This is an interesting dichotomy. LinkedIn and Skype are $8B+ market cap software companies that have developed popular platforms (Social networking for “business professionals” and VoIP/conferencing) which depend on Internet access for customers. Yet, mature telecom and networking companies that provide the infrastructure (or “plumbing”) for the Internet have depressed stock prices. And more of them (Ericsson, NSN, Alcatel-Lucent) want to diversify away from network equipment to the telecom services business. In the past, cutting-edge telecom/Internet technology and innovation came from telecom/ networking start-up companies. But where are those telecom/networking start-ups now that we need them?
Unfortunately, telecom and networking start-ups almost don’t exist anymore. That’s because VCs don’t want to invest in them. According to the Money Tree Report, prepared by Price Waterhouse Coopers and the National Venture Capital Association (with data from Thomson Reuters), there were only 28 investments worth $142M in telecom start-ups in 1Q11, compared with 39 deals worth $254M one year earlier- 1Q10. For network and equipment companies, the numbers were 15 deals totalling $111M in 1Q11 vs 13 deals worth $238M in 1Q2010. That’s a steep drop in funding of over 50%!
Meanwhile, Internet-specific companies received more than one billion dollars in Q1 2011 with $1.2 billion going into 171 deals in the first quarter, a 19 percent decrease in dollars and an 18 percent decrease in deals from the fourth quarter of 2010 when $1.5 billion went into 208 deals. Internet-Specific is a discrete classification assigned to a company with a business model that is fundamentally dependent on the Internet, regardless of the company’s primary industry category.
The San Jose Mercury 1Q2011 Venture Capital Survey revealed that VCs are targeting their investment in more mature start-ups, rather than newbees. In the first quarter of this year, the average VC investment in fledgling companies was a mere $2.1 million. Meanwhile, the 56 nationwide seed deals was the lowest total for any quarter in six years. The number of investments in seed and early-stage companies dropped 14 percent from the prior quarter, investments in later-stage firms jumped 54 percent in dollars (to $2.1 billion) and 11 percent in terms of deals (to nearly 200). Software companies took in the biggest slice of funding for all industries, with $1.1 billion invested during the first quarter. The software industry also had the most deals with 187. Both numbers, however, were declines over the previous quarter. There were 736 VC deals and $5.9 billion raised in the 1st Quarter of 2011. Very few of those deals were with telecom or network equipment companies (see spreadsheet at: http://www.siliconvalley.com/ci_18058891?source=pkg).
VC reluctance to invest in early stage companies is a strong trend in motion. During the second quarter of 2010, the U.S. venture industry’s average seed investment was $6.8 million, according to the National Venture Capital Association. The following quarter, that number had fallen to $3.5 million.
Contrast, the difficulty telecom and networking start-ups have in raising money with the $8.5B Microsoft is paying for Skype and the blow out IPO of LinkedIn, which is worth over $8B. Neither of those companies will make any money in 2011!
From a recent Bloomberg Business Week article – Silver Lake Partners Wins $2.9 Billion Skype Payday
“Despite Skype’s heady usage stats—170 million subscribers, 600,000 new registrations a day, and 207 billion minutes of chat time last year—challenges still loom. Last year, Skype lost $7 million on revenue of $860 million and pushed back its planned public offering. Many skeptics still question whether Skype can turn its users, most of whom don’t pay for the service, into customers. Sounding like a luxury car salesman complimenting a buyer about his taste, Durban insists that Microsoft picked a winner. Plans have been put in place to flank Skype video chats with advertisements and to sell the service to businesses. “Microsoft probably got it at an inflection point before we showed the next big wave of growth,” he says.
The bottom line: Microsoft’s $8.5 billion purchase of Skype is a windfall for private equity firm Silver Lake. The Internet calling company is still unprofitable.”
LinkedIn was worth $4 billion as per the IPO pricing, but more than doubled on its opening day of trading to reach an $8B+ valuation. That event caused several skeptical analysts to compare the LinkedIn IPO to that of Netscape in 1995, at the start of the Internet/ dotcom bubble. Many observers are now asking: What has LinkedIn done to deserve its current price? Without any fundamental support from earnings or even any promising indicators of future growth, the company has done little besides feed off Silicon Valley’s latest buzzwords of “social networking.” Can we ascribe LinkedIn’s current market price to Facebook fall-out? Were those that bought LinkedIn stock after the IPO “smart money” investors?
Josh Bernoff, a social media analyst at Forrester Research wrote, “You can make some reasonable assumptions that the company will be successful and profitable in the future.” Perhaps, that’s because the number of LinkedIn members are growing and there aren’t visible competitors to lure them away. LinkedIn has over 90 million registered users, almost double as many as it had only two years ago. But many think that unless LinkedIn CEO Jeff Weiner can introduce a spectacular new innovation quickly, the stock will be selling below the IPO price very soon.
Columnist Stephen Zhu wrote, “Rather than being a game changer, LinkedIn only shows the promise of being a strong Internet media company with modest potential returns. Unfortunately, its IPO was overrun by hordes of public investors who wanted a piece of social networking and ignoring the value of LinkedIn itself. As more social media companies enter the market in the coming years, expect LinkedIn to revert to a more appropriate valuation. If LinkedIn as an investment interests you, check back later for a chance to catch it on sale.”
Summing up, we seem to have an “investment” mania for popular Internet software companies, yet a dearth of new money going into telecom and networking start-ups. Early stage start-ups have particular difficulty raising money.