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Through The Looking Glass
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
March 1st, 2002


By Brent Holliday
Greenstone Venture Partners

 

“Hey, it ain't gonna change overnight, no
And it ain't goin' away without a fight, no!

Now I ain't sayin' that I'm never gonna beg you
Oh, baby come back” – Van Halen, Aftershock

A year ago, I came to the same conference that I am at today in San Francisco.  The Robertson Stephens Technology Conference is a 4 day maelstrom of technology CEOs, public and private, presenting 20 minute updates on the progress of their company to a sea of VCs, fund managers and, inevitably, competitors.  I looked back at what I wrote last year and some of the trends that were happening.  In a nutshell, February 2001 was a time when everyone was in complete shock.  The full extent of the telecom wreckage was just dawning on everyone.  It was miserable, at best.

In what just might become an annual event, I want to update you on the trends that people were discussing here this year.  In a sense I was just taking the temperature of the industry.  In a possible omen to good things, I should let you know that the temperature was 21 degrees and sunny all week long…  Last year, I was busy making brazen predictions of a stock market rebound after mid-April.  For a while I looked like some sort of market maven with the NASDAQ bottoming out at 1620 on April 5th and racing back to 2200 by June.  The true bottom ended up being 1420 on September 20th and we are only at 1750 today.  So don’t bet the farm on my short term predictions.  Long term trends are safer bets.  Here are five areas that I concentrated on at the conference:

IT Spending Recovery – Like a broken record, I keep coming back to this IT spending by the enterprise thing. When will the enterprise ramp its spending on PCs, servers, networking gear, software infrastructure, applications and services? Consider this:

  • The biggest bubble in PC sales was in late 1998 and early 1999 when the enterprises stocked up or upgraded for Y2K.  The average shelf life of a PC in a company is 3.5 to 3.8 years according to a recent CIO survey.  That means that we are likely to see a second order bubble in PC sales as the upgrade cycle begins anew in late 2002 through 2003.  For those of you developing for Win2000 or XP, there will be a concomitant rise in the OS sales as companies go through that upgrade.

  • The IT downturn of 2000 and 2001 was caused by the Y2K hangover, combined with the dotcom and telecom meltdowns.  IT spending was reduced as business, in general, slowed.  But a funny thing happened on the way to downsizing the company.  The IT department didn’t scale down very well.  Here’s why:  70% of IT budgets in 2001 were for non-discretionary fixed costs (meaning that people in IT and the maintenance of IT were things that absolutely had to be a part of the budget to keep the IT wheels moving).  Only 10% of the IT budget in the enterprise was allocated for software licenses, which can be discretionary (“I don’t have to buy new software this year”, for example).  Think of how much money is being spent on service, maintenance and hardware, if only 10% is software.

  • CIOs report that, for the most part, after 14 years of spending internal software projects are by-and-large done.  There is a huge product cycle lull in enterprise applications for behind the firewall.  Most feel that now is the time to lower spending and reap the rewards of all of the development and training effort.  But outside the firewall, that’s another story.  More on that in the section below.

The summary is that IT spending should pick up in the 2H of 2002 as the upgrade cycle is forced upon IT managers.  But the other reason spending will increase is that CIOs want to make IT budgets more flexible.  In other words they want to be able to throttle it better to suit the cycles of the economy.  This means that they will spend more some money soon on upgrading the software and infrastructure that will, in the end, drive costs of running IT down.  The trend toward outsourcing will gain steam as well.

Financing and IPOs – There was a brief shining light of hope among investment bankers and VCs two weeks ago when Paypal went public on the NASDAQ and shot up 50% on the first day of trading.  Could it be?  A company that lost $140M last year with revenues of $16M and a business model that makes no sense whatsoever does a moonshot IPO.  Hallelujah!  Let me hear you scream Onvia!!!  C’mon baby, Daddy needs a new pair of shoes!

Alas, the word on the street now is that PYPL will be an anomaly.  The scuttlebutt here is that Salomon Smith Barney underwrote the IPO after every other bank said no.  There is a palpable fear here that you will be tarred with a certain brush if you promote and sell un-profitable companies in this day and age.  No, there will be no mad rush to get IPOs listed as in 1998 just because PYPL made it out the door successfully.  Two quarters of growing profit is a bare minimum to get the bankers to think IPO at this point.  Unless you area biotech company, then you can go public on a genomics patent and a couple of beakers.  It’s their silly season now.

Financing in general is picking up.  At least half a dozen private companies here announced rounds that had closed in the last two months.  Significant amounts are being placed at the later stage.  At the start-up stage less money is going into deals than before.  It used to be that a team and an idea would get you $20M to get started in the Silicon Valley.  Now its back to a more reasonable $4-5M in most of the A rounds being done.  Don’t expect wild fluctuations in valuation or amounts of money being invested over the next few years.  It will be a slow growth in number of deals and amount of money.

Optical Communications – I must have seen 15 public company CEOs in the components or system vendors for communications all say that they have seen the bottom and it is now.  So they are a confident bunch.  Looking forward is anyone’s guess and as Corning said, “we just don’t know how long we will be at the bottom”.  The CFO of JDS Uniphase said we could quote him on his guidance for Q3 of this year.  So I will.  He said, “It will be below, the same or above our Q2 number which we are comfortable with.”  Well, that’s certainty for you.

