Communications Wrap: VCs Not Quite Out of Touch With Optical

Despite the recent public flogging of optical networking stocks, venture capitalists and analysts alike seem to think that the the sector hasn?t yet seen its last day in the sun.

At the very least, there appears to be widespread optimism that an ever-increasing global demand for bandwidth and connectivity will be enough to keep the valuations of most fledgling private optical communications companies from heading south down the road. Theoretically, the hope is that a vast majority will avoid the fate of many of their public peers ? some of which have seen their stock prices fall by as much as 90% below their annual highs in recent months.

Regardless of the sector?s lackluster public market performance, it?s clear that, for now, optical networking has not yet fallen out of favor in private equity circles. According to preliminary figures from our VentureXpert database, 35 such companies received venture disbursements from July 1, 2000 to Dec. 1, 2000, netting a total of $833.622 million. Interestingly, the deal flow remained relatively flat compared to the same period last year, when only 37 companies in the optical communications space received venture financing. However, total venture disbursements were much higher in 1999, weighing in at just over $1.229 billion.

The likely explanation for the disparity is that there is still some data outstanding on a few of this year?s recently completed deals, said Richard Gruber, an analyst with Venture Economics.

Optical Takes Off Offshore

The most significant change, however, seems to be in the amount of venture capital being directed offshore. In the past five months, seven companies have received financing from both domestic and international VC firms. A majority of those investments were concentrated in the United Kingdom and Israel, as those nations have exponentially stepped up their efforts to beef up their fiber optic technologies in order to accommodate soaring numbers of consumer and corporate Internet users.

The big winner was Native Networks, an optical communications play in Israel that provides products for optical access networks designed to improve the efficiency of data, video and voice transmissions. Backed by Anschutz Investment Co., Apax Partners Ventures (Israel) Ltd., Delta Capital, Jerusalem Venture Partners and Soros Fund Management LLC, the company closed its Series B round on Sept. 7, raking in $18.2 million.

Cognito Ltd. ranked a close second, pulling in just shy of $13 million from Baring Private Equity Partners and one other undisclosed venture firm. Based in the UK, the company develops integrated mobile software for corporate customers, making it easier for mobile workforces to communicate with each other.

On this side of the great pond, Silver Spring, Md.-based Global Metro Networks Inc. ? formerly known as Riveira Networks ? garnered the largest chunk of venture financing, reeling in an impressive $240 million. Ironically, the company, which is backed by Alta Communications, Columbia Capital Group and Providence Equity Partners, has an international bent: It provides fiber optic network services to telecommunications companies, Internet service providers and businesses in several major European cities.

The Death Knell Hasn?t Sounded Yet

Although he concedes that optical networking plays could be considered the last “overly-hyped fad” of the bull market, Market Analyst Dan McCarthy said he believes the IPO window hasn?t slammed completely shut on their privately held peers in that sector the way it has on most of the dotcom disasters and e-commerce calamities that preceded them.

“The business model for these companies is more viable than any of the Internet companies that came before, and if they can parlay that technology into something bigger, then perhaps they can compete with Cisco, or at least be acquired by it or another big player,” he said. “This isn?t I wouldn?t be embarrassed about buying into [an optical networking company], even if I lost all my money. It?s a risk, but at least it?s viable.”

McCarthy added that he feels the public markets could very well turn around sooner rather than later, though. “It may mean that many of these companies [and their VCs] will have to accept lower valuations, which could throw wrenches into their plans to gain marketshare and become profitable,” he said.

Then again, lower valuations could actually translate to a better reception from investors. “Once we see some sort of equilibrium has been established and the clouds over the economy are cleared up one way or the other, people are going to realize this is a growth area,” McCarthy added. “They may decided it?s worth it to take a chance on these companies as long as the valuations aren?t too high.”

David Lane, managing director with Diamondhead Venture Management LLC, agrees. His firm invests primarily in Internet infrastructure companies that, like their optical cousins, are still considered venture capital gold mines despite having followed a downward trajectory in the public sector.

“Markets go in cycles, and we?re in a down cycle right now,” he said. “The fundamental question is, ?Do I believe companies in the Internet infrastructure and communications spaces will create value over the long-term? The answer is yes. The ability to achieve a liquidity event is dictated by the markets and, at some point, they will come back and be receptive to high-growth, cash-generating companies.”

Robyn Kurdek can be contacted at Story Feedback.