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Optical/IP

Contrarian Indications

Forbes magazine recently came out with its “Top 50 VCs” list, which got me thinking... Where are the VCs these days?

The data shows that venture capitalists, to a large extent, remain idle. Venture capital peaked in the first quarter of 2000, with $28.49 billion invested during that period, according to the MoneyTree Survey from PricewaterhouseCoopers, Thomson Venture Economics, and the National Venture Capital Association. Lately, it's slowed to a trickle, averaging about $4 billion per quarter during 2003. As indicated in the graph below, VC funding rose a bit toward the end of last year, with nearly $5 billion invested in the fourth quarter.

But what's wrong with this picture? Well, for one thing, VC spending peaked precisely in conjunction with the top in the stock market, and it hasn't come back. That dashes the idea that venture capital money is "smart money" and is in any way predictive. If it were smart money, VC spending would have peaked 12 to 18 months before the Nasdaq topped – but in fact you could argue that the VCs were slow to catch on, as it kept flowing at $10 billion+ levels per quarter well after the bubble had popped.

The Nasdaq Composite has rallied 50 percent, but there's been little more than a mere burp in VC funding – it's back to mid-90s levels. And that doesn't factor in inflation and economic growth.

Now, this wouldn't be so much of a problem if the VCs were broke, or trying to feed their families. But the fact is they are sitting on piles of capital (and collecting management fees) – capital that could be used to help the economy keep rolling with entrepreneurial ideas. There are billions of dollars in uncommitted VC funds, just sitting there.

Some funds are sitting on cash hoards as high as $1 billion – and doing very little. For those of you who mailed your check into the VCs, you might have done better to invest in Treasury Bonds. For those clamoring for government stimulus (plenty of which we got), it's time to clamor for VC stimulus.

In fact, a VC looking at the VC industry with the same critical eye that he or she looks at potential investment areas might conclude that it’s unfit for investment – "Living Dead," as they say in the business.

But back to my point (and believe it or not, I actually have one). I’m not urging venture capital to go away – in fact, I’m arguing the reverse. It's time for the venture capital industry to get back to work on a greater scale.

The arguments I've heard from VCs for why they're not active just don't cut it. "We can't make money," is the first argument. That's because the climate for exit strategies is not clearly visible. That's pretty lame, considering that Juniper Networks Inc. (Nasdaq: JNPR) just bought recent IPO NetScreen Technologies Inc. (Nasdaq: NSCN) for $4 billion.

You hear that valuations were so high in 1999/2000, it's impossible to make money on deals at the current valuation level. Well, from what I see in the public markets, it's the VCs that helped drive those valuations up. VCs didn't have much trouble with valuations of 10-times sales during the peak of the bubble. So why are they so concerned about valuation now, at a time when things are actually more subdued?

Case in point: On a recent trip to Silicon Valley, I asked some venture capitalists why they hadn't invested in Google, and their answer was "valuation." At the time they were considering the investment, Google was valued at about $50 million. Pretty soon it will have an IPO that will likely value it north of $10 billion.



So we have this myth that venture capital is somehow leading markets. Right now, there's little leadership in the VC community.

The chart above establishes that VCs aren’t very good leading indicators – of anything. But what if they are good contrarian indicators? The idea works pretty well, if you consider that the latest cycle of VC investing bottomed in the first quarter of 2003 – and that was a pretty good time to invest!

Here’s an idea for the venture capital community: The telecom market is 2.5 percent of U.S. GDP. Buy Telecom. Invest now.

You say there are no great ideas out there? Well, then, create them. That's where economic growth comes from.

— R. Scott Raynovich, US Editor, Light Reading

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road__runner 12/5/2012 | 2:27:39 AM
re: Contrarian Indications Great analysis Scott!

Most VCs appear to be trend following speculators without any expertise or desire to build lasting franchises.

Witness the recent rush to invest in pre-IPO VOIP companies (Vonage etc). The same VCs wouldn't have invested in these companies 6 months ago but now are scrambling to get in prior to IPO. They see the opportunity to sucker the public markets which appear to be bidding up anything and everything which is even remotely associated with VOIP.
Scott Raynovich 12/5/2012 | 2:27:30 AM
re: Contrarian Indications Thanks Road_runner.

The prospect of VCs just piling into the hype-du-jour for quick flip for an IPO is depressing.

I'd rather hear some old-fashioned story about folks funding some eccentric engineer in a garage with a revolutionary new technology. There's got to be some out there.
opticalwatcher 12/5/2012 | 2:27:29 AM
re: Contrarian Indications It just brings to mind the old joke about how the VC system works:

You go to Menlo Park, find a tree with a VC in it and shake it till he falls out.
Then before he comes to his wits you start shouting words: "INTERNET! IP! EXPONENTIAL GROWTH!" or nowdays "BIOTECH! VOIP!", until he gives you some money. Then you go off and form a company.

