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Optical/IP

VC Casts Gloom on Telecom Startups

Here's some bad news for infrastructure startups: Telecom network equipment vendors are not good investment prospects these days, because companies that rely on carriers for their revenues offer too little potential for a "liquidity event."

So says Jean Schmitt, managing partner at European venture capital firm Sofinnova Partners, which recently raised a €385 million ($513 million) investment fund (see Sofinnova Grabs €385M).

The firm is now sizing up the technology markets, looking for early stage firms that offer decent prospects for a profitable return on investment, either through an acquisition or an IPO.

Sofinnova has a history of backing telecom hardware and software companies such as photonic switching systems vendor Calient Networks Inc., broadband access equipment firm Narad Networks Inc., PON systems vendor Salira Optical Network Systems Inc., and billing software firm VoluBill (see Narad Networks Raises $17.5M, Calient Networks Raises $20M, and Salira Secures $7 Million More).

But Schmitt says that telecom network equipment and OSS firms are no longer attractive to VCs. "With our previous fund we invested in a few telecom software companies, but we quickly stopped, as operators haven't really been investing much there. Companies that rely on telcos as their customers make me very nervous. On the network side, it's possible to create exciting companies, of course, but not the kind of companies that will attract VCs," he says.

The main problem is that the operators are not willing to invest in innovative technology, he says, and it's hard to determine how much they will spend, and when. "And if you're landing big deals with Tier 1 operators, they are squeezing your margins so hard it's tough to make money. If you are winning contracts with Tier 3 carriers and a competitor is winning the Tier 1 contracts, then you're dead," adds Schmitt, cheerily.

He says Sofinnova has looked at a few companies in the video equipment and triple-play systems space, but "we didn't see anything that would crack the market."

He adds: "We still look at the infrastructure market but we don't see many opportunities, as there aren't any real opportunities to grow a company to very quickly become a $100 million [annual revenues] player. It's a big issue -- how to build a business model with carriers as customers. It's possible to build a company that has revenues of $20 million, but that's not enough for a liquidity event. The bar is going higher," says Schmitt.

Instead, Schmitt and his colleagues see greater opportunities in companies that are developing software and hardware components for mobile handsets.

He notes one such company in which Sofinnova has already invested, California-based fingerprint authentication technology vendor Upek Inc.. Sofinnova led the company's $20 million Series A investment in March 2004, and Schmitt claims the company is already experiencing financial success.

Embedded technologies for mobile phones are "a big growth area," reckons Schmitt. "Feature phones are growing in terms of market share, and there are opportunities for companies developing embedded systems that provide functions such as location services, and security. The handset market is still very nascent in terms of embedded software," says the VC.

"We're looking for the missing pieces, and there's a lot of work to be done on download technologies and creating good user interfaces. There's also some amazing battery technology that is being used in other industrial sectors that hasn't been applied to mobile phones yet. And machine-to-machine technologies, allowing machines to communicate with each other for maintenance, downloads, upgrades, stock control, and so on, is also a very interesting area."

He also sees investment opportunities in companies developing IP Multimedia Subsystem (IMS) client software for mobile phones that would connect back to the network-based application servers delivering services such as presence, instant messaging, and other SIP services. IMS is one of the hot telecom topics of the moment (see IMS Tops 3GSM Agenda, HR Says Wireless, Wireline Converging, and Urgence and Convergence).

But he believes that Europe is falling behind in terms of its innovation potential, while the U.S. is becoming more of a hotbed, especially in wireless. "The U.S. is waking up. There are a lot more interesting technology startups there now. Many of them have naïve business plans, but they are very innovative, and they are being helped and supported by the U.S. carriers. But in Europe I see the opposite happening. The carriers here are not interested in innovation."

Schmitt believes carriers should do much more in promoting and developing their own new technologies. "A lot of operators don't invest in technology – they're only interested in milking the cow instead of helping to create wealth. Sure they have R&D teams, but often they're looking outside their own companies at what other companies are producing, and they're not creating anything themselves. That's not good for them or the economy. The telcos are reluctant to innovate, but they shouldn't forget that they're technology companies themselves."

He says this "plays into the hands of the large vendors, such as Alcatel (NYSE: ALA; Paris: CGEP:PA) and Siemens Communications Group. They will take control. I would rather see an innovative France Telecom SA (NYSE: FTE) or Orange SA (London/Paris: OGE). But these operators are only interested in making money from their intellectual property, and they're just giving away their R&D. That's not a good move," concludes Schmitt.

— Ray Le Maistre, International News Editor, Light Reading

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particle_man 12/5/2012 | 3:22:50 AM
re: VC Casts Gloom on Telecom Startups Speaking of due dilligence, Jean is a "he".
sir-wish-pro-wide-her 12/5/2012 | 3:22:50 AM
re: VC Casts Gloom on Telecom Startups As stated in the article, Telecom network equipment vendors are not good investment prospects these days, because companies that rely on carriers for their revenues offer too little potential for a "liquidity event."

