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The Great Spring Melt
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
April 14th 2000


By Brent Holliday

And now the end has come
You're feeling pretty dumb
But you deserve it
You had no choice."–
- Odds, It Falls Apart

How many of you have had your Dad say, "I told you so" in the past week? Damn those grey-haired, earnings-focused dinosaurs! Look what hell they hath wrought: a 28% correction (and climbing) for the NASDAQ. The carnage is breathtaking. Research in Motion down 70% in three weeks. Dot-com stocks are becoming microscopic. My RRSP just lost a zero! Help, the sky is falling, the sky is falling!  

It's pretty easy to get caught up in the sudden and ferocious bear market for technology that is upon us. For the most part, the change in direction of the markets has left us feeling a little hung over. Malaise and fear have swept through the entire technology sector. The media have rolled out the deathwatches for many Internet companies and dusted off some old "value-investing" stock analysts that have been on the shelf since the Asian crisis to explain what a P/E is to the listeners...

Here are some more numbers: 

CDNX Tech index is down 36% in the past 21 days
The NETDX, from Robertson Stephens is down 40%
The EtailDX, also from Robertson Stephens is at its 52 week low and down 58% from its high. (The lucky analyst covering consumer e-tailing dotcoms says that this sector has been "hit particularly hard and some great bargains may be available". Uh-huh. The real estate market in Iraq has also been hit pretty hard. Some great bargains may be available...)

Is it going to get worse? Probably. Will there be massive consolidation in the next year? Bet on it. Should we all buy back those Y2K Honda generators and stock up for a long hard financial crisis? Nope.

Calm down people! The reality is that people still have disposable income, still have great jobs and still think that the Net and all the new technologies will continue to fundamentally change our lives for the better. Having said that, there are some changes to watch for if this bear sticks around.

Let's look at what is going on in the technology sector from a couple of perspectives: What sectors are truly on life-support? What does this mean for companies and their employees in the short term? The long term?

If you had to bet on which sector investors would flee from, would you consider the one where the collective profit for all of the public companies is negative $600 M per quarter? Yes, the dotcom e-tailers are lepers these days and they have fared the worst. No surprise there. Sporting a dark cape and a scythe, Joe Sawyer and his colleagues at Forrester Research announced yesterday that 85% of current e-tailers would be out of business by the end of 2001. That's 25,000 companies worldwide. Ouch. Some e-tailers have responded and said that they are doing fine thank you, even if they still don't expect profitability for another 18-24 months. Pure play Internet retail sales of merchandise is turning out to be an unprofitable business model for everyone, with the possible exception of the largest brand name providers (Amazon and a handful of others). Why? The fulfillment will kill you. The business does not scale well, either.

Fact is, as I surmised two months ago, investment capital has dried up for e-tailers. B2C as a whole (including e-tailers and "eyeball" sites) has not been a popular investment area in VC for over 9 months. The early stage funders have moved, herd-like, in other directions. If you are leaving your day job to start a company in this space (let me emphasize again, pure-play ideas) then please re-think your business plan.

Another sector that has been bruised is the "eyeball" sector. Portals, communities and content companies on the Net have not been crushed as much as e-tailers, but it's close. Advertising is a viable business model. Massive media companies have been built for the past 50 years on that business model. But, increasingly, investors are looking for more than ads. Banner ads need an overhaul. Privacy issues are about to make "one-to-one marketing" and "personalization" dirty words. People just don't have enough time in a 24 hr day to spend time at 50 different community sites.

The good news is that broadband is coming very fast. With bigger pipes and more "rich" media, content and community sites become more compelling. Ads will morph into more like TV and radio ads. Ultimately, the model will work in the new medium. So, I recommend you look for bargains in this sector, if you have the stomach for it. Remember, I am thinking long term.

The magic word for the past while has been "transactions". Why was Yahoo at $400? Well, the story went, increasingly they will move from ad revenue to "transaction" revenue. People buy stuff through their sites and they get a cut. Wait a second. Isn't that what a broker gets? What happened to disintermediation? New intermediaries will be successful going forward because the Net really enables connectivity and communication. Large portals are becoming lead generators for on-line or real world services and products. Big brokers make tons of money. This will be a good business model.

