by Stephen Hardy
The financial environment in which optical communications companies operate offers a conundrum. On the one hand, market research indicates that more money is being spent on optical communications technology today than at any time since the height of the bubble in 2001. On the other, the balance sheets for companies active in the space don't reflect the kind of prosperity such customer spending would normally imply, particularly in the optical components and subsystems niche. Not surprisingly, the financial community doesn't like conundrums—so when companies go looking for venture funding, they'll find that while carrier capital expenditures have risen, venture capital (VC) expenditures have not. Two sources in the VC community suggest that although funding isn't impossible to find, it's not likely to get significantly easier to locate anytime soon.
"Optical communications is still a tough play in the venture community," concedes Don Bossi of Technology Venture Partners. His firm has invested in ROADM technology vendor Nistica (www.nistica.com) and optical channel monitoring company Aegis Lightwave (www.aegislightwave.com). The ongoing lack of a clear path to a lucrative exit continues to dampen VC enthusiasm, Bossi notes.
Daniel Docter of Intel Capital—which has current investments in such companies as APIC (www.apic.com), Bayspec (www.bayspec.com), Ceterus Networks (www.ceterus.com), Chiaro Networks (www.chiaro.com), Circadiant (www.circadiant.com), Cortina Systems (www.cortinasystems.com), CyOptics (www.cyoptics.com), LightSmyth Technologies (www.lightsmyth.com), and StrataLight Communications (www.stratalight.com)—agrees. "How many acquisitions greater than $100 million have there been, where the company had $25 million or $30 million capital into it?" he asks. The financial markets' current unfriendliness to initial public offerings (IPOs) creates a barrier to a satisfactory exit as well. As a result, "there are a lot fewer venture capitalists looking for investments in this area because there are better opportunities in other areas," Docter says.
If there's a positive aspect to this lack of enthusiasm for companies trying to get started, it's that competition for VC funding has diminished as well. Both Bossi and Docter say they're seeing fewer pitches from optical communications companies than they have in the past; emerging photonics companies are focusing on such areas of perceived investor interest as displays, photovoltaics, and solid-state lighting, Bossi reports.
Which is not to say that there aren't new companies looking to get started. Docter reports he's recently had conversations with companies looking to enter such areas as free-space optics, PON, and 40- and 100-Gbit/sec ICs, as well as a slightly more established but still pre-revenue company active in the interconnect space.
"The ones we see are more later-stage companies," Bossi says. "So there are still a fair number of pre-revenue companies that are maybe getting a little long in the tooth, that are still around, still have a value proposition, and hopeful that their markets will materialise in the next couple of years."
Despite such negative sentiment, recent funding announcements from companies such as Nistica and CoreOptics (www.coreoptics.com) indicate that funding can be had with the right set of circumstances. Those circumstances include "good companies with good value propositions and differentiating technology and a good business model and a path to profitability in a reasonable market size," says Bossi.
When it comes to "a reasonable market size," Bossi and Docter agree that the ROADM, PON, and 40G/100G spaces hold at least some appeal. While noting that "I don't think there's anything that's hot," Docter adds interconnect technology as an area of potential interest. Bossi believes that VCs in general view telecommunications, particularly at the higher end, as supporting more differentiation and better margins than datacom plays.
Meanwhile, industry events portend a potential easing of the path toward satisfactory exit strategies. Emcore's (www.emcore.com) acquisition of Intel's optical communications assets and Finisar's (www.finisar.com) merger with Optium create two companies with significantly larger assets and revenue streams—streams perhaps large enough to be able to support the kinds of major acquisitions that VCs would find appealing.
The IPO environment should improve as well. "There's some general opinion that in the second half of the year there may be an opportunity to go out," says Docter. "It depends really on how the second half looks and perhaps how the elections look and how everyone thinks about the next year. And then people are much more confident that next year looks like it will be open again."
The issue for companies looking at IPO is whether they can wait for the environment to improve. If not, they have to find alternative paths to keeping their businesses going—and they shouldn't expect VCs to change their minds about optical communications in the near term.
"I actually think the funding environment will improve over the next five years, but I don't have any expectations that funding in optical communications is going to get dramatically better in the next 12 months," says Bossi.
If VCs aren't interested in them and an IPO appears out of reach, then the only other alternative cash-starved companies can pursue is acquisition. This may bode well for inciting the industry consolidation that the financial community—not to mention the major industry players—has sought for some time.
An upturn in M&A activity therefore would be a logical outcome of the current funding environment. However, just as companies probably won't get all they seek out of the VC community, financiers shouldn't necessarily expect cooperation from optical technology vendors. "This industry isn't always completely logical, is the trick," Bossi says.
Stephen Hardy is the editorial director and associate publisher of Lightwave.