of admirers. "I can tell you that in my experience, ESG has been extremely ethical," says David Scott, president and CEO of 3PARdata Inc. "ESG has never asked to be paid for an 'independent report' to be written -- unlike some other analyst organizations, whom I have politely refused to play ball with."Scott adds that ESG has never asked his company for shares. "Though Steve is very colorful, he has never approached me or anyone else at 3PAR with such a request."

To put this issue in context, it's important to realize that the practice among cash-strapped technology startups of granting shares to suppliers -- such as PR agencies or Web design firms -- is very common. But an "independent" analyst firm is in a different boat, and the fact that ESG has accepted equity in companies it's supposed to be critiquing does raise the question of whether the firm can remain objective in its analysis.

A general skepticism about the independence of so-called independent analysts has always existed, but lately it's been fueled further by allegations of conflicts of interest among Wall Street banks' investment arms and their stock analysts. The issue has affected everyone in the business. Forrester Research Inc., for example, recently issued a statement that it will no longer conduct sponsored product comparisons. The research firm was reacting to criticism that it didn't properly disclose that a study it published was funded by Microsoft Corp. (Nasdaq: MSFT) -- a report that found (surprise!) developing applications on Linux and Java is more costly than using Microsoft technologies.

A longtime storage industry executive, who asked to remain anonymous, offers this observation: "Irrespective of the type of remuneration received -- money for services, stock for services, food for services -- a company that doesn't separate its forecast/opinion group from its paid consulting group should have every piece of advice it offers taken with a grain of salt."

But Duplessie insists that he treats everyone, large or small, with equanimity."The big accounts pay us a lot of money, but we don't treat them any differently," he says. "I don't get paid enough by anybody to lie... I don't give a shit about 25 grand. You can't buy me for that. For 25 grand I won't sell my soul."

— Todd Spangler, US Editor, Byte and Switch