Ovum: VC interest in networking startups may be returning

Venture capitalists' (VCs') interest in networking startups has waned since the financial crisis began. But the sector shows signs of becoming more attractive, according to a new report from market research and analysis firm Ovum. In the meantime, service providers have become the white knights of startups looking for alternative funding sources.

VC funding in the telecom infrastructure sector dropped from $796 million in 2009 to $270 million between 3Q11 and 2Q12, according to the report, “Networking Start-ups Overdue for VC Rebound.” Instead, the money was going to mobile, social, and OTT enterprises. However, Ovum believes the comparative funding dry spell may be ending.

For example, VC in general appears to be bouncing back from the shock of the global recession. Overall VC investments have grown from $20.1 billion in 2009 to $27.8 billion during the four quarters ended 2Q12. Most of these investments involved high-profile digital media services startups, from Facebook to Spotify.

“A funding disconnect has thereby emerged between network builders and network users,” Matt Walker, Ovum Principal Analyst and author of the report, assert. “Lots of innovation and venture capital is targeting the network users, such as mobile apps and OTT platforms. However, little of it is directly helping the network builders. With a weak startup pipeline, the industry relies more on incumbent vendors to generate new ideas and products. Their budgets are bigger, but VCs are often better at funding ‘game changing’ ideas ignored by established vendors.

“Incumbent vendors’ internal R&D budgets are now nearly 90 times larger than VC investments in the sector, up from 30 times two years ago,” Walker continues. “This narrows options for service providers, who rely on both large and small vendors for innovation. The big vendors also need access to the startup pipeline, to fill in gaps in their own portfolios through partnership and M&A.”

Walker points out that, based on data from the PWC/NVCA MoneyTree Report, the “Networking & Equipment” segment’s share of total VC investments shriveled to 1.0% in the past four quarters (3Q11–2Q12), versus about 10 percent in 2003.

Service providers have attempted to fill the gap by becoming more actively involved in funding and working with startups, according to the report. Telefonica, Vodafone, Verizon, AT&T, KDDI, China Mobile, and other service providers have funded startups, whose products they deploy in their networks or labs ahead of commercial availability.

Adds Walker, “Carriers really need help from suppliers, yet what they face is a vendor market in confusion. Most large vendors are now shrinking and reorganizing, even the Chinese suppliers. Several vendors are modifying business plans and selling assets in order to stay solvent. With the recent VC drought in networking, it’s not surprising that big telcos have become more directly involved in funding startups.”

Meanwhile, Walker says he sees hopeful signs of returning VC interest in the form of recent IPO and M&A deals. He points to the fact that VC-funded start-up Nicira Networks was recently acquired by VMware for $1.26 billion. “The tide seems to be shifting. With heightened investor interest and carrier need for solutions in such areas as small cells, network virtualization, and network optimization, telecom network infrastructure VC seems ripe for a rebound,” concludes Walker.