So says Jean Schmitt, managing partner at European venture capital firm Sofinnova Partners

I disagree with the JeanGÇÖs statement. Here is why. If Mr. Schultz the founder of Starbucks Coffee had thought like Jean, that coffee is a commodity and a saturated and unexciting business, with little or no rewards, then we wouldnGÇÖt have had Starbucks.

I think Jean needs to do one of the following two things:
-Go back to school, and take classes and do internship on innovation, risk-taking, and business plan evaluation, or
-Change her field of work. Whiners complaining about disappearance of low hanging fruit, reveal their colors and have no place in real world leadership club

Poor due diligence and lack of smart forward-thinking analytics and extrapolation, is no excuse for lack of exciting investment prospects. I think real paradigm shift is needed in the VCs camps. Too many theoretical number crunchers, and paper pushers are hiding in that area, and slowly but surely they are being exposed, and their whining and finger pointing is just a squealing sound a pig would make when cornered. Lets face it. Money is commodity. An excellent business idea, business plan, and execution team, is not.

I think there are many exciting opportunities that can challenge the incumbent carriers. Here are some examples:
-Form an ecosystem with hardware and software suppliers as well as CLECs/ISP/MSO/WISP/Small-or-emerging next-gen carriers. The business model should be of revenue sharing rather than traditional buy/sell transaction. If big boys are getting bigger, little guys have to band together to take on the 800 lbs gorillas.

-Learn to compete on customer service, instead of just whiz-bang technology or cost improvements. Big incumbent carriers are still sorely lacking in their customer service.


-Finance the poaching the best key people from the incumbent carriers. This could be a win-win situation for the poachers. If you get the incumbent carrierGÇÖs best key people, be happy that you got talent on your side, and you created a gaping hole on the incumbent carrierGÇÖs side, who therefore would be more vulnerable and therefore may become more receptive to looking at addressing that need via new technologies or acquisition. If the incumbent carriers up the ante in retaining their key people, the poacher still achieves its objective of raising the cost of doing business for incumbent carriers, if incumbent carriers continue to operate in the status quo mode.

-Offer insurance on your product/service if your product/service is really superior and works as advertised. This will prevent the competitor who is hyping things up, and making false promises, to win Tier-1 or Tier-3 business, and is forced to plays by the rules and competes on real-stuff and not on cost slashing or hype. Also, this will reduce opportunities for Tier-1 carriers squeezing out your margins.


-Buy up the intellectual property assets of the dying technology companies, and partner with bunch of smart Intellectual Property lawyers, and sue the hell out of incumbent carriers for any direct or indirect IP infringement, unless they want to buy equipment from the companies you have venture-backed. This may seem mean on the surface, but it is not, as you are trying to foster innovation adoption, rather than engage in pure extortion, and that is always good for the society in the long run. (FYI, this is no different than taking a cue from the US government wanting to be proactive in democratization of the parts of the world :)). (Another fine example of this concept in action is the totally upside-down healthcare system with malpractice suits; told you lawyers have their place in the world)[Flames >> /dev/null]

-Partner with smart people to expose any flaws or holes in the incumbent carrier network and create a strong PR out of that deficiency. Show how the ecosystem network architecture backed by VC is not vulnerable to those kinds of shortcomings.

-Hire lobbyists to work on your side, to counteract the lobbyists working on the side of the large incumbent carriers.

-Adopt a model of try for an extended period of time before you buy. And offer forever-free basic yet important services to the consumers. An analogy of yahoo messenger and free ISPs come to mind. Both those business models have proved lucrative in the long term. Other examples include Google, NetZero, Skype, Linux, etc. The idea is to go after the core profit sanctuaries of the incumbent carriers.

I can go on, but I hope you get the point. If Sofinnova is looking for a new managing partner to replace the current dud in office, let me know.

- swpwh
douggreen 12/5/2012 | 3:22:49 AM
re: VC Casts Gloom on Telecom Startups Peter,

While I agree that Telecom is a tough investment market at present, the VC model is also completely broken. The telling statement in this article is:

"... as there aren't any real opportunities to grow a company to very quickly become a $100 million [annual revenues] player... It's possible to build a company that has revenues of $20 million, but that's not enough..."

This shows that many are still in a bubble mentality. Prior to the bubble, funds were smaller. VCs expected to put $20-30M or less (aggregate, not per VC) into a company over several rounds (5+10+15), become profitable at $20M in revenue, and grow over time (Ciscos first VC round was $2.5M if I recall correctly). Some of these $20M revenue companies became $100M companies over a period of years, and a few became billion dollar companies over a decade. VCs looked at longer horizons for exit, and needed much smaller exits to be successful.

Trouble is, this actually takes a lot of work. During the bubble, VCs learned to throw a hundred million or more at a company (aggregate) and expect billion dollar exits within a few years. This was fairly easy to do for a while.

