Investors warm up to content delivery startups

As consumption of video and other bandwidth-intensive digital content surges, venture capitalists are increasingly seeking out developers of technologies that make distribution more efficient.

Companies offering so-called content delivery networks (CDNs) have attracted an impressive influx of capital from public market and private investors over the past year, and VCs say there is still room for more investment.

“The biggest opportunity today is to produce a next-generation CDN,” Chamath Palihapitiya, a principal at Mayfield Fund, said during a panel discussion on the future of digital media last week in Palo Alto, Calif. “But the amount of companies I see doing that as opposed to launching YouTube Version 6 … is unfortunate.”

One of the two CDN startups to raise money this year is Limelight Networks, which runs a profitable network for delivering live and on-demand digital media online for customers, such as YouTube. The Tempe, Ariz.-based company raised the year’s third largest round of capital in July, pulling in $130 million. Goldman Sachs & Co. put up the bulk of the investment ($110 million), while Oak Investment Partners chipped in $20 million, according to Thomson Financial (publisher of PE Week).

The mere fact that Goldman did the deal speaks to how hot the market is. In the month prior to the investment, LimeLight was sued for patent infringement by Akamai Technologies. One Silicon Valley VC told PE Week he passed on the deal because of the litigation. But the upside is that the company expects continued growth, particularly in the Asia-Pacific region. Last week, Limelight announced the opening of its new Asian headquarters in Singapore. Matthew Sturgess, who heads the new Limelight office, said in a press release that there is an enormous demand in Asia for “a high-performance, scalable solution to deliver video, music, games, software downloads and social media content over the Internet.”

Another CDN company poised for growth is CacheLogic. Not long after the LimeLight funding deal closed, CacheLogic pulled in a Series C round of $20 million led by Amadeus Capital Partners. (Previous investors 3i Group, Pentech Ventures and The Cambridge Gateway Fund also participated.)The Cambridge, England-based company provides peer-to-peer technology that allows Internet service providers to manage content on their networks.

Investor interest in CDN stems in part from a sense that Akamai, the industry’s leading player, is due for some intensified competition, says Perry Wu, CEO of BitGravity, a content delivery startup based in Burlingame, Calif. Wu, a former partner at ComVentures, launched BitGravity this year to support Web 2.0 applications. He has received inquiries from venture capital firms over the past few months, but he says he is not yet seeking outside investment for his self-funded startup.

Another draw for VCs: Public market appetites for CDN companies remain ravenous. Shares of Akamai (Nasdaq: AKAM) have more than doubled to about $50 in the past year, and its market cap is approaching $8 billion. Over the same period, shares of Savvis Inc. (Nasdaq: SVVS) have tripled in value, even though the Missouri-based CDN company is in the red.

Exit by acquisition is also an option for CDN startups, with Akamai’s stock price putting it in prime position to scoop up promising newcomers. In November, the company paid $160 million in cash and stock for Nine Systems, a San Diego-based developer of tools for managing streaming and downloadable media. The sale is a windfall for Catalyst Investors, which was Nine Systems’ only private equity investor. New York-based Catalyst invested $1.5 million in Nine Systems back in 2000, according to Thomson Financial.