A little history for you Black. Don Valentine, Chairman of the Board.................................
redherring.com
DON VALENTINE'S NEXT BIG BET IS ON C-CUBE MICROSYSTEMS
Why C-Cube Microsystems, a manufacturer of video compression chips that went public in April, has a similar chance for success as Cisco Systems, the venture industry's biggest hit.
By Anthony B. Perkins
The Red Herring magazine
Mune 1994
Since Sequoia Capital was started in 1972, they have provided venture capital for over 200 companies including Apple Computer, LSI Logic, Electronic Arts, Radius, Cypress Semiconductor, and Oracle. But even these venture successes pale in comparison to the $2.5 million investment Sequoia made in Cisco Systems in 1987, which has grown in value to an astonishing $2.7 billion. Yes, that's a billion with a "b." The venture capital record of all time. "Cisco was at the right place at the right time to exploit a new technology standard that emerged in the computer networking market," Sequoia's founding partner and Cisco's chairman, Don Valentine, explained this month to The Herring.
What Mr. Valentine also explained was that one of Sequoia's most recent success stories, C-Cube Microsystems, a manufacturer of video compression chips that went public in April, has a similar chance for success. "C-Cube could be the Intel of the 1990s," he said with a straight face. "If you believe all the hoopla about the different information superhighways being built, they all require video compression, and that, in simple terms, is what C-Cube does." The Herring is not sure whether to believe all the hoopla about the information superhighway, but, after listening to Mr. Valentine's insights on how he makes money in venture capital, and studying Sequoia's record of success, we are ready to believe in him.
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The Herring: You have previously alluded to an analogy between the Cisco Systems business model and that of C-Cube.
Valentine: Yes. The point I have made is that both companies sell enabling technologies, and each company was an early implementer of a new standard for its industry category. In the case of Cisco, it was the networking standard TCP/IP, and for C-Cube it is MPEG II, the video compression standard. We believe that given its place in history, C-Cube has an opportunity similar to the one Cisco had of exploiting a new standard. If you believe any of the hoopla about all the different information superhighways being built, from online services to on-demand entertainment, they all require video compression. And that is what C-Cube does. The other similarity, of course, is that we are the only venture investor in Cisco, and we are the only venture investor in C-Cube.
The Herring: Sequoia has a history of investing in chip companies.
Valentine: That's right. We have financed a number of semiconductor companies over the last 20 years. And among the significant reasons for that investment focus has been that buyers of public stocks have always been very generous and gracious about paying high PEs for semiconductor stocks. Semiconductors have always been the asparagus of high technology. We have always been interested in investing in the part of the food chain where the most change occurs, and that has been with silicon-based companies.
The Herring: Back in 1988, when C-Cube first talked to Sequoia, you weren't as pumped up about the company's potential for big success.
Valentine: That's right. We talked to the company a number of times over the last five years but weren't compelled to invest until 1993. Back in 1987 and 1988, we didn't feel that the company was focused. C-Cube was kind of in the customization business, building specific products for their foreign investors and running around in a bunch of different directions. We also did not believe in the JPEG market. There is still no worldwide market for JPEG. Early on, we also didn't believe that there was much of a short-term market for MPEG.
The Herring: What changed your mind?
Valentine: Two things happened. One, we began to believe that there was a market for video compression and video conferencing. And second, there was a change in management. So with all of its challenges, opportunities, and flaws, the state of the company was sufficiently satisfactory for us to want to make an investment. But we knew it was going to take a tremendous resource commitment from Sequoia people.
The Herring: It doesn't seem so long ago that you were making fun of the multimedia market.
Valentine: Back in 1988, I said that I didn't know what multimedia is because I didn't know what it did. In 1994, I am still not sure what it does. I, therefore, do not see C-Cube as an example of a multimedia company succeeding. In my opinion, C-Cube is not greatly enhancing the multimedia world; it is enhancing real applications, such as video conferencing.
The Herring: Will video conferencing applications and services be sold primarily into the corporate market?
Valentine: Yes. I think that for the indefinite future video conferencing will be primarily a business application. C-Cube has a video hook-up with one of its major companies, PictureTel, and it works brilliantly. Engineering, design, and review are done via video conferencing, and people don't even have to bring their American Express cards because they never leave home. Does this mean that people will not spend $2,000 for a telephone that offers a two-by-two picture? No. There will always be a Sharper Image type of consumer who will buy exotic gadgets.
The Herring: What do you think about the debate over whether the PC or the television will be the primary communication device of the future?
Valentine: I have stated on record, along with Andy Grove, who has, perhaps, more self-serving reasons for his opinion, and George Gilder, who may also have book publishing-related incentives behind his position, that the PC will be the primary communication device in the future, not the TV with a pizza box sitting on top. The PC is the established interactive product today, and it has been in the home for a long time. And the evidence suggests that interactive people like to use their PCs, and they are generally not television watchers. The people who think they are going to convert television watchers into interactive players who will want to change the ending of movies and play interactive games are engaged is pure 2001 fantasy. Hal will have to be there verbalizing how to operate the interactive TV set before the couch potatoes in Des Moines, Iowa, will be able to learn how to use it. And while the press and the White House may have just recently discovered the Internet, it has also been around a long time and has a large and growing number of users. So the highway exists, the interactive product exists, and millions of people are happily operating on the information highway today.
