Category: Investing/Markets

Ashlee Vance from the Bits Blog has a nice piece on why Cisco raised another $4b of cash through a debt offering yesterday even though they have $30b in cash. 

"As word of Cisco’s debt sale hit Wall Street, the standard chatter surrounding possible targets began anew. As usual, companies like EMC, NetApp, Sun Microsystems, Red Hat and BMC were discussed as desirable properties."

Regarding Cisco I have heard the same acquisition rumors.  On the smaller private company side, my two cents would be platform consolidation opportunities in the security space (software that can help tie their disparate security products together), bolstering their Scientific Atlanta acquisition by adding more interactive and ad targeting products for the digital set top box, and tuck-in acquisitions for their EOS or social networking initiative (see CNET article for more on this initiative)

I would love to hear your thoughts on this as well.

As we all know, Google got whacked because it missed Wall Street’s projections.  Sure, investor expectations are quite high for Google especially when they are paying 90x earnings.  However, the reality is that the company is still performing quite well.  From my perspective, when investors pay such high multiples for these companies, the inevitable correction in market price will happen.  That being said, let’s focus on the numbers that really matter, revenue and profits. Google still did deliver $372mm in earnings on $1.92b of revenue up from $204mm in earnings the year before. 

Sometimes we all focus on the short-term at the expense of looking at the long term.  Sure Google is overvalued now but the company is delivering some impressive results.  Remember the First Law of Technology:

"A consistent pattern in our response is to new technologies is we simultaneously overestimate the short-term impact and underestimate the long-term impact."

Well, we did that starting in 1995 when Netscape went public and are doing it again today. And remember Scott McNealy touting "the network is the computer" years ago. Somewhere lost in the translation was this comment from Eric Schmidt when asked about Google’s entry into consumer electronics (thanks to David Jackson who runs the Internet Stock Blog and has been posting transcripts of investor calls):

There’s an awful lot of speculation about Google playing in those markets. The Google PC, those kinds of things. To me, most of those are people projecting the last one, not the next opportunity on us. And from my perspective, those are not very interesting business opportunities; they’re well covered in the market, we partner with many of the players and we would much prefer to deepen our partnership with them than to go into competition with them.

We are relentlessly focused on this new end-user experience, which is multi-platform and based on the internet and that’s where our future is. That’s where the growth is, that’s where the revenue and monetization is. And, as I mentioned earlier, it’s so large, it makes no sense to divert our resources to these other and somewhat smaller opportunities.

Sound familiar?  The network is the computer, the web is a platform, the browser is the OS, services will live in the cloud, and we will access information from anywhere, anytime, and any place.  Once again, sometimes we overestimate the short-term impact of new technologies and underestimate the long-term impact.  This is why I am so excited to be investing now because if you believe services will live in the cloud and anything that can be digitized will be digitized (media, voice, etc.)then I am sure you will agree with me that we are just in the second inning.  And this is not just a consumer-driven change, this will affect enterprises as well.  So Google missing its incredibly high expectations is not all that bad because when looking at the bigger picture, Google is still delivering some spectacular results and causing the old guard to get with it and respond to the changing times.

BTW, it doesn’t mean I would buy the stock at these valuation numbers and nor do I own it now but the point is that there is still plenty of significant opportunities for startups to create value in the years ahead, especially since Google will not and cannot do everything.

I had lunch with a friend of mine yesterday who is an officer with a public technology company.  As we started discussing his business, one of the topics of conversation was Sarbanes Oxley.  His company just went through an expensive Sarbox audit to get into compliance and while his company passed with flying colors on most of the important issues, his company failed the audit.  Why?  Here is the short story.  One of his sales reps was hosting a client meeting and bought $15 worth of donuts.  The rep got a signature and approval from the CFO on the purchase.  Why did they fail?  The accountants said that the rep needed to get 2 signatures, one from the VP Sales and one from the CFO.  If the rep could buy $15 worth of donuts with only one signature, then think about what else he could buy.  That too me is quite inane and ridiculous.  There has to be some threshold, for example, on when 2 signatures are necessary for an expense report.  This is a perfect example of why Sarbox is expensive for public companies.  While I believe that Sarbox is a good thing and better and more stringent accounting is necessary, I also think that there is alot of waste ineherent in the regulations and that it needs to be reexamined.

This brings me to another point.  I had the opportunity to speak on a panel the other day hosted by Venture Scene New York.  The panel focused on exits or liquidity events and how VCs thought about them.  The clear trend that I am seeing is that companies really have second thoughts about going public these days due to the costs and requirements of Sarbox.  That obviously is not the sole reason many companies that can go public choose to be acquired but it is one of the top few.  In addition, it is no surprise that you see many public companies, particularly smaller ones, looking to go private as well.  Something has to be done to make Sarbox more relevant and less onerous, particularly for smaller companies.

