A lot was said on this board about Rosen's brilliant investment acumen and how it was driving the value of COMPAQ. I have seen no posts about the recent heavy losses in the value of the portfolio. This article mentions that COMPAQ lost 50% of the value of its investements in the first three weeks of April - but wasn't the loss from the high to the low nearer to 2/3rds? No doubt values will rise again - but it does highlight why Wall Street is reluctant to award a multiple to investment portfolios which are not central to a company's operations.
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May 3, 2000
The Wall Street Journal/New England
Heard In New England:
Venture Funds
Are Sprouting
At Companies
----
By Andrew Caffrey
So you want to be a venture capitalist? Get in line.
Every week, it seems, another public company launches an in-house venture-capital fund. Invariably the companies, many of them based in New England, say the investments are for "strategic" purposes, in businesses or technologies that will add value to their own operations. But they also have one eye on the stock market -- and on the outsized gains that traditional venture firms have been raking in.
Corporate "venture funds" aren't new, of course. Some well-known companies, such as Xerox, have long poured venture money into firms too small or unseasoned to sell stock to the public. But what's striking about the recent trend is that very young companies with short track records in their own fields say they have enough experience to pick out the next winners of the New Economy.
For example, Viant, a Boston Internet-technology consulting firm, next week is expected to announce the formation of a $60 million venture fund. Breakaway Solutions, another hot Internet-consulting firm in Boston, started a smaller fund several months ago. Both firms went public less than a year ago, and both have been tremendously successful. Now their executives are betting that the same skills and knowledge that made them an overnight success will rub off on their investing choices.
"We understand the critical resource for launching a new business is talent," says Robert Gett, Viant's chief executive. "By way of our work in helping clients build their digital businesses, we have that talent in-house. We think 80% of what a typical venture capitalist knows about, we've been doing all along as part of our work."
Other local companies that are trying to get into the investing game include Tyco International, the Bermuda conglomerate principally managed from Exeter, N.H., which announced a fund in March. Artificial Life in Boston plans to invest $10 to $15 million in companies that adopt or promote its software applications. The number of firms doing venture finance has grown so large that Asset Alternatives, a Wellesley, Mass., firm that tracks the private equity industry, recently started a monthly newsletter devoted just to corporate venture funds, says David Barry, its senior editor.
This booming practice poses questions for investors. Many are caught unaware that a company's earnings may be driven by its venture fund. And even once investors realize this, they may have trouble calculating how big a role the venture fund should play in the stock price. What's more, as many companies have learned in the past month, venture funds are a lot more fun when the stock market is soaring than when it is plunging and then bouncing around sharply. A big gain in a venture fund's portfolio can be erased by the next quarter's stock market.
"It's the flavor of the month. Everybody's got to have a venture fund," says Todd Dagres, a principal at Battery Ventures, a traditional venture-capital firm in Waltham, Mass., that had huge successes last year launching public companies, including Akamai Technologies of Cambridge, Mass.
Old-line venture investors don't have a monopoly on the kind of knowledge that young companies need to succeed, contends Art Coviello, chief executive of RSA Security, Bedford, Mass., which is in the process of starting a venture fund of at least $100 million. Still, "I'm sure they view it with some level of cynicism" when others poach, he says, with a needling reference to the old-line venture crowd as "those brilliant captains of capitalism."
Mr. Coviello says RSA's venture fund is a natural outgrowth of the company's history of successful stock investments. In the mid-1990s, it took stock from Netscape Communications in lieu of payment for a license to use RSA's Internet-security solutions. It then sold the stock in 1996 and 1997 for a $15.3 million profit.
In 1998, RSA took public a subsidiary, VeriSign, Mountain View, Calif., whose stock has since shot to the moon and halfway back. RSA locked in a profit on its remaining holdings of VeriSign by buying options on the stock, and has since been steadily selling off its position. Mr. Coviello says RSA will ultimately gain at least $600 million from the VeriSign sales.