If there is cautious hope in IT infrastructure and software, then there is serious praying in the optical space.  Nortel completely avoided the discussion about its numbers or its lingering $8 share price by sending some buffoon in to talk about their new religion in products for the metro area network.  The private companies put on brave faces about their multiservice edge switches, superior transport silicon and way better optical GigE transceivers.  But at the end of the day, the inventory glut is still in the market and the customers have shrunk to a few crusty old telecom companies who are looking at only one thing: reduce the cost of my network.  Hardly a rallying cry for the new, new thing isn’t it?  As one analyst put it, “We used to be on Internet time, now we are on CFO time.”

This year is still a write off for most sectors of optical communications.  There is life in the metro area, which is why Nortel talked for 20 minutes about it.  But the consensus seems to be that 2003 will be the start of better things for companies like JDS-Uniphase, PMC-Sierra and Nortel.  Maybe.

Wireless - If there is a shining light in telecom spending, it is in wireless as widespread network upgrades to GPRS and 1xRTT (about 1/3 of 3G, which would be 1G, but 1xRTT sounds cooler) abound.  A new generation of handsets to take full advantage of these new networks will be rolling out soon.  This bodes well for the infrastructure players in wireless: chips, sub-systems, base station technologies and access devices.  You might think that the application developers for the enterprise and consumer apps would benefit as well.  The jury is still out there. 

If you make software solutions for network management, quality assurance or provisioning (stuff that reduces the costs or increases the efficiencies for the service providers) then you are in for a good year and the long term prospects are bullish.  If you are making applications or gateways for corporate data (in other words you are selling to the enterprise) you are in for a long because you fall into that enterprise IT spend that we already talked about.  The survivors that are around and have traction in 2003 will likely do well as the promise of wireless mobile workers finally begins to match the hype.  Security will be hot in the wireless space, especially 802.11a/b and Bluetooth.

The analysts seemed very bullish on the consumer applications, citing the Japanese DoCoMo and European SMS (short message service) success among consumers, especially young ones.  I don’t share their enthusiasm for consumer apps because I don’t think that there is a sustainable business model for a stand alone wireless game/chat/music application company. 

Enterprise Software - As mentioned, the emphasis for enterprises is outside the four walls.  The gang at Crystal Decisions or Pivotal would no doubt disagree with the observation that the internal build out is by and large done, but the analysts claim that there is no new compelling reason to invest in the new thing. 

Outside the four walls, supply chain communication, integration, logistics and fulfillment are the order of the day.  Groupware is getting a new life with remote teams and extranets looking to make the enterprise more connected to its employees, consultants and partners.  Overlaying this need is security once again. 

The really big debate today is the adoption of web services.  There is substance to this hype as Microsoft with its .NET and Sun with its J2EE try and become the platform of choice.  This is not a revolution and it’s not complex.  It’s an evolution from the myriad of web based technologies that are in use today (application servers and their connections to databases are still the method for creating web based functionality).  The move to web services is all about cost and efficiency.  With a standardized set of connectors and simpler, better abstracted code, the world of application creation, integration and delivery moves from the domain of the bearded, open-toed sandal software gurus to the corporate IT worker.  Of course there will be religious wars over .NET and J2EE, but that’s an unavoidable side show.

So service providers and outsourcers will flourish short term as the need for movement to web services hits a fever pitch.  Long term, the promise of web services is shorter development cycles and ease of use which means that the consultants will have to find new fertile ground besides application integration and maintenance.

That’s the general thinking from the people that pay attention to these things 24 hours a day.  There is obviously a lot more detail and specific niches and areas to be exploited that don’t fit these trends. But no matter what you are doing, it helps to stick your finger up and find out which way the wind is blowing once in a while.

Random Thoughts –

From The Told You So Files:  The final 2001 numbers for VC investment came in last week.  As predicted right here, the second half of the year was dismal in Canada as our investment retraction followed the US by about 6 months.  In BC, the whole year showed $465M CDN invested in technology companies.  As you will recall, the first 3 quarters of 2001 showed $420M invested.  That means that 90% of the money was invested before Sep 30th.  The trend to watch is the quarter over quarter improvement because going from $170M invested in the summer of 2001 to $45M invested in the fall is a pretty big drop.  Somewhat akin to the huge drop in the US, delayed by about 6 months.

Letters From Last Time –

Hi Brent,

As always, another insightful column....Re your comments on shutting down TechBC and the need to double the number of IT / Engineering grads, I think if you dig a little deeper you'll find that TechBC is in fact not closing but carry-on operations as a satellite campus of SFU. Also, at least from what I'm hearing from inside this institution, that the Double the Opportunity is still slated to happen.....

Bob MacDonald

Bob, I did here that the TechBC grads were moving over to SFU.  But that hasn’t stopped the grumbling about lost opportunities to develop a centre of excellence in Surrey or the fact that most of the students are unhappy with the move.  There wasn’t much in the latest budget about direct double the pipeline stuff.  But I guess the government had a few other issues to deal with first.  Thanks for the letter and I hope everyone ends up with a good education from SFU.

 
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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