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August 2002
A Battered Telecom SectorChaos Or an Opportunity ???
Shastri DivakaruniGeneral Partner
Continuum [email protected]
August 8, 2002.
August 2002
Operations of a VC Fund
August 2002 3
Stages of a VC Fund
• Formation – Partners, Roles, Equity, Niche etc.
• Fund Raising – Road show, Validation and acquire LPs
• Investing
• Deal Flow, Screening, Selecting and establishing a value
• Term Sheet and Equity negotiations
• Agreements on Governance
• Building Value for the Portfolio Company
• Harvesting – Design & facilitate an exit
• Liquidate and Distribute to partners (LPs + GPs)
August 2002 4
Positioning for a Fund
Size/Stage
Expansion & Consolidation
Growth
Development
Early Stage, Seed, and Start-up
Investor Risk
Minor Minor Majority Total Control
NurtureInfluence/Facilitate
Guide Control Role
< 10% 10 – 25% 25 – 50% > 50% Ownership
• Special Situation Playerseg: Bowman
Dom
ina n
c eT
ech
ni c
al F
o cu
sM
ark
et F
ocu
sF
ina n
c e F
ocu
s
Market & Execution
Execution
Product, Market & Execution
Technology, Product, Market
& Execution
• Merchant Bankers• Madison Dearborn• Soros Group
Levered Buyout(KKR, etc.)
• Private Placements(Several)
• Large VC firms• Institutional VCs
Public Markets
ML, GS, CSFB, etc.
IPO Markets
• Angels
InvestmentFocus
August 2002 5
Investment Focus: An Example
System & Subsystems• Routing & Switching• Transmission Systems• Access Loop (Last Mile)• Media Gateways• SAN/NAS Systems
Infrastructure Software• Enabling Platforms• SAN (Virtualization)• Network Middleware• QOS• Multimedia Content Handling• Security
Next Gen Integrated Circuits• Security• Wireless- Multiprotocol Chips• SAN Protocol Chips• Special Purpose ASICS• Multimedia Integration• Power Saving Devices
Breakthrough Applications
• Enterprise Productivity• Integration of ApplicationsTechnology & Tools
• Process Technology• CAD/CAM Tools
35%
25%
10%10%20%
August 2002 6
Understanding the Value Chain
Chips Subsystems SystemsComponents
Infrastructures/w
OperationsManagement
EfficiencyEnhancers
Next GenerationService Operators
• Philosophy:• Leverage broad trends in industry
• Focus on attractive segments (target areas)
• Invest in multiple areas of value chain
Euphoria&
Bullish Markets
Gloom&
Bearish Markets Ride the Value Chain
August 2002 7
Multi-Stage Investing: Investor Expectations
Formation Seed Series A Series B Series C Series D
Seed & Series A• Feasibility
• Core Team
• Engineering
• Marketing
• Biz Dev
• Positioning Advantage
• Sustainable Competitive Advantage
• Customer Validation
• Create barriers to entry
Series D & Mezzanine• Market Acceptance
• Product and Sales Scaling (expansion)
• Multi-Functional Teams
• Organization
• Product Margins
• Production
• Financing
• Customer Satisfaction
• Financial Integrity
Series B & C• Product / Productization
• Customer Acceptance
• Operations Infrastructure
• Execution
• Engineering
• Sales
• Marketing and BD
• Financial Controls
• Product shipments
• Revenue Forecasting
Mezzanine Exit
August 2002 8
Forces Influencing Investment Decision
InvestmentDecision
TechnologyTrends
Market Pull &
Needs for Products
Status of Financial Markets
Portfolio Intrinsic Value
Competition
August 2002 9
Screening Criteria:A Template Approach
Prioritized Components Weight
100 max.
Team (Founders & Mgmt) 15 points
Market Timing - Exit View 15 points
Space - Idea (Mapped to fund Focus) 15 points
Financing Risk (Co-investors) 13 points
Intellectual Property and Patents 12 points
Investment Leverage & Intangibles 10 points
Valuation 10 points
Competition 10 points
A minimum of 70 points needed for consideration.Criteria varies per investment stage.
August 2002 10
Deal Flow
Appraisal
Due Diligence & Approval
PartnerContacts
Extended NetworkVC ReferralsTAB
Partners/Industry Experts/TAB
Rigorous Methodology
Investment Committee Approval $$$
Governance & Nurturing
Board Of Director and/or Operational Participation
$$$
Investment Process
Syndication & Funding
Spin Ins
August 2002 11
A Fund’s Advantage:Designing An Exit
•Knowledge Network in Action•Early Stage: High Leverage•Network of experts: SME•Proven Methodology
Investing
•Rigorous process forQualification•Syndicated Investments•Value oriented approach•Milestone based financing
Nurturing
•Operating expertise•Entrepreneurial history•Leverage extended networkin industry relationships•Continuous refinement
Harvesting
•Relationships with bankers•Relationships with strategic buyers•SBIC leverage enhances return
Continuous Improvement
Dealflow & Screening
August 2002
Selected Market Data & Dynamics
Source: CSFB
August 2002 13Source: Factset based on data from 4/9/90 and 10/31/2001.
