THE
SEGWAY SEARCHES FOR A MARKET AND OTHER TRENDS FOR
THE 2003-2004 VENTURE CAPITAL WORLD
Introductory
Class for Rotman Venture Capital Strategies MBA course
Jim de
Wilde
jim_dewilde@yahoo.ca
September
10, 2003
Jim
de Wilde is a Canadian venture capitalist.
Since 1993, he has divided his time between Montreal
and Toronto, focusing on the commercialization of
early-stage technologies through JdW Strategic Ventures.
He has advised financial institutions on their strategies
for developing early-stage technologies and has been
involved in a number of universities in developing
commercialization strategies. He is currently on
the Advisory Board of the RBC Capital Markets Technology
Fund (Toronto) and the MSBI (McGill Bishop's Sherbrooke
Fund).
Dr.
de Wilde has also taught at a number of Canadian business
schools, including the Rotman School at the University
of Toronto where he currently lectures on venture
capital strategies and technology commercialization.
He has lectured in Finland, Mexico and Argentina on
venture capital strategies. He was on faculty at McGill
from 1991-1993 and the University of Western Ontario
School of Business Administration from 1984 to 1991.
Dr.
de Wilde has a PhD in political science from McGill
with a dissertation on the capacity of Canadian political
institutions to promote technological competitiveness.
He has spoken and written extensively on federalism
and Canadian capital markets and the preconditions
for Canadian global competitiveness.
There
are significant transformations going on in the global
capital markets right now that affect the evolution
of venture capital strategies both in terms of portfolio
design (space and concept selection), financial engineering
(restructuring models involving both consolidation
and M&A), and the development of a variety of
new private equity instruments under the broad category
of "hedge funds". These developments reflect a disillusion
with public capital markets, whose credibility was
reduced by the day-trading epidemic of the late 1990s
early 2000s, and the hype-and-boom excesses of valuation
models in the 1990s. They also reflect the strategic
realignment of technology-driven companies toward
the search for new markets given a different pattern
of global consumption.
In
financial markets, the return to private equity makes
possible a return to patient capital, seeking long
term durability as a criterion for company creation.
This is all, in my view, extremely healthy, and promises
the return to a sounder economy which can manage globalization
with greater benefits to all stakeholders. However,
it does create some short term challenges for venture
capitalists and private equity fund managers, who
need to:
(i) reassure institutional investors that they are
on top of the next wave of commercialized innovation which
leads to a major source of growth in knowledge-based
economies;
(ii) ensure that they have portfolio strategies to
manage the number of new companies already created
in areas like biotechnology and information technologies;
and
(iii) develop exits strategies other than reliance
on the IPO which requires working .with technology-oriented
corporations and government actors to ensure that
there is a network for implementing innovation.
Similarly, the search
for strategies that are aligned with emerging patterns
of global consumption for knowledge-based products
requires a different approach than strategies for
commercializing emerging technologies. Again, this
is not bad news, as it reflects the movement away
from strategies that targeted saturated and unstable
product markets and makes possible significant opportunities
for returns. It also means that the art of venture
capital and the art of value-creation through investment
banking increasingly converge as skill-sets.
One of the best places
to start looking at trends and strategies in global
venture capital/private equities is to look at the
recent IPO market.
In the second quarter
of 2003 (reported from Financial Times data), only
two venture-backed firms received NASDAQ IPOs (iPayment
www.ipaymentinc.com
and Form Factor www.formfactor.com
). These were not high concept deals, but well-managed
incremental improvements in semiconductor chip manufacturing
and credit card processing.
It
is worth noting that five of the top six performing
IPOs are from Asia, four (NHN, KHVatec, Webzen and
LG petrochemical) from South Korea.
See
www.kocca.or.kr/ctnews/eng/SITE/data/html_dir/2002/10/24/200210240125.html,
www.khvatec.com
, www.lg.co.kr
. This raises a number of questions concerning globalization
and capital market trends, but for our purposes, this
means that the international capital markets are looking
for new agents of consumer demand and new instruments
for accelerating rapid growth.
A
useful case study on private equities strategy for
Asian markets is Longreach Global Capital. Longreach
Global Capital.
http://news.ft.com/s01/servlet/ContentServer?pagename=Synd/StoryFT/FTFull&artid=1059479467190.
Longreach is the beginning of a new global trend,
the use of private equities as an instrument for cross-border
restructurings and its deal profile and success is
well worth monitoring as an innovative growth strategy
with implications for. Future case studies of designing
financial instruments to access rapid-growth markets
( e.g. like the portfolio strategies for Chinese private
equities: www.chengwei.com
and www.newmargin.com.)