"We think we're pretty good at this," Mr. Coviello says. Moreover, "it's the industry knowledge" the company gains from the investing experience that's crucial.
"The New Economy creates greater levels of interdependency" among companies, he says. "What's really important is to have a track into a lot of companies and technologies. Because if you don't do it, you leave yourself at risk" of missing the next wave of technology. He calls such investing "creating a corporate ecosystem."
Breakaway, meantime, plans to use the fund as an employee-retention tool: Top-performing employees will be rewarded with some profit from the venture fund.
And in Viant's case, Mr. Gett, the CEO, says his company has already served as an "incubator" to young client companies. Among other things, a venture fund will provide a more formal structure for selecting companies to be partners with, he says. And the targets won't include just clients. Viant expects to use the fund to support its own employees who want to develop their ideas into potential businesses.
But the money doesn't hurt either. "I'd be lying if I say we didn't think about it," says Mr. Gett.
When the stock market collapsed in April, some corporate venture funds experienced the risks of riding such a wild tiger. In the first three weeks of April, the value of Compaq Computer's investments dropped from $6.1 billion to $2.9 billion, according to the Houston technology concern.
Such market fluctuations can also make it tricky for companies to count on these investments.
Cambridge Technology Partners, for example, has had a venture fund since 1997, and is in the midst of starting a successor fund. Cambridge Tech uses an accounting method that allows it to treat the unrealized gains on the investments of its first venture fund as income, which it then counts toward company earnings. Other companies don't count the gains as income until they sell the securities. Either accounting method is proper, so long as the company is consistent in its reporting method.
In this year's first quarter, Cambridge Tech reported $5.1 million of unrealized investment gains as income, which, along with the gain from an asset sale, helped shrink the company's reported loss to 7 cents a share from 19 cents a share. But after the wild market swings in April, "we've given back some of the gains," says John Gavin, Cambridge Tech's chief financial officer.
The venture fund invests largely in Internet companies, so its value "is off quite a bit" from when the Nasdaq, for example, was soaring earlier this year, he adds. But because investors don't give Cambridge Tech any credit for the paper gains when the market is up, says Mr. Gavin, he doesn't expect the company to be penalized if the market falls again and the fund's value declines further.
Overall, though, the fund has had "huge gains" since making its initial investments, Mr. Gavin says, meaning there is a long way to go down before those investments are underwater.
Still, the Cambridge Tech situation does show the inherent volatility in including stock gains on a company's income statement. And investment gains, whether real or on paper, can be confusing. When Compaq in January reported fourth-quarter earnings of 19 cents a share, it included three cents from profits on sale of investments. Wall Street analysts reacted by saying the company had beaten their average estimate of 16 cents a share by three cents, according to Chuck Hill, director of research for First Call/Thomson Financial.
Then, last week, Compaq reported the same level of earnings for the 2000 first quarter: 19 cents a share, including three cents from investments, against a 16 cent-a-share average estimate of analysts. "We said the analysts are likely to view" first-quarter earnings as 19 cents, Mr. Hill recalls, and that Compaq "beat the quarter by three cents, based on what they did in the fourth quarter."
But instead, he says, analysts used the lower 16 cents-a-share income from operations as Compaq's first-quarter earnings, and decided that the company had met, not exceeded, expectations. "We had a hard time explaining that one," Mr. Hill adds. "We got a bunch of calls questioning what is the right number."
Now, given the number of companies that are starting venture funds, Mr. Hill says the erratic way of reporting the resulting gains is "troubling. What is the proper way to do it? And secondly, the analysts haven't been consistent" in how they treat such income.
What about the benefits to shareholders? Do their stakes in the parent company rise in value if the venture funds succeed? In fact, investors may tend to discount earnings from these investments. For example, RSA Security's sales of VeriSign stock will add $25 million to $30 million in pre-tax income each quarter for the next two and a half years. But Mr. Coviello, the CEO, says investors "look right past the investment activity and only evaluate us on the operating business. As a result, we feel we're not getting credit for this wonderful value we've created." |
