Light at the end of the tunnel

Light at the end of the tunnel

Despite the downturn, third-quarter investments remained slightly higher than in the first quarter and more than double the amount spent in the third quarter of 1999. Altogether, 870 network hardware, software and services startups received an average of $US15 million each during July, August and September.

Much of the decline was related to dot-coms, with investments in Internet content, e-commerce sites and related services plunging $2.2 billion - or 30 per cent - from the previous quarter. Among the startups that had trouble attracting funds were business-to-consumer e-commerce sites, business-to-business e-commerce sites and consulting firms offering Web site design.

However, venture firms remain optimistic about network equipment, with investments in this segment more than doubling to $2.48 billion. Indeed, half of the third quarter's 10 largest deals were for fiber-optic equipment, while the other half were for Internet collocation facilities and service providers.

Fiber optics "is hotter than a pistol", says Kirk Walden, national director of PricewaterhouseCooper's MoneyTree survey. "When you're talking about laying fiber-optic cable or building a piece of optical equipment, you're talking about notably more money than you need for software or services."

Bill Collatos, co-founder and managing general partner with Spectrum Equity Investors, says venture firms are interested in Internet infrastructure startups such as fibre-optic and wireless companies because they seem like a safer bet than content or e-commerce providers.

"If you think of this entire space as a network . . . what you find is a lot of traffic always runs over the core, regardless of whether some small tributary of the network is slowing down," Collatos says. "There's more reliability in the infrastructure opportunities, in the hardware and software that actually manage the network."

With hot areas such as fibre optics picking up the slack for weak areas like e-commerce, Walden predicts that year-end figures will show network investments in 2000 being twice the amount made in 1999.

"We are sticking to our guns on the prediction that we made earlier this year . . . that overall venture capital investments are going to double to $US70 billion in 2000, compared with $35 billion in 1999," Walden says, adding that the same trend will hold true for the network segment of the economy, which should reach $46 billion by year-end.

"We are slowing, methodically plateauing to a sustainable level of venture-capital investment," Walden says. "But the bottom is not dropping out of this market."

However, the key statistics were down this quarter for network investments:p The number of deals dropped 9 per cent from 960 in the second quarter to 870.p The average size of these deals declined 4 per cent from $15.65 million to $15 million.p The largest deal of the quarter - a $207.5 million investment in Internet data centre operator Relera - is about half the size of last quarter's $402 million investment in Carolina Broadband.p The 10 largest deals of the third quarter ranged from Relera's big prize to a $100 million investment in Chiaro Networks, a Texas startup that's developing an optical router for Internet backbone carriers.

Investments in fiber-optic startups are expected to remain strong for the next few quarters because of several recent billion-dollar acquisitions by Nortel Networks and Cisco of companies building fiber-optic products.

"There used to be only a handful of players in fiber optics," says Tracy Lefteroff, managing partner of PricewaterhouseCoopers' Venture Capital Practice. "With the Internet deals slowing down, everyone wants in."

Lefteroff predicts the market for fiber-optic equipment will remain strong even though the stock values of most telecommunications carriers are down, and big players such as AT&T and British Telecommunications are splitting up.

"The fiber-optics market is fundamentally more solid than many Internet investments," Lefteroff says. "[Telephone companies] around the world are all going to modernise their systems [with] fiber optics because of the capacity advantage they can gain."

Although the Net's traffic patterns point to a fiber-optic future, not all fiber-optic startups will succeed, warns Cliff Higgerson, a general partner with ComVentures. He says the best opportunities may be for component suppliers rather than bandwidth or system suppliers.

"In the optics business, the value is as much in the components as in the systems. It looks more like the PC business where the value is in Intel and Hewlett-Packard, and Dell are glorified value-added distributors," Higgerson says.

In addition to fiber optics, venture firms also like wireless startups. For example, EveryPath, which provides Internet services over wireless devices and telephones, raised $70 million, and Ensemble Communications, which offers wireless broadband access, raised $63.8 million.

"We like both mobile and fixed wireless. We believe they both have enormous growth potential," Spectrum's Collatos says. "On the fixed side, the challenge is simply getting the networks built. On the mobile side, the challenge is getting the networks built as well as getting the applications built that can use the network to the fullest capacity."

Higgerson favours carrier-grade wireless equipment, pointing out that the "infrastructure has to be dramatically upgraded for the carriers to be able to support mobile services".

Venture capitalists agree that investment in Internet infrastructure startups is good news for corporate IT managers.

"The long-term benefit is increasingly sophisticated networks with bigger pipes," Collatos says. "Enterprise customers are experiencing exponential growth in data distribution and consumption. They're looking to the future and saying: ‘I'll forever need bigger and bigger pipes'.

"Corporate users are going to be the big beneficiaries," ComVentures' Higgerson adds. "With more companies being formed, the level of competition goes up, which provides a combination of lower prices and higher-performing services."

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