STRATEGIC VENTURE CAPITAL
AND THE RECOVERING GLOBAL ECONOMY
Three
recent financial market stories (from the Wall Street
Journal and Financial Times) reflect some trends beneath
the surface of public capital market activity.
NORSK HYDRO TO LIST
AGRI ON OSLO EXCHANGE
DOT-COM HOPE AKAMAI,
OTHERS DISCOVER NEW LIFE
INVESTORS LOOK FOR
KODAK'S DIGITAL FOCUS
Each of these reflects
an emerging trend:
-
Norsk
Hydro demonstrates the attempt to unlock new sources
if value in emerging technology sectors www.kynoch.co.za/en/press_room/news/archive/2003_07/kaltenbach_en.html
-
Akamai
shows that it is may be possible to revitalize
innovative companies from the 1990s with restructuring
strategies based on realistic valuation models
and the opportunities for investors that comes
from investment banking strategies being applied
to restructuring opportunities in spaces like
streaming media (www.akamai.com
) ;
-
Kodak is an example
of the attempt to find reincarnation of value
in strong corporate technology brands whose key
markets are saturated, shifting focus from consumer
applications to the digitalization of health .
www.expresshealthcaremgmt.com/20030831/news03.shtml
It
is useful to start with some case studies to see what
is going on "out there". Here are four developed at
length and some suggestions as to other interesting
developments in venture capital and private equity
strategies that should be known about and discussed
further :
CASE STUDIES OF CURRENT
VENTURE CAPITAL/PRIVATE EQUITY MARKETS
The
private equity/venture capital market reflects the
search for new sources of value in the economy. Four
case studies give some insight into where some actors
in the market are casting their glance.
Case study #
1 The Segway Seeks a Market
Segway is an interesting
venture capital case study. Initially, I confess to
a Rule Number One in venture capital reaction to it.
Let's call Rule Number One the anti-Hype rule. If
something is hyped, instantly short it But Segway
raises interesting questions about what is bankable
and is an attempt to focus investor decision-making
in new spaces. An excellent recent piece by Matt Richtel
in the NYT points out three things about the Segway
case which venture capital strategists should reflect
on:
-
John
Doerr is one of the world's most successful venture
capitalists. His investment style is a best practices
of strategic venture capital. (*) Doerr described
the Segway as "as big as the Internet as far as
making a difference";
-
The
LA Metro Transportation authority likens the first-generation
Segway to the first PC "a nice toy and it can
solve some problems";
-
The
Segway is in the words of Herman Leonard, of the
Kennedy School of Government, like a Jeopardy
question, to which Segway is the answer.
Clearly,
transportation logistics is a great space in which
to anticipate expanded market opportunities a great
space. But where is the competition to Segway? (Incidentally,
one of the most frequently interview-ending answers
in venture capital presentations is "we have no competition",
which shows either the product is useless or the management
team is not on the ball. In either case, a great deal
of time and money can be saved by asking that question
first). So, who is Segway's competition? Vespa? Harley-Davidson?
Bicycle manufacturers? Public transportation? Bombardier?
Golf-cart manufacturers? How can the marketing strategy
redefine the sector (personal transportation and transportation
logistics) to the advantage of the product?
(*) He
saw a market need for cable-delivered internet, spent
two weeks interviewing fifty-plus people for the CEO
and leadership roles . Then, he financially engineered
the company which was to become @Home, bringing in
major cable companies as partners. This Kleiner Perkins
deal is often cited as a best practices of strategic
venture capital.
Case
study #2 Carbon sequestration or storage
Canadian competence
in energy investing is globally recognized. The portfolios
of Arc Financial ( www.arcfinancial.com),
Hydro Quebec Capitech ( www.hqcapitcech.com),
Ventures West ( www.ventureswest.com),
RBCCapital Markets ( www.rbccm.com),
OPG Ventures ( www.opgventures.com)
represent a concentration of expertise that has potentially
global significance if these strategies in the post-Kyoto
world can lead to a concentration of globally-investing
energy strategies. The energy technologies sector
remains one that is defining its pattern. There are
a number of critical case studies which reflect different
doors through which the energy technology market can
be entered. In this context, carbon sequestration
makes an interesting case study ( www.iea.org/impagr/zets/dc/1_kar.pdf
). In a portfolio of alternative energy driven technologies,
how highly does one place a value on technologies
which try to ameliorate the environmental effects
of fossil-fuels as opposed to those technologies which
seek to replace fossil-fuels. The short term answer
is that there is an immediate market for remediation
technologies that offset the problems of carbon dioxide
pollution.
