Access network fuels optical investment

By Meghan Fuller

During the bubble years of 1995-2000, venture capitalists (VCs) embarked on a spending frenzy, investing big money in innovative technologies and often reaping huge rewards; more than 50 companies had exits of $500 million during this period. A markedly different investing environment has unfolded over the last five years, however. Today’s investors prefer sound business strategies to cool technologies. They have been looking outside the United States, focusing their attention further down the food chain, and targeting the access/premises rather than the metro/core.

Investors in the post-bubble market remain forward-thinking, but they are also pragmatic. Many require revenue and customers before they will even consider investing in a company.

Michael Goguen, a partner with Sequoia Capital (Menlo Park, CA), delivered a “Market Watch” presentation at the recent OFC/NFOEC conference entitled “Venture Perspective: Investing in Communications,” in which he listed the elements of a sustainable company. First and foremost, a company must communicate clarity of purpose, he said. Team DNA is also important, as is market potential. The company should have “incredible product focus,” be able to demonstrate real operating margins, and have the ability to “start an inferno with a single match,” as Goguen put it.

No one understands these criteria better than Carol Fuller, founder and CEO of Ceyx Technologies, a San Diego-based startup that plays in the optical-transceiver space. The company has developed a firmware approach to improve laser performance-and recently attracted $4.5 million in first-round venture funding. The funding process began in earnest for Ceyx back in December 2003.

“We really scrubbed our business model,” recalls Fuller. “We tested it different ways to look at how we would be affected by low, medium, and high targets in terms of meeting revenue and forecast changes. We looked at different models associated with how the revenue would flow based on where we are with different customers and projects and the lead times involved.”

Not only will investors thoroughly investigate the company’s business model, but they also will carefully examine the potential of the market opportunity. “We like to see some sense of a market actually happening,” confirms Julie Kunstler, managing director at Triport Advisors (Ra’anana, Israel). “For example, when we first invested in Teknovus, there were some people who said, ‘Yes, EPON is going to happen,’ and some people weren’t sure. But there was enough of a probability that it was likely to happen, and that’s part of what a venture capitalist does. You decide which risks you’re going to take, but certainly you want to see some potential market opportunity.”

The next big idea does not necessarily have to be a new one, adds Drew Lanza, general partner with Morgenthaler Ventures (Menlo Park, CA). In fact, the best idea may be a simple improvement on an existing idea. “People can see what the network of the future is going to look like, and therefore any startup company has to have a 2 or 3X better solution for an existing network,” he says. “You can say, ‘I understand FTTH, there are three or four core pieces that go into FTTH, and I’m going to make one of those pieces 2X or 3X better, either in terms of performance or cost or lifetime,” he says. “All those guys still coming out of labs and universities going, ‘Here’s how we’re going to do 100 Gbits/sec,’ I just don’t think there’s much interest in that.”

Today’s investors are more concerned with what a company can do for its customers now. As Sequoia Capital’s Goguen explains, VCs look for companies who “alleviate customer pain.”

“There’s a little phrase VCs like to use,” reports Ceyx’s Fuller. “They say, ‘Are you aspirin or are you vitamins?’ If you’re in pain, you want aspirin; vitamins just make you feel better when you already feel good. The idea is companies can only afford to take on challenges that relieve pain, and they’ll leave the vitamins for some other time when the economic conditions are a little better.”

According to Triport’s Kunstler, startups in the optical-component space face a tough challenge, thanks to tight margins and stiff competition. “Optical components are still having a hard time,” she acknowledges, “because it’s still not clear what this little component does better than that little component. But some of the subsystem stories are doing well. If you’re more than a component and actually have the subsystem that a Ciena or an Alcatel or a Siemens can use, you’ve got a story.”

“It’s worth pointing out that the component companies targeted at FTTH are doing pretty well,” adds Morgenthaler’s Lanza. “The pragmatic guys, the guys who are building parts that are actually being deployed in the network today, are doing pretty well, driving revenue, heading toward profitability. But I still think components overall are a tough area to get funded in. If you don’t have the revenue and you don’t have the prospects for revenue, it’s just really tough to get funded.”

Systems startups also face an uphill battle in their quest to secure funding. Only about 20 of the systems companies established in the late 1990s have survived the optical telecommunications bust, says Lanza, but they’ve each managed to raise at least $100 million, and they all have products on the market. As such, he says, “the prospects for these guys are fairly good. I think it’s difficult to start up a new systems company because those guys have lots of products that seem to be getting traction.”

There may be opportunities for optical startups outside the U.S., however, as the post-bubble investment landscape is more global in scope. “More recently, Silicon Valley startups have found it easier to get money even if they don’t have a North American story,” says Kunstler. “What more American investors have begun to accept is that not all the world goes into recession at the same time for the same reasons. While the U.S. telecom industry was really badly hurt, the Asian industry was not that badly hurt across the board.”

She cites IC startups Teknovus and Passave as two companies who raised significant venture funding and found market success outside North America. Of course, both play in the access, which is today the hottest area of the communications network.

For his part, Lanza is optimistic about the future of the optical telecom market. “A lot of the guys who have survived in optical telecom are doing very, very well right now,” he says. “The survivors, having crossed the desert, are finding the land of milk and honey.”

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