Category
> $1 Bn
$100MM - 1Bn
< $100MM
33
118
134
$194
$38
$5
322
582
759
$2,807
$210
$23
# Companies# Companies Market Cap ($Bn)Market Cap ($Bn)
# Companies# Companies
19901990 20012001AllAll
Market Cap ($Bn)Market Cap ($Bn)
285 $237 $3,0401663
Dramatic Growth in New Companies and Market CapTechnology Companies and Market Cap by Size Now vs. 1990
16.5% CAGR 24.7% CAGR
August 2002 14
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
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Moore’s Law of Nasdaq Ran Out of Gas in Y2K
January 1983 - Present
Doubles in 8 years
Doubles in 4 years
Doubles in 2 years
Doubles in 1 year
August 2002 15
Performance of Top IPOs of 1999 and 2000
Top 50 IPOs of 1999 Top 50 IPOs of 2000
1805%
78%-6%
-92%-72%
1004%
-200%
0%
200%
400%
600%
800%
1000%
1200%
1400%
1600%
1800%
2000%
IPO Priceto
12/31/99
IPO Priceto High
High to5/23/00
5/23/00 to7/17/00
7/17/00 toCurrent
IPO Priceto Current
328%
103%
-32%
-66%-62%
84%
-100%
-50%
0%
50%
100%
150%
200%
250%
300%
350%
400%
IPO Priceto
12/29/00
IPO Priceto High
High to5/23/00
5/23/00 to7/17/00
7/17/00 toCurrent
IPO Priceto Current
August 2002 16
Continued Volatility Results Multiple Short Market Windows
# of Negative Pre-Announcements (1)
(1) 3 weeks into each quarter
1Q 2001 2Q 2001 3Q 2001 4Q 2001
61 110 118 161
1/2/01 4/4/01 6/19/01 9/23/01- - - -
1/24/01 5/22/01 7/2/01 10/16/01
# Days 22 48 13 23 27 23
Trough to Peak 24.8% 41.2% 7.8% 21.0% 23.7% 22.9%
1/24/01 5/22/01 7/2/01 10/16/01- - - -
4/4/01 6/19/01 9/23/01 10/23/01
# Days 70 28 83 7 47 49
Peak to Trough -42.7% -13.9% -33.8% -1.0% -22.8% -23.8%
PEAKS Average Median
TROUGHS Average Median
August 2002 17
$153.0 $123.2
$318.9
$691.0
$33.8$10.0 $16.6
$111.1$97.3
$0.0
$100.0
$200.0
$300.0
$400.0
$500.0
$600.0
$700.0
$800.0
1993 1994 1995 1996 1997 1998 1999 2000 2001
M&A MarketTechnology Mergers & Acquisitions, 1993-2001
$ Billions$ Billions
YTD
Source: Securities Data Company as of 10/31/2001.Incl. Domestic and Int’l transactions, pending or completed,
with transaction value >$50MM, excl. share repurchases.
95 95 228228 833833
289289
120 120 164 164 48748765 65 3535# of
Deals
August 2002 18
THEN: MAY 1999 NOW: June 2002
Accretion/DilutionAccretion/Dilution
Acquirors willing to accept significant earnings dilution for promise of significant growth opportunity
Acquirors typically accept zero to small amount of earnings dilution in exchange for growth prospects
Little tolerance for cash burn
ValuationValuation
Many bidders drove up valuation Public market offered liquidity
events for startups, driving up valuation
Few acquirors in this market Public market more stringent;
therefore, fewer startups obtaining liquidity
Time to revenueTime to revenue
Revenue could be more than one year away
Revenue and Clear path to profitability
Must be at least in customer acceptance and scaling mode
Customer baseCustomer base
Potential for customers Small base, many in trial stage Highly concentrated revenue
Quality, well-financed and diversified customer base with recurring revenue stream
Perceptions Towards Strategic Transactions Have Changed in This Difficult Market Environment…
August 2002 19
Consolidation activity has slowed significantly from the torrid pace of early 2000
Operating issues have forced many traditional acquirers to focus internally
Market volatility has created uncertainty as to “true values” and hesitancy to make commitments
Current Status
Public MarketScrutiny
Public equity markets have become less forgiving of ill conceived or poorly executed transactions
Heightened scrutiny of both long term strategic and near term financial implications of any transaction
Integration plans must be well thought out and expertly communicated to the market at time of announcement
Earnings dilution is a major concern
Valuation
Uncertainty over proper valuation levels remains
Many sellers focused on last year’s valuations
Valuation analysis has returned to traditional earnings and cash flow based methodologies
Consolidators no longer playing with “funny-money”
Resulting in a Challenging Near Term Environment
August 2002 20
(90% ) (90% )
(68% )(74% )
(100%)
(75%)
(50%)
(25%)
0%
PERCENTAGE CHANGE IN STOCK PRICE SINCE MARCH 1, 2000
Comm. Equipment eBusiness Internet Infrastructure
Semiconductors Optical Internet
Nortel Lucent Alcatel Cisco
(94% ) (98% ) (98% )
(72% )
(100%)
(75%)
(50%)
(25%)
0%i2 Ariba C1 Siebel
(96% ) (99% )
(80% )
(99% )(100%)
(75%)
(50%)
(25%)
0%Inktomi Akamai VeriSign InfoSpace
(56% )
(83% )(91% ) (88% )(100%)
(75%)
(50%)
(25%)
0%Intel BroadcomPMC-SierraConexant
(94% ) (98% ) (94% )(85% )
(100%)
(75%)
(50%)
(25%)
0%
JDSUniphase Sycamore Corvis
New Focus
(88% ) (93% )
(44% )
(23% )
(100%)
(75%)
(50%)
(25%)
0%Amazon Yahoo! AOL eBay
Note: Corvis and New Focus data is from IPO Pricing of $36.00 and $20.00, respectively.