Case study #3 Battery Ventures and the Tennis
Channel
Specialized
investments make the new media issues (e.g. www.thetennischannel.com)
another interesting case study. After a number of
interesting new media business concepts (e.g. www.pseudo.com)
a more specialized market in cybercasting and networked
communities is emerging from the debris of the digital
community inspired dotcoms. The Tennis Channel makes
an interesting case study, backed by branded names
in a highly individual sport, with serious venture
capital money and a business model which leads logically
to some tie-ins. Battery Ventures (www.battery.com
) is considered a top-of-the-line venture capital
firm, whose strategies are worth watching both in
terms of "best practices" and the effect of their
portfolio strategy on market appetites and judgments.
The experience of new media investments to date is
that realistic valuations are as always a critical
precondition of success and that the business models
which organize digital communities can be highly successful
if this core precondition is met.
Case study #4
The Coming Biotech IPO trend (maybe)
Early
stage health sciences venture capital is now starting
up again. While there are some interesting new investment
categories around specific scientific trends (e.g.
patient cooling and cooling technologies is an example
of a small trend as it results in less invasive surgery
( www.croycath.com)
and emergency treatment procedures (e.g. www.biotimeinc.com
), a significant amount of medical venture capital
is tied up with creating successful business from
biotechnology research. A number of biotechnology
IPOs are planned in the next few months, including
Canadian plays like www.neurochem.com
. Other scheduled are Eyetech www.eyetk.com
, Myogen www.myogen.com,
Acusphere www.acusphere.com,
Genitope www.genitope.com,
Advancis www.advancis.com,
Cancervax www.cancervax..com,
Nitromed www.nitromed.com
, Pharmion www.pharmion.com,
Acorda www.acorda.com,
Cordentech www.cordentech.com
. The question of market appetite for these offerings
will reveal a great deal about the dynamics of the
IPO process and its implications for the next stage
of venture capital activity.
STRATEGIES AND
TRENDS IN THE 2003-4 WORLD OF VENTURE CAPITAL AND
PRIVATE EQUITIES
Investment
criteria obviously respond to the anticipation of
market trends. While "lists" risk misleading analysis
by excluding well-managed opportunities that exist
outside of the focus (like Priveq's investment in
www.globalrailway.com,
in the rail maintenance space), here are six categories
of investment that can start to focus a discussion
of venture capital strategies, and the reasons they
make this list:
i.
Security and encryption: In this category,
there are clearly some conventional categories of
investment: the search for personal and network security
and encryption. An interesting case study of a portfolio
strategy built on specifically galvanizing energies
in this space is www.in-Q-tel.com
.
ii.
Biotechnology restructuring. There are other
visible and documented trends about biotechnology
financings based on restructuring companies and launching
new IPOs. The belief that there is a value proposition
here lies behind some current Euro-deals, including
the new round of capitalization of Schroders Life
Sciences (www.svlifesciences.com)
and the second fund for Abingworth (www.abingworth.com).
This opportunity is discrete from the IPOs discussed
above and involves the creation of new corporate entities
to commercialize research effectively.
iii.
Relaunching second chance stocks and second-stage
stocks. Business School strategists have not spent
enough time looking at companies that are being reborn,
either "second chance" stocks, rising like a phoenix,
or simply second-stage stocks, looking to build a
sustainable suite of businesses after the successful
commercialization of a single product or concept.
The familiar technology stock-charts with their dips
and peaks demonstrate exactly how frequent a phenomenon
this is. While this is often misleadingly and annoyingly
referred to as "vulture capitalism", the phenomenon
of rebuilding companies like Akamia discussed above,
reflects a significant new trend in the creation of
knowledge-based value, again where technology analysis,
venture capital and investment banking skills are
required.
iv.
Refinancing of public private partnerships.
Combined with the need for different financial instruments
to deliver public services, the refinancing of public-private
partnerships has produced a range of investment opportunities:
smart traffic, educational financing, healthcare insurance
and consumer choice, markets in statistics and data
about sociological trends all contain within them
powerful potential for business models around which
significant companies can and are beings designed.
Educational futures options, ESRI ( www.esri.com)
activities in using global positioning satellites
to turn geographical spatial awareness into a traffic
management product are the kinds of examples of where
public policy will create the possibility of the creation
of commercial value.
v.
The commercialization of new sources of science
and the "next big things". Fields like agricultural
chemistry and energy storage technologies potentially
have incredible significance. See again www.estglobal.com
in this context. The important point for venture capital
analysis is that these are "new" market opportunities
and require that investors look off the current radar-screen
to find the "next big thing" to use the Silicon Valley
language of the 1990s.
vi. New disruptions based on market needs - the
concept of strategic venture capital, i.e. creating
companies around emerging value propositions.
