Communications Investing Binge Continues,
November 29, 2000
By Matthew A. DeBellis

Although venture capitalists have already bet heavily on communications startups, they say there's still plenty of opportunity to invest in new ventures and new ideas in the sector.

VCs say some niches in the communications market are over-funded and crowded with startups, but room remains for innovation and investment. Communications comapnies in fields such as networking and wireless technology demand large amounts of capital to launch because they require more investment in physical infrastructure.

"Of all the areas in venture capital that can absorb money the easiest, (the most promising) is communications," says Vincent Occhipinti, cofounder and managing director of Woodside Fund.

Communications startups hunting for first-round financing are generally valued between $25 million and $40 million, according to Mr. Occhipinti. Startups in the application service provider and business-to-business markets range are valued from $10 million to $25 million. These days, he says Woodside is receiving the most intriguing and promising business plans in its 17-year history.

FUNDING SPREE
Other VCs also say they're seeing more promising proposals than ever in the communications market.

Fourteen firms have invested more than $100 million in communications startups so far this year, according to research firm Venture Economics. The five VC firms that have invested the most money in communications companies this year are Hicks, Muse, Tate, and Furst ($256 million in two companies); New Enterprise Associates ($162 million in 18 companies); Sprout Group ($156 million in 15 companies); Meritech Capital Partners ($154 million in 10 companies); and Yahoo (Nasdaq: YHOO) ($150 million in one company).

Chase Capital Partners ranks sixth in overall communications investing with $149 million, but the firm has invested in 25 startups this year, more than any other firm.

This year alone, Woodside received more than 2,000 business plans for communications startups, which represent at least 20 percent of the total pitches the firm has received. Despite the tsunami of business plans, the firm intends to make no more than 10 investments this year, only two of which will be communications companies, according to Mr. Occhipinti. "There are tons of new ideas," he says.

Mr. Occhipinti sits on the boards of three companies, including SS8 Networks, which develops an Internet signaling technology to deliver high performance data, telephony, and video services over the Internet. SS8 raised $25 million in venture capital this month, bringing its total funding to $35 million.

SS8 could have raised $50 million easily in its most recent round, says Henry Wong, SS8 chairman, founder, and CEO. Mr. Wong says he turned away 19 venture capital firms. In addition to Woodside, Kleiner Perkins Caufield & Byers also invested in SS8. Kleiner Perkins general partner Vinod Khosla acts as a mentor to company management.

In many ways, Mr. Wong epitomizes the business opportunities in the communications industry. He started four successful communications companies prior to SS8. He continues to believe in limitless potential for technology innovation in the communications field.

For instance, Mr. Wong says the development of networking technologies has only begun. "There will never be enough [VC] money" to fund all the startups with ideas worth exploring, he says.

Catherine Lego, a general partner at the Photonics Fund, which focuses on optical communications startups, says, "Having lots of money allows a lot of companies attacking different problems to get started."

GROWTH BY TAKEOVER
Established communications companies are watching with interest as venture capitalists and entrepreneurs collaborate to develop revolutionary technologies. These grown-up firms view startups not simply as competition, but as surrogate research and development operations, says Ms. Lego, who's the sole general partner at Photonics, a $25 million early-stage firm that invests $1 million to $2 million in optical communications startups.

In today's ruthless public market, companies can't afford to sink millions of dollars into technology research that may not pay for itself with commercial success, Ms. Lego says. In the communications business, companies monitor the few startups that are the most threatening and acquire those nearing the brink of success.

Opportunities are ripe for entrepreneurs in areas such as security and support software for monitoring networks, says Zenas Hutcheson, a general partner at St. Paul Venture Capital. "All these optical networks have to be managed," he says. He says two St. Paul investments in those categories are Granite Systems, which develops network management software for telephone carriers with wireless and optical networks; and Gold Wire Technology, which develops software that lets Internet service providers manage Internet configurations so they can set up customers more quickly.

This month St. Paul closed a $1.3 billion fund, earmarking as much as $500 million for communications startups, Mr. Hutcheson says. "This is a great time to be an early-stage communications investor," he says.

NO ELBOW ROOM
Still, there are too many startups tackling certain areas of telecommunications, such as digital broadband access, optical access, and high-capacity routers, Mr. Hutcheson says.

Earlier this month in a interview with Red Herring, Kleiner Perkins' Mr. Khosla, a renowned networking investor, predicted that 90 percent of today's optical networking firms will fail.

Woodside's Mr. Occhipinti agrees the optics market will thin. "Every VC I know has a plethora of optical deals," he says. "It makes me a little nervous."

Mr. Occhipinti may have good reason to be nervous. The amount of money invested in optical companies rose from $58 million in the first quarter this year to $360 million in the third quarter, according to Venture Economics. During that period, 92 VCs invested an average of $8.14 million each in 38 companies, bringing the total dollars invested in optical companies in the first three quarters to $749 million. On November 1 alone, three companies -- Lightwave Microsystems, Kymata, and Centerpoint -- pulled in $282 million in funding.

"The optical market may be overbuilt now," Mr. Hutcheson says. "VCs are like developers. [They] always over-build."

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