Let’s not forget the companies that have gone bankrupt:
Many Potential Buyers Have Seen Their Share Prices Plummet
August 2002 21
With stock prices at record lows, the notion that cash is king is being reinforced
In particular, large cap companies with depressed P/Es are using cash as their preferred acquisition currency
Sellers prefer liquidity in these uncertain times
Interest rates are at unprecedented lows
Many companies are taking advantage of the convertible market’s tremendous appetite for technology issues to build “war chests”
Premium PaidAnnc. FD Equity NTM 1-Day 30-Days
Date Target / Acquiror Value ($MM) P/E Prior Prior Acquisition Currency
2/22/01 1,492 NM 89.9% 121.2% Cash
6/11/01 1,208 54.9 91.5% 101.9% Stock/Cash
4/24/01 1,000 - NA NA Cash
3/30/01 400 - NA NA Cash
10/2/01 200 - NA NA Cash
SELECTED ACQUIRORS USING CASH AS ACQUISITION CURRENCY
As a Result, Companies Have Begun to Use Cash To Fund Their Acquisitions
August 2002 22
Source: Venture Economics Information Services
VC Returns Under PressureCumulative Vintage Year Performance of U.S. Venture Capital
Funds
Pooled IRR average %
August 2002 23
There have been 5 recessions in the U.S. since 1969
The average recession lasted for 12 months and resulted in a 2% contraction in GDP
During recessionary times, the S&P 500 has not demonstrated significant drops, except in ‘73 - ’75 (-23%)
Markets begin to recover one quarter before the trough and gain an average of 23% in the following 6 months
Expected Timing of Recovery by Sector
Overviews of Previous Recessions
Peak-to-Trough3M Pre - 3M Post
Trough
RecessionLength of
RecessionDecline in
GDPPerformance Of
S&P500Performance Of
S&P500
Dec-69 - Nov-70 12 Months -0.6% -7.0% 18.7%
Nov-73 - Mar-75 16 Months -3.0% -23.0% 38.8%
Jan-80 - Jul-80 7 Months -2.2% 12.7% 19.9%
Jul-81 - Nov-82 17 Months -2.9% 5.6% 23.9%
Jul-90 - Mar-91 9 Months -1.5% 4.8% 12.4%
Average 12 Months -2.0% -1.4% 22.7%
Q4'01 Q1'02 Q2'02 Q3'02 Q4'02 Q1'03
Comm. Equipment
Semiconductors
IT Services
Internet Infrastructure & Services
PC & Hardware
Electronics & Contract Manufacturing
Software
Recessions Are Followed by Market Rallies
August 2002 24
2000 2002
Revenue in Sight $10M +
Time to Profitability 6 - 8 Quarters Profitable Now
Valuation Metrics Revenue Multiples P/E Multiples*
Revenue Base (in quarter going public)
The Bar is Set Higher for IPOs
* Depends on Industry segment and Supply
August 2002 25
Return to “irrational exuberance” any time soon Indefinite losses will be bankable Me-too, undifferentiated companies will be bankable Valuations on private financings will hold up
Don’t Count On:
Focus on business model, sponsorship, uniqueness, barriers Develop alternative financing plans, merger partners Shift business models to accelerate profitability and cash flow Finance ahead of needs when windows present themselves
Plan To:
Implications
August 2002 26
Summary
• We get back to the Basics of Venture investing
• Amid the chaos, it is an opportunity for those who understand the technology and the industry
• Our expectations should be realistic. Implied correlation between public and private market valuations
• We may have been set back to 80’s type of investing – with proper risk/reward structure
• Equity markets are still good – Private equities have higher reward for those who can tolerate higher risk
• This cycle will continue. Stay tuned……