B2B has not survived the carnage. While it has been hot and still is warm in VC investment circles, B2B means a lot more than exchanges and supply chain integration. Simple vertical industry marketplaces have suffered badly. E-tailers have been hammered because they can't make a profit. The B2B exchanges have been hammered because they have no revenue! Chemdex, e-steel, Paperexchange… they are all struggling to get users. While we all bought into the exchange theory of connecting many suppliers to many buyers, the reality has been a tepid, toe-dipping response by the big suppliers, who fear that the exchange will commoditize their prices. It turns out that a one-to-many exchange is what the supplier really want!

B2B tools providers are having a better time of it. They are finding many customers in need of using net applications or tools to efficiently communicate with their supply chain. Again, this is a big shift and there will be lots of money made here. But the bucketloads of money will be made by the web applications developers and the "software as a service provider" (ASP) model that is emerging. Software will not be sold in a box to business going forward. Internet delivered applications are as close to the holy grail of "lower total cost of ownership" that company IT departments have been promised for a decade. This area is molten right now in VC land. Why? Businesses will pay, and always have paid, for enterprise software. Especially those applications that make mission critical processes happen faster and cheaper.

The real bulletproof technology sectors for the next while are wireless and communications infrastructure. If it boosts bandwidth or delivers wireless data, it's a better bet now. There are some fallable business models in wireless data, such as simply translating HTML to WAP. Killer wireless apps will use the mobility factor, such as localization, to make our lives easier. The wireless infrastructure still needs to be built out to handle the demand for mobile information, so it will take 2 or 3 years to reach maturity, but this genie ain't going back in the bottle, no matter what the NASDAQ does. Same for bandwidth. From photonics to cable modems, at the chip level or as a service, bandwidth provisioning is just getting started. You used to brag about how many Mhz your processor was. Now it will be how many MBps you can get.

So is Research in Motion a buy at $70 (P/E of 285)? What about PMC-Sierra (P/E of 225)? According to my thesis, these are companies in an industry that cannot be stopped in the near term. I do not know where the bottom of the trough is. Two years ago, these companies would be considered overpriced at P/Es of 40. Now, as an early stage investor, I want to invest where the market will be hot when my company matures. In the vacuum of common sense that is still, today, the public stock market, I will bet on what trends that I see businesses and people following. I will invest in companies that I see will have something fundamentally valuable to the chosen market, such that they will pay more for it than the company bought or made it for. In other words, they can extract money to grow from their customer, too.

If this bear continues, it would be really prudent of me to have invested in companies that don't require $100 M in marketing dollars to reach profitability. If the IPOs dry up for an extended period of time, I want to know that the company can grow through sales. I think a lot of VCs are thinking like me. Hey, don't despair! There are still billions of dollars in VC funds that has to get placed in the next 3 to 4 years. Even if the IPO market dries up, there will be plenty of money seeking great early stage opportunities.

What does worry me is the shift in attitudes of the employees in a prolonged time of stock market uncertainty. What happens when the 300% IPO jumps stop? Do employees turnover at a faster or slower pace? Do they start to actually look at their career aspirations instead of their portfolio of dotcom stock options collected at 4 different companies? Do they start to think quality of life over expensive, crowded, culturally devoid places like the Valley? Could this be a good thing? I think I'll defer that discussion to next time and see what two weeks can do to this market...

Letters From Last Time:

Brent,

Read your article on our event. Thanks for the supportive words and sentiments - they are definitely appreciated by all us underpaid and overworked bureaucrats toiling away down here in the Valley. It is especially cool when someone in the actual VC community voices them as well.

Thanks again. Cheers,

Handol Kim
Consul & Trade Commissioner
Canadian Consulate Trade Office

Handol,

A comment from an attendee at the event that also read my column afterwards and said, "Gosh, you type almost as enthusiastically as you speak." Could have been that she sat in front of me and I drowned out anyone else in the room. I enjoyed the Moosehead and look forward to another some time soon.


What Do You Think? Talk Back To Brent Holliday



Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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