When I first taught an MBA course on venture capital
strategies in 1991, we emphasized the difference between
market-driven technologies (at-home diagnostics was
the hot topic that year and would have been a disruptive
technology in terms of the economics of health-care)
and technology-push (several areas of mobile telephony
with excessive applications). Now, in 2003, the market
continues to seek disruptions. For example, a medical
software company that tells consumers what they need
to know about the statistical odds of certain treatments
for comparable medical conditions has the potential
to reorganize markets in medical information by consumers/citizens
and creating incentives for more efficient delivery
of health-care. If designed by a venture capital firm
(in the manner that John Doerr at Kleiner Perkins
designed @Home to service the need for cable-delivered
internet services discussed above), these approaches
to "strategic venture capital" could yield some of
the most significant returns in the industry.
FIVE
TRENDS TO WATCH IN THE 2003-2004 YEAR
Here are five trends
to watch in the next year which we can bring back
in September 2004 for a reality check .
-
Private
equity firms will have a significant opportunity
as restructuring leads to buy-outs. In
the past six months, one of the most interesting
deals in the Canadian capital market was the Bain
Capital, CDP buy-out of Bombardier's recreational
vehicles unit. It is cited here as a case study
of some new trends in capital market . This makes
new innovators in capital market design companies
with specialized investing strategies and management
depth like www.borealis.com
and www.edgestone.com
. On a global scale, the deal strategy discussed
above of Longreach Capital is another example
of private equity-led investing with longterm
strategic thinking.
-
The
area of corporate venturing will lead to the development
of real economic opportunities. This is
partially because corporate venturing contains
within it the potential of an obvious exit strategy.
In the case of Cloakware, the role of Intel Ventures
is significant. The structure of the Intel Ventures
portfolio (www.intel.com/capital)
and Nokia Ventures Partners (www.nokiaventurepartners.com)
provides excellent insight into using venture
capital activity both as a window on technological
trends and as a revenue-generating activity within
the company. It is possible that corporate venturing
activities will prove to be adept at the generation
of "strategic venture capital" deals, creating
value from component activities where market opportunities
can be discerned.
-
The
privatization of government activities now leads
to the development of innovative financial models,
sometimes called public-private partnerships.
The development of "smart roads" is an infrastructure
megaproject which contains within it certain real
capabilities for the creation of value, e.g. the
design of wireless billing capabilities. The broader
issues of public policy (e.g. financing educational
costs for the next generation of citizens) also
provides the opportunity of creating a market-based
strategy for financing investment in knowledge.
Similarly, new areas of commercial activity ranging
from food toxicology (governments now almost exclusively
do food testing) to transportation logistics (smart
roads) are coming onstream.
-
The
next generation of technologies to be commercialized
takes place in quite different areas.
Specialized venture capital firms like Foragen
(www.foragen.com)
and Primaxis (www.primaxis.com)
are a new wave where expertise is concentrated
in future market activities. The development of
a specialized cybercasting venture firm or a specialized
transportation logistics venture firm are examples
of opportunities which exist for combines specialized
expertise in technological categories with core
company-building, value-creating venture capital
capabilities. This approach will increasingly
be seen by institutional investors as a technique
for accessing the new sources of technology to
be commercialized, often in partnership with corporations
in the sector.
-
The
market is now global for company creation and
value creation. In other contexts, I have
argued about the importance of creation of demand
in places like Africa leads to some possibly highly
valuable growth-creation models. An interesting
case study is www.blueorchard.ch
. There is a more real opportunity in the development
of venture capital firms to back entrepreneurs
in new rapid-growth markets. For that reason,
case studies like www.chengwei.com
are prototypes of investment activities in other
emerging capital markets with a concentration
of intellectual capital as exists in China and,
possibly in the next year, Iran, Morocco, Thailand,
Malaysia.
There
are many reasons for caution in the current global
investment and capital market context. However, venture
capital is about creating new sources of value from
knowledge and organizational capacities. The line
between creating value (commercializing research in
digital geological surveying or temperature control
management) and unlocking value (traditional investment
banking activities focused on restructuring public
sector activities or merging corporate structures
that are inappropriately engineered) becomes increasingly
blurred in a period of realignment.
The opportunities
that exist in the Canadian marketplace are substantial
and concrete, but do require new instruments, psychologies
and portfolio strategies to apply the best practices
venture capital thinking to current contexts. That
is what we shall be talking about in the next few
weeks. For these reasons, I have focused on portfolios
which look at value creation from commercializing
engineering knowledge about transportation technologies
(among other Canadian competences) or understanding
of the developments in energy markets as they affect
value-creation. It is also essential that the best
practices venture capital focuses on less obvious
areas of science, like transportation logistics, portable
refrigeration technologies as profitable niches for
investment activity can be uncovered in a global market
that is now restructuring its approach to globalization.
The opportunities are there, they are just not in
plain view. But if they were, it wouldn't be venture
capital.
Companies and technologies are cited here as case
studies for discussion purposes only.
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