Interesting overview of the Asian incubator scene
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Net Incubator Hopes to Temper
Glare of Reality for Start-Ups
By DOUGLAS APPELL
Staff Reporter of THE WALL STREET JOURNAL
Ravi Sarathy, a former top-ranked Internet analyst with Lehman Brothers (Asia), is about to become the object of analysis himself as the president of iReality Group, a new company that aims to help budding Internet start-ups become leaders in their sectors. But some of Mr. Sarathy's former competitors say he's jumping into crowded -- and dangerously turbulent -- waters.
Internet investment companies have been savaged recently by the sell-off of technology shares that began on Nasdaq. Softbank and Hikari Tsushin in Japan, Internet Capital Group and CMGI in the U.S. and Hong Kong's Pacific Century CyberWorks have lost more than half their value since March. Meanwhile, new entrants keep emerging. For instance, Hong Kong-based Internet incubator techpacific went public last week. Others, such as Singapore's Silk Route and Hong Kong's Strategic Capital Group, are looking to list later this year.
Despite that competition, Mr. Sarathy predicts iReality -- which could be listed in Tokyo as early as this year -- can carve out a niche as "the first and only Internet investment and enabling company" serving all of Asia, including Japan. IReality will have dual headquarters in Hong Kong and Tokyo.
Internet Calculus
Until now, Internet investment companies have been valued more on the quantity of their investments than on their quality, he says. But going forward, investors will focus more on the execution of business plans because the calculus of the Internet sector demands it, Mr. Sarathy says. He explains that 50 out of every 100 entrants in any segment will go bust, with another another 30 being bought out at fire sale prices, he says. Of the remainder, perhaps 15 will find niches, while four or five will become dominant players.
IReality will offer "a seamless suite of services" that can help young Internet companies that are already past the seed-financing stage to reach that winner's circle, Mr. Sarathy says. Whether those start-ups need help on strategy, co-branding, financing, inventory management, credit-card transaction systems, Web design or hiring key personnel, iReality will support them with its own team of top managers and through "preferred partnerships" with leading companies that offer those services, Mr. Sarathy says.
The company recently raised $33 million by selling an initial 10% equity stake and plans to raise another $200 million in the next few months, says Mr. Sarathy. He declined to say who bought the stake and what percentage of iReality's capital the next stake would amount to. IReality is now examining 80 to 90 potential deals and will choose eight to 10 where it can add value, he says.
Mr. Sarathy, whose former investment bank took a lead role in benchmark Asian Internet deals such as China.com, is at ease talking the New Economy talk. IReality's model fits the emerging Internet world, where a "center" exploits the "connectivities" of the "eco-nets" being formed while "driven entrepreneurs at the end of the tentacles" make all the decisions, he says.
Old Economy Strategy
But the model for his company's broader investment strategy is decidedly Old Economy. For the 15 to 20 Internet companies that will form the core of iReality's network of companies, "we anticipate a very long-term holding period, a la Berkshire Hathaway," says Mr. Sarathy, referring to the investment holding company run by Warren Buffett. Ironically Berkshire Hathaway has suffered recently as a result of the investment guru's aversion to Internet stocks.
Skeptics could argue that Mr. Sarathy has been too bullish on the Internet investment company model in the past. Just before leaving Lehman, for example, he boosted his 12-month price target for Softbank to 400,000 yen ($3,779.20) at a time when the stock was trading at around 150,000 yen. In line with its closest competitors, Softbank's shares have tumbled over the past month and -- even after a limit-up gain Monday -- closed at 57,300 yen.
Analysts, who say they have yet to learn the details of Mr. Sarathy's plans, warn that the competition in Internet investment will be fierce. Several companies joining the fray already have some winners in their stables, notes Jay Chang, the Hong Kong-based Internet analyst with Credit Suisse First Boston (Hong Kong). In addition, he says it's unproven whether the so-called eco-net-of-winners model -- which envisages a synergistic stable of companies mutually enhancing each other -- can actually work. Some people suggest that investors are better off picking and choosing the best Internet companies to invest in themselves, he says.
Mr. Sarathy concedes that many companies offer pieces of the puzzle. But in general, the biggest names in Internet investment offer more capital than "enabling services." At the other end of the spectrum are players who can guide start-ups through the "seed" finance stage of development but can't necessarily help them evolve to the next stage, he says. IReality is looking to claim that space, Mr. Sarathy says, noting that some big Internet investment names have discussed the possibility of a cooperative arrangement.
Personnel Are Key
Fund managers say it's too early to guess how the market will rate iReality's chances, but a lot will depend on the kind of managers the company can attract. Mr. Sarathy insists that iReality will field an all-star team -- attracted by a Silicon Valley-type policy of "giving away a lot of equity" -- that will be able to "execute as well as anybody else in the space." For now, though, only three senior hires can be mentioned, since others are still working out their departures from current jobs. The team includes Matthew Burlage, who will become chief executive officer after heading Lehman's investment banking desk in Asia; Tom Britt, who headed the Nasdaq practice at law firm Clifford Chance Rogers & Wells and, says Mr. Sarathy, has done more Asia Internet deals than anyone else; and Manny Ayala, who was second in command at Singapore's Discovery Channel.
Asked about the recent Nasdaq plunge that has spooked investors following a year of spectacular gains, Mr. Sarathy says he hasn't been forced to rework the conservative assumptions behind iReality's business plans. For example, iReality was looking for its shares, upon listing, to be valued at roughly one-fifth the average of sector heavyweights such as Softbank and PCCW. Even after the steep declines of the past month, that still leaves ample wiggle room, he says.
Mr. Sarathy expects a shakeout of Internet investment companies, with only a few producing extraordinary returns over the long run. Among them, he believes, will be iReality. IReality, he says, should be judged by the quality of the earnings that the companies it nurtures can generate.
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