Silicon Valley Firms Admit They Were Wrong About Making Profits
San Francisco, May 30 (Bloomberg) -- Internet entrepreneur
Mansoor Zakaria doesn't have time to enjoy the view of the
Golden Gate Bridge from his San Francisco apartment. He's
grappling with a new mandate: making his four-year-old software
company, 2Bridge Inc., profitable.
``I had venture capitalists throwing money at me,
promising to make me a billionaire,'' Zakaria says, recalling a
time last year before Internet stocks began their swoon and his
backers pulled the plug on an initial public offering they said
would have raised as much as $57.5 million.
``Before, we had to grow revenue,'' Zakaria says, ``Now,
profit is what it's all about.''
It's the morning after, and Silicon Valley is sobering up:
More than 450 dot-coms have closed since January 2000,
according to Webmergers.com, a San Francisco firm that matches
buyers and sellers of Internet companies.
Nasdaq stocks have lost $3.5 trillion in value in the past
year as shares of such bellwethers as Intel Corp. and Sun
Microsystems Inc. tumbled 60 percent or more from their highs.
JDS Uniphase Corp., Hewlett-Packard Co. and 3Com Corp. are
firing workers. And Internet companies cut 52,000 jobs in the
first four months of 2001, according to Challenger, Gray &
Christmas, a Chicago-based outplacement firm.
Venture capitalists, who had pumped $144 billion into
computer and Internet companies during the past two years, are
reverting to some old-fashioned investing values. They want
profits and they want them soon.
False Focus on Eyeballs
``We never understood the focus on eyeballs and page
views,'' says Thomas Laming, portfolio manager at Kornitzer
Capital Management in Shawnee Mission, Kansas. ``If you aren't
making a profit, it will come home to roost.''
In the wake of the worst quarter for corporate profits in
a decade, managers at established companies and upstarts -- as
well as the people who finance them -- have embraced two simple
principles: Companies must produce products that customers are
willing to pay for, and managers must have a clear plan for
making money.
``We found out that the Internet is not an industry unto
itself,'' says Tony Perkins, chairman and editor in chief of
Red Herring, a magazine that was often a cheerleader for the
Internet frenzy and that responded to the slump by cutting its
own staff by 20 percent. ``The so-called new economy is a bit
of a myth.''
Shattering New Economy Myth
The myth is shattering. Just three new stock issues were
priced in the computer, Internet and telecommunications
industries in the first quarter of this year compared with 74
in the year-earlier period, according to Bloomberg data.
In the last quarter of 2000, venture funds that make up a
private equity index created by Venture Economics, a research
firm, posted their first quarterly losses since 1988. Private
companies raised $14.5 billion in venture capital in the first
quarter of 2001 -- about half the amount they raised a year
earlier, according to Venture Wire, an online newsletter.
The statistics reflect the new dictate from VCs. ``There's
a higher expectation about how a business is going to make
money in the short term,'' says Andreas Stavropoulos, a partner
at Draper Fisher Jurvetson, a Silicon Valley firm that counts e-
mail system Hotmail among its successes and that stumbled with
sports retailer Fogdog Inc., which ran up more than $90 million
in losses before it was bought out by a competitor.
Draper Fisher now asks clients to show how they will break
even on a cash flow basis in two to three years, depending on
the nature of the business. That compares with the three- to
five-year business plans the company was accepting a year ago.
More Rational Environment
Stavropoulos says he welcomes a return to a more rational
environment. ``Some of these people would drop out of their MBA
programs, slap something together and get funded,'' he says.
``That's going away.''
VCs still have money to spend, and many insist they have
not backed away from taking risks because of the flameout.
``Our strategy is the same as it's always been,'' says Kevin
Harvey, a founder of and general partner at Benchmark Capital.
``We try to work with great entrepreneurs who are pursuing big
markets.''
Benchmark financed No. 1 Internet auction site eBay Inc.,
whose shares have lost more than half their value from a high
of $121.88 in March 2000, closing yesterday at $59.75. The firm
also backed food shopping service Webvan Group Inc., whose
stock has fallen to 18 cents from a high of $25.44 in December
1999.
New Technologies Now
As they emphasize profits, VCs are focusing on companies
that have a distinct technology or product now rather than
those that promise to develop new services later. Current bets
include network management tools, fiber optics and wireless
transmission to cell phones and handheld devices.
``The whole Internet infrastructure group is poised for
recovery,'' says Jim Chen, a portfolio manager at Roger
Engemann & Associates, which has $2.5 billion under management.
``We like communications networking equipment, server companies
and storage companies like EMC and Veritas. They will do well
coming out of this slowdown.''
