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Soul Searching

Column
Column
Column
9/26/2001

What's in a startup?

These days, Wall Street gives you one cynical answer: nothing but the cash on hand.

Just two years ago pundits were declaring the Silicon Valley venture capital model to be the future of global capitalism. Risk capital had put American technology companies ahead by leaps and bounds. Startups and entrepreneurs were king. Large monolithic corporations were dead.

Fastforward to the present. Cash is king, venture capitalists are loathe to fund anybody, public market investors are disinterested, and the large monololithic corporations are in a position to consolidate markets by snapping up startups or their assets at bargain-basement prices in bankruptcy court.

Silicon Valley, in short, has lost its allure. It's now the world's largest community of former paper millionaires collecting unemployment checks.

Massive terrorist attacks on America and the ensuing global political crisis have done nothing to help the situation, of course.

Cheery, eh?

The most telling sign of the times is the valuation of larger public optical networking companies that once commanded valuations in the tens of billions of dollars. Sycamore Networks Inc. now trades at a market capitalization of $1 billion, while it holds nearly as much in cash; Corvis Corp. (Nasdaq: CORV) trades at $576 million, while it still holds $726 million in cash.

Yes, those valuations in the tens of billions of dollars were absurd. But valuing these companies at cash-on-hand may be taking things to the other extreme.

Markets have reasons behind their actions. In these cases, the market is punishing these companies for poor use of the capital they acquired in their billion-dollar IPOs. That is, they burned much of the capital, mismanaged growth, and failed to generate projected profits or revenue targets.

Things aren’t any better in the private company market. Recent research by Optical Oracle, Light Reading's subscription research service, indicates that most private companies are valued at their total amount of funding -- if not less.

This brings us back to the crisis of confidence in the startup model. If we really believed in startup culture, would we value companies at the equivalent of their cash in the bank? Of course not. If that were the case, there would be no reason to invest (or even create) startups. Everybody would just put their capital in bank or government bonds and earn far better returns with the interest rate.

In better times, a young technology company would be worth more than its cash position. That’s because the market believes that some aspect of the company -- the technology, the people, or even the investors -- will yield more value out of the startup capital. Of course, everybody counts on a larger percentage of failures, but the high-risk bet is that the ones that pay off will more than compensate for the losses.

From the perspective of potential customers, startups have an allure. First of all, they are more willing to work for your business -- and perhaps offer more value. The technology is more likely to be cutting edge. Then, there's the promise of hiring a young rising star for pennies on the dollar of the cost of the aging, wealthy executive.

It was only when the startup value system was corrupted by the financial bubble -- i.e. the stock became of more value to customers than the product itself -- that this value system failed. Hence, today's cynicism.

For the leaders of this industry, including the investors, entrepreneurs, customers, and rank-and-file employees, it’s time to do some serious soul-searching. Do you still believe in the startup model? Are you willing to take the risks involved in either working at or funding a startup, in the belief that the advantages outweigh those risks? If you work at a startup, are you willing to focus on technology, people, and products -- rather than financial shenanigans -- to succeed?

If not, then it's time to get out (if you haven't already been booted). It’s time to restore this market to its core constituency: leading technologists and the savvy investors who think they can help them. We need to rebuild confidence in the technology startup. That said, there’s no room for the nonbelievers.

Those of us who remain will some day be rewarded. The value of technology companies will rise again. Startups will regain their nimble edge. And as for working in the startup technology business....hey, it's still a lot more exciting than shuffling papers at ABC Corp.

-- R. Scott Raynovich, executive editor, Light Reading http://www.lightreading.com Editor's Note: Light Reading is not affiliated with Oracle Corporation.

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Scott Raynovich
Scott Raynovich
12/4/2012 | 7:48:05 PM
re: Soul Searching
Actually, that was exactly my point. Maybe I wasn't clear enough. The entire market is being valued at cash. And, most investment decisions these days seem to be an evaluation of whether or not the company has enough cash to survive the downturn.

My point was not to advocate buying or selling specific stocks. It was meant to be a discussion of the fact that sentiment for technology startups in the investment community is at an all-time low. Unless we believe that the venture-capital startup model is broken (I for one, don't), this sentiment will eventually rise.
dietaryfiber
dietaryfiber
12/4/2012 | 7:48:05 PM
re: Soul Searching
By the way, excluding what looks to be extraordinary junk Corvis probably netted $24M in Margin on OpEx of $65M. This loses an average of $40M/quarter.

Now the thing is to cut back for Sycamore is an 80% layoff. For Corvis, its a 66% layoff. This is the problem. They can't do these layoffs and have a company. Without them, they eat into the shareholder's cash position. The only way out is to grow revenue and hold or lower OpEx.

The outlook going forward is murky, bleak, no visibility --- you pick the words. Without reasonable growth visible in the model, they will lose $$ and investors will expect them to cut OpEx hard to make a profit.

