Telecommunications Sector Holds Luster For Investors Chastened by Past Missteps
By REBECCA BLUMENSTEIN, SUZANNE MCGEE and ALMAR LATOUR
Staff Reporters of THE WALL STREET JOURNAL
During the past year, investors have lost tens of billions of dollars as highflying telecommunications start-ups crashed. A glut of fiber-optic capacity and state-of-the-art equipment has many worried that a recovery is unlikely soon.
With telecommunications plays faltering, where is venture capitalist David Spreng putting his firm's money? Telecommunications.
"In a way, this is the best of times to be doing early-stage [investment] deals, because there's less dumb money around, and there's less risk of too many competitors being funded and money going to too many foolish business plans," says Mr. Spreng, a general partner of Crescendo Ventures LLC, a Palo Alto, Calif., company that has invested a total of $27 million in five telecom start-ups this year.
The torrent of investments into telecommunications in the U.S. and Europe has slowed -- a lot -- but, somewhat surprisingly, the spigot hasn't been turned off. The reason: For all its current troubles, telecommunications offers growth possibilities, especially for start-ups with potential to deliver the right product in the right place at the right time, that might help the industry extricate itself from its mess.
Looking Glass Networks Inc., for example, has managed to raise $475 million during the past year. The Oak Brook, Ill., start-up is one of an array of U.S. companies rushing to build fiber networks in metropolitan areas. While there is an overcapacity of nationwide, long-haul fiber networks, there is a dearth of capacity in most cities. Companies that can fix these local bottlenecks, thus stimulating Internet demand, could win lots of business.
"Today, you have to be very surgical about where you build. But there is still opportunity," says Sunit Patel, chief financial officer of Looking Glass, and former treasurer of Clinton, Miss., long-distance company WorldCom Inc. Looking Glass is laying fiber through 10 metropolitan areas, connecting buildings in any way possible -- underneath bridges and streets, and even through Chicago's old coal tunnels.
It is more difficult, of course, to raise money than it was a year ago.
While venture-capital funds have poured $2.85 billion into 180 telecom start-ups this year in the U.S., that is down from $7.55 billion in 365 companies for the first half of 2000, according to Thomson Financial Venture Economics, a Boston group that tracks the industry. Last year, VC firms invested $17.48 billion in 584 U.S. companies. Similarly, European telecom start-ups continue to get funding, but at a lower rate. This year, 80 European start-ups have received a total of $968.9 million, according to Venture Economics, meaning they almost certainly will fall far short of the $4.18 billion raised during 2000.
There has been a sharper fall in debt financing. Junk-bond lending to companies with a credit rating below investment-grade fell 78% in the U.S. for the first half to $4.4 billion, Chad Leat, head of global loans at Salomon Smith Barney, says. "People have pulled back," he says. "Many parts of the emerging telecom lending market are closed."
Weighing on the market is the fact that it is harder for venture investors to cash in on their investments, when companies they help finance go public or are acquired. Not only have mergers and acquisitions dried up, but also there hasn't been a single initial public offering of stock in a telecom this year, according to Thomson Financial, other than the spinoff of Agere Systems Inc., Allentown, Pa., by Lucent Technologies Inc., Murray Hill, N.J. In contrast, during the first half of 2000, telecommunications companies going public raised $11.2 billion in IPO proceeds.
As a result, some investors say, the investment outlook for telecom start-ups remains cloudy. "You can't look at the number of transactions, or even the dollar amounts," Christopher Kersey, a partner at Blueprint Ventures of San Francisco, says. "There are a lot of financings that happen where the only people putting money in are the existing investors, and where they're doing it at a discount" in which investors pay a lower price for a bigger stake.
Despite the carnage in the industry, some investors are sticking with telecom. "There are still huge business trends you can capitalize on in this business," Mr. Spreng of Crescendo says.
About 10 of the 80 telecom investments Crescendo made during the past few years have gone bust. Most were small companies, but the firm wrote off a $28 million investment in Telegis Networks Inc. of Los Gatos, Calif., when the company folded earlier this year after being unable to raise the $1 billion needed to complete an Internet network. "It hurt, but it's not the end of the world," Mr. Spreng says, noting that Crescendo has had more winners than losers. Crescendo has become more cautious this year, cutting back by about 75% from the $103 million invested in 25 new companies during the first half of last year.
One of Crescendo's recent investments is in local fiber-optic networks, one of the hottest investment areas this year. CityNet Telecommunications of Silver Spring, Md., installs local networks by using a Swiss robot in city sewer systems. This year it has raised $175 million in equity plus $100 million in debt financing on top of $100 million it raised in April 2000. To complete the necessary due diligence, one of Mr. Spreng's partners descended into the sewer system in Albuquerque, N.M., to see the technology at work.
Other telecom niches receiving funding range from network management to artificial-intelligence software that allows communications networks to function more efficiently. Atreus Systems Corp., Santa Clara, Calif., a communications-software concern, got $17 million of financing from Blueprint Ventures and Softbank Ventures, Mountain View, Calif., in May. The terms of that financing put a value on Atreus roughly double that of last August, when Blueprint led a $4 million round. Atreus, a Santa Clara, Calif., communications-software company "has real revenue and real customers," Mr. Kersey said.
In Europe, BaBy XL, a Dutch provider of wholesale digital subscriber line service, or high-speed Internet access, closed a $1 million financing round in May, and hopes to raise as much as $60 million -- half in debt and half in bank lending or vendor financing -- this fall. One of the attractions? The management team, many of whom came from KPN, the onetime telecom monopoly of the Netherlands.
Wicom Communications Oy, a Finnish start-up, closed recently on an investment round raising $12 million from venture capital firms Accenture Technology Ventures, 3i in London and Stratos Ventures of Finland. The company develops software that allows voice telephony over the Internet, with the goal of replacing telephony systems at companies and allowing them to run their telephony over existing information-technology infrastructure.
Wicom also lined up a slew of clients, unlike rivals that failed. "The big difference is that we have cash flow, that we have existing customers," Wicom Vice President Matti Lamanen says. Wicom set out to raise $10 million, but investors insisted on injecting an additional $2 million into the company to make sure a new investment round wasn't needed any time soon, should the investment climate get worse.
Write to Rebecca Blumenstein at rebecca.blumenstein@wsj.com, Suzanne McGee at suzanne.mcgee@wsj.com and Almar Latour at almar.latour@wsj.com |