Draper Fisher Jurvetson has invested $10 million in
Mimeo.com Inc., a company that prints and distributes secure
business documents, and $5 million in Lumeta Corp., a spinoff
from Lucent Technologies Inc.'s investment arm and Bell Labs
that analyzes the vulnerability of intranets.
Some Silicon Valley executives say they're happy they let
Internet fever pass them by. John W. Thompson, chairman and CEO
of Symantec Corp., joined that maker of computer virus
protection software from IBM after a 28-year career that ended
with his running much of IBM's own software business.
Pressure to Play the Game
He took over Cupertino, California-based Symantec in 1999
as the Internet economy was building to a fury. ``People kept
asking me why I didn't go to a dot-com,'' recalls Thompson.
Symantec's results are Thompson's best response. The
company had revenue of $632 million in the fiscal year ended in
March 1999. Revenue jumped to $944.2 million in fiscal 2001 and
is on track to cross the $1 billion threshold in fiscal 2002.
Symantec lost $27.4 million, or 37 cents a share, after
acquisition costs in the fourth quarter that ended in March.
Excluding the costs, it would have earned $48.2 million, or 62
cents a share, on a 15 percent revenue increase to $250
million.
So far this year, Symantec's stock has doubled and at
$69.81 yesterday was well above last year's low of $29.81.
Thompson started shaking up his company long before the
technology bubble burst in March 2000. With PC sales beginning
to level off and most of the company's revenue coming from its
consumer software line, he saw an opportunity to sell
Symantec's antivirus know-how to big firms.
Move Pays Off
The move has paid off. Even as corporations trim their
budgets for information technology, they worry about keeping
data and networks safe.
A recent Computer Security Institute survey of 600 big
companies reported that some 80 percent experienced attempts to
penetrate their networks. Almost a third said breaches had cost
them money -- a total of $400 million.
That's not to say Symantec has been unscathed. Thompson
has cut back on hiring to as few as 50 people a quarter from
the customary 150 to 200.
Departments used to get staffing budgets and were free to
fill positions at will. Now, each new hire must be justified to
top management.
Thompson also centralized the company's marketing and
advertising budgets, once controlled regionally, into the hands
of a senior executive to make sure Symantec delivers a uniform
message in all 37 countries in which it has operations.
Military Techniques
``I spent a lot of years in a company that was like the
military,'' Thompson says, referring to IBM. ``They teach you
some things about how to lead and how to manage.''
One lesson: Don't spend faster than revenue growth.
Another: Get products out quickly but not at the expense of
quality. ``The Internet economy introduced the idea of Internet
speed,'' he says. ``There are some valuable things that can't
be done in that time.''
While investors like the changes Thompson has made at
Symantec, shareholders in other computer-related companies that
claim to have mended their ways have been less than
enthusiastic.
Shares of Oracle Corp., the No. 1 maker of database
software, have lost 46 percent of their value this year and
were trading at $15.61 yesterday, down 66 percent from their
high of $46 in September. The drop came even though Oracle
fired 850 employees, or 2 percent of its workers, in the past
few months.
Not Enough
CEO Larry Ellison told analysts that by using its own
database and financial management software and adding online
technical support, the company saved $1 billion in expenses in
the fiscal year ended in May 2000.
Savings will total at least $500 million in fiscal 2001,
he said. The company plans to buy back $3 billion in stock to
reduce the diluting effect -- on earnings per share -- of
issuing new shares to employees.
``We had already been working hard on getting more
efficient,'' says Chief Financial Officer Jeff Henley. ``We
haven't been on a big spending ramp.''
The company has lowered its forecast for the May quarter,
blaming the weakening economy. Even that may be too optimistic:
``It's a risk for them to make the numbers,'' says James
Pickrel, a senior analyst at J. P. Morgan Securities Inc. in
San Francisco, who rates Oracle a ``long-term buy.'' ``It's
going to be tough at best.''
Drastic Methods
Some Silicon Valley companies have adopted more drastic
methods -- even changing the business they are in. Until CEO
Ken Potashner, 43, saw a red flag, SonicBlue Inc., formerly
called S3, was making graphics cards that control the video
display of a personal computer.
As PC makers began building the graphics controller right
on the computer's main board, Potashner realized that
SonicBlue's business would evaporate. His solution? ``We've
picked up stakes and moved to a new neighborhood,'' he says.
First, Potashner unloaded his graphics business and bought
Diamond Multimedia Systems Inc.'s line of Rio MP3 digital music
players.
Then he made deals to acquire Sensory Science Corp., a
maker of DVD and home theater products, as well as the digital
video recording business of ReplayTV Inc. He's introduced a
line of MP3 digital music players for cars and one that works
with home stereo systems.