So, Desh and David --- which is it? Are you going to grow or cut?

dietary fiber
dietaryfiber
dietaryfiber
12/4/2012 | 7:48:05 PM
re: Soul Searching
I think you have missed how investors are valuing these companies. They are valued at cash, because the ongoing business models show them losing money from operations, with a top line that is not growing (per their own projections). Sycamore's revenue (for example) is down $40M over last year (July quarter comparison). OpEx at the same time is up $5M. So, are they going to grow out of this situation? The current situation has Sycamore requiring $261M revenue per quarter to break even. To break even at the current revenue, OpEx needs to be cut to $12M. So, if there is no growth....then the business is worth its cash.

dietary fiber


Now these models
dietaryfiber
dietaryfiber
12/4/2012 | 7:48:04 PM
re: Soul Searching
Scott,

My point is that Cash or less than cash is a reasonable value for these companies.

dietary fiber
Scott Raynovich
Scott Raynovich
12/4/2012 | 7:48:04 PM
re: Soul Searching
I probably can't (or wouldn't want to) argue with that. But let's talk about the startup market. Are all startups worth the cash on hand, and nothing more?
lightmaster
lightmaster
12/4/2012 | 7:48:03 PM
re: Soul Searching
Question: when is a $100 bill not worth even $100?
Answer: When it is on fire.

lightmaster
lightmaster
12/4/2012 | 7:48:02 PM
re: Soul Searching
"Are all startups worth the cash on hand, and nothing more?"

No, many of them are worth much less ;)

Seriously, many companies have been unfairly hit. But...if a company has a billion in the bank today, but could easily burn through half of it in a year with no visibility into turning the company around, is is still worth a billion?

dietaryfiber
dietaryfiber
12/4/2012 | 7:48:01 PM
re: Soul Searching
I honestly believe that the public company valuation is about right. I believe Cisco is valued about 2x where it should be and we shall see how that one goes.

Startups are in that boat as well. Example: If the product is not much better than Redback or Sycamore or Corvis, then I am better off buying the public company. So, the value of the startup is set by the value obtainable in the public market. So unless these companies can show why their mousetrap is significantly better, they have no value.

2nd way to analyze this is the return on investment. How is the "liquidity event" going to occur for these companies? Are buyouts at large premiums likely to happen before they have traction and major revenue (read like Cerent)? Probably not. Nobody is left to buy them. At the same token, the public markets are not likely to give them big payouts until they are profitable as well.

I think this is very healthy for these startups. Look at the position that a company like Mahi is in. At 220 employees, they likely need a quarterly revenue of around $25M to break even (its probably a bit less, but you get the idea). When is this likely to occur? Well, its probably not next year and maybe not the year after. This means whatever cash is in the company must last or they must further dilute the shareholders to get more money. So, startups will go back to the mode of very cautious spending. This will make the company be very lean and more likely to be profitable early. This is good for the people that fund this company as they will get more money back sooner.

The heady days of 1999 and early 2000 are gone forever. Never to return. The market, the players and the game have changed and it will not return to the way it was. The important thing is to figure out what is important and move on that.

dietary fiber
fk
fk
12/4/2012 | 7:47:57 PM
re: Soul Searching
Startups are in a difficult stage right now. Due to the ailing economy and painful funding climate at present, startups are in a bind. On the one hand, customers are much slower to pull the trigger and issue a PO. On the other, getting the funding to maintain continuing operations is getting harder. The reaction to the heady days of overindulgence is one colossal hangover.

The bad news for startups as far as funding goes is that we are experiencing positive feedback in terms of the bad feelings that investors have for providing funds to startups. They've become cautious about providing funding, as they are concerned about investing in a company that's not going to make it. Unfortunately it's the companies that get starved for cash that can't make it. A self-fulfilling prophecy, as it were.

The good news for companies that have funding to last for awhile is that if they can control their burn rate and don't get caught needing money, they have a chance to survive until the backlash recedes. In the meantime, companies that are not well run financially will close up shop, regardless of the underlying value of their technology. This should eliminate many of the marginal startups, clearing the way for carriers to focus on the remaining companies, which in turn will help the remaining companies. In this way the ailing economy is a good thing in that it helps cull the herd of the weaker members. If you succeed in this environment, you're likely to be a strong company in the future. You only hope you don't have to endure overly hellish dilution along the way, so that you eventually get some degree of compensation for all this hard work.

Anybody that needs money right now is getting unbelievably harsh terms. Even if the company makes it, the employees are getting fornicated out of their share of success. The investors are few and far in between, and the few that are providing money are taking advantage of this fact to rape the companies on the term sheets. It's ugly. If the companies that they are investing do succeed, current investors will profit disproportionately. It's the nature of the game, I guess. Still, hearing the late investor premiums on current term sheets is pretty nauseating.
dietaryfiber
dietaryfiber
12/4/2012 | 7:47:56 PM
re: Soul Searching
I think you live in a different universe than I do. CapEx from carriers is down about 20% this year. CapEx is estimated to be down an additional 20% or so next year. This means to me that we will not see CY 2000 run rate until perhaps 2005 or 2006.

I think there may be some breakthrough products developed and they may be succesful. Some of these companies may be able to succeed in spite of the overall market.

dietary fiber
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