I was reading Barron’s this morning and came across an article (sorry-need subscription for this) claiming Cisco’s potential appeal as a value stock.  It is hard to believe that this high flying company which once was the largest market cap company at $600b is now potentially a great value play.  The hot growth sector these days is energy and now Exxon Mobil is the largest market cap company at $400b.  Anyway, this table from the article says it all.  The P/E ratios (range from 18.7 to 19.6)of the tech giants like Cisco, Microsoft, Intel and Oracle are equal to or less than non-tech large caps like J&J, Wal Mart, and Coca Cola (range from 19.4 to 21).  In fact, Cisco’s 2005 P/E at 17 is less than that of the S&P 500’s at 17.4.  When most people think tech, they think high growth but this chart and these P/E ratios should really bring us back to earth.  I don’t disagree with Larry Ellison’s assertion a couple of years ago that the technology markets are maturing.  That is one of the reasons we see all of these huge mergers happening as companies seek to expand their markets, their product lines, and revenue.  That being said, there are still large pockets of growth which will provide startups with plenty of opportunity to succeed.  Cisco, for example, is spending heavily in new markets like security, VOIP, storage, and wireless.  The great news is that in pursuit of growth many of these big players are not afraid to pay up for the right products (think of the $450mm Airespace acquisition in the wireless area as an example).

I was catching up on my Barron’s this week and a quote from Ajay Kapur of Citigroup caught my attention.  When discussing his macro investment themes Ajay said, "The world is driven by Asian exporters and U.S. consumers.  In the future, it will be Asian consumers and U.S. exporters."  Given that perspective, it is no surprise that VCs have been pouring dollars into consumer technology plays over the last 18 months in addition to investing in China and India to tap into their consumer bases in the future.  Many VCs seem to be down on the enterprise space.  Corporations are hoarding cash and are risk averse in terms of spending on new technology.  That being said, there are some major trends occurring like the move to a service-oriented architecture and automation and virtualization of the data center.  Given the amount of time VCs are spending on global and consumer investments, I believe it is the right time to continue investing in enterprise start-ups developing product 12-24 months ahead.  As for the consumer globalization trend, I have been quite happy with my investment in the the Vanguard Emerging Markets Stock Index fund (VEIEX) which has been up 19.75% YTD.

Ok, now for some boring accounting stuff. Red Hat (RHAT) recently restated its financials. Its auditor, PWC, suggested that it change its revenue recognition policy. According to a CBS Marketwatch article:

Under the accounting method used in the past, the company would recognize a full month’s revenue from a subscription agreement, even if a deal was sealed in the middle of the month, for example.

The effect of the accounting change is to defer a portion of the revenue that had previously been recorded during the month that the subscription started to the end of the contract.

So what it comes down to is a timing issue. In the example above, a full month of revenue gets recognized even only if the customer signed in the middle of the month. I don’t really think that this in and of itself caused such a huge selloff in the company. One could argue that the company is overvalued at a $2.8 billion market cap and a 20.5 TTM revenue multiple.

Anyway, I checked around with my portfolio companies which sell hosted software and it seems that we are taking a conservative approach by recognizing a set up fee in the month that we sign a deal and do the work and then begin recognizing the subscription revenue the following month. Anyway, while a boring and mundane issue, I believe this will impact a number of other companies in terms of revenue recognition. My general rule of thumb is to always have portfolio companies prepare for success – this also includes making sure our accounting is conservative and inline with best practices.

Russell Beattie has a thorough post on Jamdat Mobile’s IPO filing. This is significant because this is the first so-called “wireless application” play to hit the market. For those of you that don’t know, Jamdat is a provider of global wireless entertainment applications and enabling technologies that support multiple wireless platforms to wireless carriers, handset manufacturers, media companies, and independent content developers. Looking at Venturesource, I see that Jamdat was first funded in March 2000 precisely the time when VCs thought wireless was the next big thing. Many of these companies are no longer around, but it is nice to see Jamdat make it through such turbulent times, only with $33 million in VC funding.

As an investor, the difficult part of any consumer wireless play is that the wireless world is a walled garden and not an open network like the Internet. This means you are dependent on the carriers for deals and access. This is starting to change but even if you want to go to your own sites through your wireless phone, it is not easy. In addition, imagine the competition to get distribution from the carriers-there are lots of little guys knocking on the door. On the upside, if you are able to get the deals, you have an incredible ability to scale. Just look at Jamdat’s numbers: $90k revenue in 2001 with a $5mm loss and $7mm revenue in Q1 2004 with $740k profit which is an annualized revenue runrate of $28mm-not too bad in a few years. As Russell points out, I am sure a successful Jamdat offering will spur renewed interest in wireless companies. That being said, I just view wireless as another pipe, an increasingly important one that every software or web-based company will have to be aware of and leverage.

Speaking of wireless, there has been lots of talk about Time Warner launching its own branded wireless service over someone else’s wireless network. Not only does this make a ton of sense in terms of the phone company/cable bundle packaged wars but also from a content and programming distribution perspective. If you believe that wireless devices and phones will continue to become an increasingly important way for end users to access data and eventually music, photos, and video, then what better way to control the economics of distribution then by reselling your own service.