The Herring: So you fall into the school that is still wondering whether there will ever be an order for a set-top box.
Valentine: If you really look at it, the TCIs and the Time Warners have all pushed out their target dates at least a year for the availability of their interactive TV services. The trials have been a disaster. And I don't know when anybody is going to figure it out -- it really mystifies me -- but there is no good programming out there. With my satellite hook-up at home, I have had 500 channels to watch for ten years, and there's nothing to watch! So when you eventually have all this whiz bang interactive stuff in place, I really don't know what programming people are going to watch.
The Herring: How about using your television to video conference with your mom?
Valentine: No, I don't think that will happen. We will have voice command and control of our PCs before we have a television that is interactive by the traditional television watcher. The traditional television viewer watches four or five hours of 30-minute segment, commercial-intensive network programs every night from 6:00 PM to 11:00 PM. I don't think these people would be easily trainable on a digital television, if there ever will be such a thing.
The Herring: Back to C-Cube. What were the specific events that led to Sequoia's investing in the company?
Valentine: Over time, the company became better focused; and when Bill O'Meara became president, it became very focused. At that same time, the technology standards that the company had committed to implement were being embraced to the degree that we could comfortably see a market opportunity.
The Herring: And you were also finally able to pick up the stock at the right price.
Valentine: The valuation paid by the original investors was stratospheric because they were more interested in their strategic relationship with C-Cube than their return on investment. There was no way we could have made an investment at that valuation because it would have been viewed by our limited partners as a charitable contribution to an uncharitable trust. So, yes, the company's management did figure out how we could invest and achieve our return-on-investment objectives.
The Herring: How, exactly, did the deal work?
Valentine: The transaction is outlined in the company's prospectus under "Certain Transactions." We bought preferred stock at, I think, an identical price to the prior preferred round, and we bought a great many shares of common stock at a much lower price to average everything out. The corporate investors that invested in the same round, AMD and Texas Instruments, did not buy any common shares.
The Herring: What was the average price you paid per share?
Valentine: Oh, I can't remember exactly. I can tell you that our average cost basis was about $3.00 per share...
The Herring: ...and then you took the company public in 18 months for $15.00 per share. Such is the art of venture capital. How did you avoid getting the previous investors upset?
Valentine: First of all, before we invested, the management owned a minority interest in the company. This meant that before any investment could be made, it had to receive the prior approval of the existing investors; Kubota et al. In the end, I think that they looked at the potential utility of the entire package, including the investments from TI and AMD as well as our commitment to participate interactively with the company's management to help them get the things done that needed to get done, and they agreed to the terms. So all of our special requirements were fulfilled even though they were different. Ours was an equity-oriented requirement; AMD's and TI's requirements were technical.
The Herring: How has Sequoia fulfilled its commitment to help the company?
Valentine: First of all, it is important to recognize that there are a number of Sequoia-related people on the company's board beyond the obvious folks. As an example, T.J. Rodgers and Greg Reyes are Sequoia technical partners. Both are also on C-Cube's board. Coincidentally, Bill O'Meara, the company's CEO, is a Sequoia technical partner. My partner, Pierre Lamond, took on the assignment to run engineering full-time and performed an elaborate restructuring of the product development and engineering process while the company conducted a search for people to run engineering. We also contributed to the negotiations with AMD and TI.
The Herring: Before you signed the check, did you get the management's assurance that you would be able to influence the company's development in the ways you have just described?
Valentine: No. That's not the way we do it. We start by asking the CEO and management what it is that they want us to do, how we can help them, and which people might be useful to them as resources. We also give them feedback on what we learn in the diligence process, after talking anonymously with employees, customers, and suppliers. Through an interactive process, we work with management and set the agenda on what needs to be accomplished and what should be expected from all parties. So the agenda is agreed upon before we cut the check.
The Herring: How much credit can Sequoia take for C-Cube's success?
Valentine: The credit for the success of the company belongs to the management. We are merely there to make suggestions and recommendations. We don't demand things or try to power things through. Pierre was the head of engineering, because Bill asked Pierre to be the head of engineering. Bill downsized the company, Bill O'Meara cut the expenses. We discuss the utility of such actions, but we don't make the decisions or issue the orders.
The Herring: You once said that Dante created a separate level of hell for investment bankers. Do you really love investment bankers that much?
Valentine: If you take Bill O'Meara's salary [$164,000 per the company's prospectus] and multiply it by five or six, you have the annual compensation for the lead investment banker who did nothing to create the brilliance of C-Cube. The bankers merely served up another hot technology company to their normal customers. And, of course, they insist on pricing the stock so their customers make ten or fifteen percent return on Day One! The company has to take a discount so investment banker's customers can make money in a week, a day, in the first minute! The whole process involves a huge transfer of compensation into the hands of investment bankers and their customers and out of the hands of people who make insignificant amounts of money by comparison yet do all the work and create all the great companies. On a relative basis, the whole system is out of whack.
The Herring: We would presume that a few entrepreneurs out there would say that on a relative basis venture capitalists are overcompensated as well.
Valentine: No question about it! I am sure that there are entrepreneurs out there who feel that way, probably with justification. Entrepreneurs are surrounded by people who are overcompensated. Lawyers take advantage of them, accounting firms take them, the financial printers take them. So I suppose that for investment bankers and venture capitalists to take advantage of them should not be surprising.
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