Then after you make your millions, you go to Menlo Park and climb a tree....


mm2550 12/5/2012 | 2:27:25 AM
re: Contrarian Indications One acquisition does not make a trend. Look at how many VC-backed companies emerged to focus on the data storage sector. I don't have the exact figure, I am certain it is well over 100, and likely approaching 150. There have been maybe seven storage related IPOs over the five years...and this figures include Gadzoox, a storage router company, and others that have mostly fizzled. How many M&A transactions? Brocade, McData, and Cisco each bought one intelligent switch company out of perhaps 30 that Byte and Switch...oh, and Emulex acquired Vixel. That's about it. Plus, if one invested in the companies acquired by Brocade and McData (I can't remember the names...Rhapsody/Sanera...I'm not sure...will look it up later), especially at a later financing round, they probably did not make much money (new investors to 3rd rounds likely LOST money)...even these lucky two were far from homerun investments for the VCs. I think the spin off of McData was the last storage related IPO. Of course, these storage sector is, if anything, much more fertile ground for making money investing in private equity than telecom equipment. The security segment looks over invested as well.

There are still far too many private companies pursuing too few opportunities, both for customers and financing. Several doomed companies have been able to survive for a long time because they raised so much money initially. Of course, people need jobs and hope. I don't blame them for hanging on, but candidly, the environment will not be back to normal into more of these start ups die. Also, there needs to be a rebound in enterprise and telecom spending, which has NOT occured.

One other point. I think VCs ARE smart money. Look at all of the great companies that VCs have helped bring into the world. Or have a conversation with a VC. I've certainly been impressed with the VCs I have spoken with.

For now, the last thing we need right now is more companies chasing the same few opportunities.

Mark
truelight 12/5/2012 | 2:27:23 AM
re: Contrarian Indications Your comment

"ne other point. I think VCs ARE smart money. Look at all of the great companies that VCs have helped bring into the world. Or have a conversation with a VC. I've certainly been impressed with the VCs I have spoken with."

Your obviously have not spoken to many then ;-)
jamesoid 12/5/2012 | 2:27:22 AM
re: Contrarian Indications Once burned twice shy. If I were a VC sitting on investable cash I am not too sure I would be investing it at this time. There are a some indications that the Macro Economic environment is not all that healthy. I would like to see the twin deficits reigned in. Fiscal responsibility demonstrated by the Whitehouse, Congress and the FED. And solvent corportions hiring before I committed any money to the next big thing regardless of the jobs it may create. One can't save another from drowning if ones self is drowning too.
Scott Raynovich 12/5/2012 | 2:27:17 AM
re: Contrarian Indications Indeed, it sounds like you may be thinking like one of them, and that's exactly my point. Isn't this a somewhat unoriginal approach? and how much fun is it being unoriginal? Many "experts" in Silicon Valley thought the world was ending in 2002, which was exactly the right time to buy because the valuations were lowest.

As far as playing macro trends, the cagey global economy has shown over time that second-guessing it is a fools game. Who in 1995 predicted an explosion of markets through 2000? Who in 2000 predicted a multi-year crash and Sept. 11? Who in 2002 predicted the Nasdaq would rise 50% in 2003?

The answer: a very small minority. That's the point I was trying to make in this column -- and its clearly demonstrated by the bar chart. Often, the least anticipated outcome is the most likely.

Thinking about "slowdowns" and worrying about "persistent recessions" after an extended economic slump is for the meek, not the bold. The bold have personal visions of what will be successful over time, regardless of what their neighbor or the Nasdaq is doing.

I think that basing decisions on what the herd is doing or whether you think markets will be up or down is like trying to earn a living playing roulette in L.V. If you really know what you are doing, you just go out and do it.

As Michael Jordan once said, "Only people that don't know what they're doing get nervous."

ThouShaltNotJudge 12/5/2012 | 2:27:16 AM
re: Contrarian Indications ... or rather "I skate to where the puck will be", or something like that.
ThouShaltNotJudge 12/5/2012 | 2:27:16 AM
re: Contrarian Indications Well put Scott. And as Wayne Gretzky said "I skate to where the puck is".
kaebrown_98 12/5/2012 | 2:27:14 AM
re: Contrarian Indications The main there are too many companies chasing too few opportunities is because the VCs that you praise funded all those companies.

Talk all you want about too many entrepreneurs with the same ideas, but the VCs fund these entrepreneurs and thus create the oversupply.
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