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

Something Ventured:
May 30th, 2008

By Brent Holliday
Greenstone Venture Partners

A Tale Of Two Companies

“We'll take the best,
Forget the rest
And someday we'll find
These are the best of times...
The headlines read 'these are the worst of times'
I do believe it's true
I feel so helpless
Like a boat against the tide
I wish the summer winds could bring back Paradise”
– Styx, The Best Of Times

With apologies to Charles Dickens, “it was the best of times, it was the worst of times” aptly describes the fate of two BC technology companies that made news in May.  Gemcom Software sold to JMI Equity and Carlyle Group for $180M after successive years of 100% and then 50% revenue growth.  Meanwhile, an army of creditors are picking the bones clean on Ascalade Communications (fka Arkon Networks), a company that went from $12M to $111M in revenue in less than four years... and then spectacularly returned to earth, leaving a large smoking crater.

As always, I like to learn the lessons of the successes and failures in BC’s technology community.  Interestingly, I have been somewhat handcuffed in getting all the details at this time because Gemcom is a public company and the deal closes in July.  So there is a quiet period to honour.  As for Ascalade, one always has trouble getting people to speak of their failures, especially “on the record”.  And I am not out to wag my finger at Ascalade... not at all.  They made some tremendous bets that just did not turn out.  We should respect their cojones for trying.  If you get anything out of this, understand that failure is an option and it isn’t shameful.

In late 1998, I went with Frank Pho to see Gemcom when I was at BDC Venture Capital.  They had a wonderful sophisticated mining industry software application that helped mining companies predict and model their deposits so they could design the mines more efficiently.  It was truly a niche product.  Remember that in 1998, mining was not sexy.  Dotcom was all the rage.  Mining stocks were in the dumps as gold was at its lowest levels in a decade.  Frank made the investment, his first in BC I believe. 

Revenue growth was slow.  The company seemed stuck in the $12-15M a year range for 6 years from 1999 to 2005.  Rick Moignard joined in 2002 after running Chancery Software for years.  Rick is truly one of the “good guys” in BC’s technology sector and I am extremely happy for him with this result.  He guided the company in a promising direction and it worked.  Two things started to happen in 2005: Commodity prices started to rise (which, despite all of his capabilities, Rick was not responsible for) causing the mining industry to revive and Rick and his team thought of expansion of their product offering to mining companies.  The company acquired a competitor from Australia and built out a mining production management tool.  This allowed a mining company to progress from exploration and mine planning (the first product) to extraction and mine management for the life of the mine.  It was a big gamble for a company that did not have expertise in management software and it paid off.  The production management software was worth hundreds of thousands of dollars in revenue for each mine they installed, which drove big leaps in sales.

The company exploded in late 2005 growing from $18M to $36M to $53M.  Profit exploded as well, coming in at close to $7M in the latest fiscal year.  The purchase offer is rich at 25 times trailing earnings, but no one is complaining in Vancouver.

I look forward to a conversation with Rick about the key strategic manoeuvres that made Gemcom a great success story for the shareholders and for BC.  Perhaps after the acquisition closes and the dust settles a bit.

Out in south Richmond, about the time I was seeing the original Gemcom product in late 1998, a company called Arkon was trucking along with a few dozen employees working as a contract design house for major phone manufacturer OEMs.  They saw an opportunity to extend their expertise in a wireless standard called DECT that was the future of all cordless phones in Europe.  They would begin developing wireless digital products (handsets, baby monitors, etc.) with new lower cost chips and utilize a cross-Pacific design/manufacturing partnership.  Ascalade was born from Arkon in 2002 and they built and shipped under global distributor labels, but not to the US or Canada.  As a result, very few people in the technology community were aware of it.

Sales exploded.  $12M in 2002.  $63M in 2003.  $84M in 2004.  $111M in 2005.  They branched into VoIP phones that worked through your wireless router to make Skype calls to PCs.  They developed a wireless conference phone that could be dropped in any meeting room.  They went public on the TSX in 2005 with $40M raise and a valuation of $100M.  Life was good.

Today, there is nothing but a massive receivership and sale of assets.  All of the employees were let go May 15th.  What happened?

In a word (actually 3), they went for it.  They used proceeds of the IPO to fund their own China plant as opposed to the leased facility that had used.  They had designs on the US and Asian markets after building success in Europe. They essentially broadened their product line by a factor of two to go after these new markets.  They were a low margin business because they sold to distributors.  For example, they shipped 3.1M units to their customers (the phone distributors and brands you know) in 2004 when their revenue was $84M.  That’s a broad average of $27 a unit.  Of that $27, they reported $22.70 in costs. That’s a 16% gross margin.  Without improvements in that number, the company would be un-sustainable.

Some say their growth outstripped their ability to fund it.  It takes a lot of capital to expand to meet forecasts and then you can be left holding the bag if sales turn. And in September of 2006, the wheels came off the revenue express. They announced that revenue would be below the previous year’s $111M and that they would lose money for the first time since 2001.  Their stock dropped by 60% immediately.  And that was the beginning of the end.

Turns out that they had a big OEM deal that had driven their decision to build the China plant.  They thought they would be growing sales dramatically based on this new customer.  Then something happened.  I have not been able to find the details, but the deal went away and, well, they never recovered.

It is too bad for the shareholders and the employees.  It is too bad for the sector here because a successful design in BC and build in Asia company could be a model for more cross-Pacific partnerships or companies.  They have little to be ashamed of.  They went for it!  They tried to be a huge global player!  Over time we may find out the details of what specifically went wrong and what decisions ended up being ill-advised.  But hindsight is 20-20.

So May is a bittersweet month for the tech industry here.  A great outcome and a terrible one.  But we should celebrate the efforts of both companies.   We should all get to the incredible growth that they both enjoyed.  And we should all have the guts to go for big wins.

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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