Curbing Costs
In an effort to curb costs, Potashner has fired 100
workers since January. He let another 300 go when he spun off
the graphics business. Once the acquisitions of Sensory Science
and ReplayTV are complete, his staff size will settle at about
850.
In the first quarter of this year, SonicBlue had a loss of
$335.8 million, or $4.11 a share, after the costs of
acquisitions and losses on investments. That's five times the
loss in the year-earlier period, which was $67.5 million, or 72
cents.
So far, investors haven't paid much attention to
Potashner's moves as they focus on the company's results. With
SonicBlue stock trading at $3.81 yesterday, down from a high of
$24 in March 2000, the company's market cap of $311 million is
less than the asset value of a semiconductor foundry it owns in
Taiwan.
Chucking the Vision Thing
``A year ago, we were being evaluated on vision,'' says
Potashner. ``Now investors are focused on one thing:
profitability.''
Phoenix Technologies Ltd. has been No. 1 in its field for
two decades, but it has started to lose money -- $4.4 million,
or 17 cents a share, in the fiscal second quarter that ended in
March.
The company is the leading supplier of the Bios, or basic
input/output system, that manages the hardware in a PC. Margins
on the product are thin, and the company worries that its
prospects could worsen as consumers begin using handheld
devices and cell phones for tasks they once performed on PCs.
Chairman and CEO Albert Sisto, who came to Phoenix from
RSA Security Inc. two years ago, started adding security
features to the company's chips. He says Phoenix's expertise in
putting complex software into small devices will serve it well
in new markets for Internet appliances.
Sisto also says he's discovered another important asset:
the company's distribution system, which channels hundreds of
millions of chips to the PC makers and component manufacturers
worldwide who are Phoenix's customers.
Asian Operations
Phoenix has operations in Osaka, Japan; Hong Kong; Tokyo;
Beijing; Taipei; and Seoul in Asia and in Munich and Budapest
in Europe. ``We probably ship more units than anybody except
Microsoft,'' he says.
Sisto is banking on Phoenix's relationship with
manufacturers and its ability to deliver products globally to
give his company a foot in the door when customers begin buying
parts for their new products.
The transition to the consumer products market from Bios
chips has been tough. Phoenix stock has fallen to $12.44 from a
high of $30 in February 2000. Sisto fired 72 employees out of
745.
Responding to the rapid evolution of technology is one of
the tenets of business in Silicon Valley. But change, even the
most radical kind, is no guarantee of success. Jean-Louis
Gass‚e had a cult following for his Be computer operating
system, which runs graphics and video.
Competing Against Windows
French-born Gassee left Apple Computer Inc. in 1990 to
create a competitor to Windows and Apple's Macintosh. First, he
tried to sell computers loaded with his BeOS.
Then he switched to selling software that coexisted with
Windows. His competitors' hold on the market proved too strong,
and he quit that business too.
Now, he's focusing on the crowded field of providing
software for digital devices and Internet appliances. That
hasn't generated much income either. Be Inc. reported revenue
of just $100,000 in the first quarter of 2001.
The stock, which hit a high of $39 in December 1999, was
selling for 62 cents in May. At its April meeting, the
company's board announced it was asking investment firm ING
Barings for advice on a possible merger or sale.
In fact, creating technology and licensing it to bigger
companies rather than trying to sell directly to customers may
be one path to profits for small companies. That's what valley
veteran Philippe Kahn is doing.
Kahn founded what's now known as Borland Software Corp. in
the 1980s and competed with Microsoft Corp. He didn't make much
of a dent.
A Name Change
Instead, the company changed its name from Borland
International Inc. to Inprise Corp. and sold a stake and some
patents to its former rival. In the 1990s, Kahn founded
Starfish Software Inc., a maker of software used in handheld
organizers. He sold that company to Motorola Inc. in 1998 for
an undisclosed price.
Now Kahn runs Lightsurf Technologies Inc., whose software
transmits digital photos over cellular networks. Kahn has
licensed the technology to Motorola, Eastman Kodak Co. and
Nextel Communications Inc. ``It's hard for a small company to
find people who will pay the bills,'' Kahn says.
Zakaria of 2Bridge is following Kahn's lead. He's
redoubled the company's efforts to get big clients to license
2Bridge software, which manages documents on corporate
intranets. He's trying to raise another $15 million to $20
million from investors to expand his offerings.
Getting Radical
Last year, Zakaria says, he tried to build an extensive
services division that would enable 2Bridge to create cash
flow. It wasn't long before he figured out there wasn't any
profit in it and fired 70 people.
Now he's making a fundamental switch. He's basing his
business decisions on creating a product and finding paying
customers rather than on expansion for its own sake or trying
to get big at the expense of making money.
``The game has got a new name,'' Zakaria says. ``Its name
is survival.'' |