Startup leadership has also forgotten how to build a profitable company with reasonable levels of investing, and VCs have lost the art of making money the old fashioned way. In some cases, it's a catch-22 because the investors can't find the old fashioned leadership to invest in.

Let me put this in perspective. If I showed a VC a startup plan today that showed sequential yearly revenues of... $16K, $22K, $381K, $1.2M, $2.4M, and $7.5M for the first 6 years, they would pass. In spite of the fact that it is growing consistantly, profitable, and is now self-funding, it is not "big enough soon enough." Congratulations on passing on Microsoft. The next few years would bring $16M, $24M, $50M (still a dog, right?), $97M, $140, $197, $346, $590M, $840M, $1.2B,... you get the picture. 10 years to reach $100M... just not fast enough.

Based on the criteria stated in this article, Microsoft, Cisco, Apple, Compaq, would all have been bad investments because they did not grow "very quickly to $100M."

The funny thing is that the very few startup leaders who DO know how to grow a company with reasonable funding over time cannot get the interest of the premier VCs because their investment needs are too small and they are looking for profitability rather than a "quick flip." A great deal of the really interesting stuff is now regionally funded.

FYI, convergence may mean lower sales in aggregate, but is also represents opportunity for those who can figure out how to take advantage of it...but then that takes innovation and insight.
minnecool 12/5/2012 | 3:22:49 AM
re: VC Casts Gloom on Telecom Startups "Form an ecosystem with hardware and software suppliers as well as CLECs/ISP/MSO/WISP/Small-or-emerging next-gen carriers"

Are you nuts? CLECs? What CLECs? They're history. ISPs? What ISPs? Only the big boys remain. MSOs? Cheapest guys on earth and Cablelabs rules the roost. NextGen? Yes, I agree, in 2015 - maybe.
rjmcmahon 12/5/2012 | 3:22:49 AM
re: VC Casts Gloom on Telecom Startups I would say that anything to do with basic infrastucture is going to be a dead duck for the foreseeable future, because of the consolidation that'll be associated with convergence. We're already seeing the carriers planning huge layoffs because of this.

Do you really believe the assertion that consolidation is due to convergence? It seems more likely that consolidation is occurring because the rate cap companies have gained the upperhand. They have fooled regulators into believing that competition exists and hence they need not even be rate cap regulated. This allows them to increase profits by raising rates while laying off staff.

Agreed that the present system does not provide an incentive to invest in infrastructure. It's the obvious problem area yet it gets no attention and no investment from either the public or the private sectors. The US will need to come up with a better system if we are going to reach our potentials.
Peter Heywood 12/5/2012 | 3:22:49 AM
re: VC Casts Gloom on Telecom Startups I would say that anything to do with basic infrastucture is going to be a dead duck for the foreseeable future, because of the consolidation that'll be associated with convergence. We're already seeing the carriers planning huge layoffs because of this.

However, I see the potential for a huge amount of innovation happening at a higher level, on creating the software platforms that will enable carriers to roll out multiple services over their converged IP infrastructure. This is going to transform telecom, and this is really at a very early stage.
DZED 12/5/2012 | 3:22:48 AM
re: VC Casts Gloom on Telecom Startups Excellent post from douggreen.
The VCs are probably as big a part of the problem as the guys touting bugus numbers to them. Which comes first, the guy with the garbage data or the guy asking for it?
Ridiculous growth figures are usually just that, ridiculous.

BTW, based on their own criteria, would a VC invest in a VC? I don't see many of them in the FTSE100, or with the kind of exponential growth they are demanding.

The VC model killed Bookham, money poured in, it was spent without thinking for the long term, now its closing.

DZED
stuartb 12/5/2012 | 3:22:48 AM
re: VC Casts Gloom on Telecom Startups "I would say that anything to do with basic infrastucture is going to be a dead duck for the foreseeable future, because of the consolidation that'll be associated with convergence. We're already seeing the carriers planning huge layoffs because of this."

Congratulations Peter, you just dogged the entire industry Lightreading covers. You won't get many sponsors for your "Future of Optical Networking" seminar with this type of mentality.
dwdm2 12/5/2012 | 3:22:47 AM
re: VC Casts Gloom on Telecom Startups Based on the criteria stated in this article, Microsoft, Cisco, Apple, Compaq, would all have been bad investments because they did not grow "very quickly to $100M."

Couldn't have said any better!

One thing I am curious about though, is there any difference in the VC environment/mindset in EU than in the US? While the common factor obviously is they all want "quick flip," however, has EU seen any CISCO or Microsoft in the last few decades? Probably not. Fortunately for them of course, they have not seen any Enron or Global Crossing either. And for that reason I always thought they are probably more realistic than their US counterpart. But the Sofinnova Partners analyst has played it way down - more than expected. Thoughts?
OptixCal 12/5/2012 | 3:22:47 AM
re: VC Casts Gloom on Telecom Startups "The VC model killed Bookham, money poured in, it was spent without thinking for the long term, now its closing."

...Bookham is closing?! Holy fiber optic, Batman!
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