OPPORTUNITIES: Profit on the Panic
Stambovsky, Jeff
Profit on the Panic Telecom over-investment is over-hyped BY JEFF STAMBOVSKY A recent Business Week special report, entitled "Telecom Meltdown;' describes the likely ripple effects~none of...
...socialist sour donkeys like John Kenneth Galbraith, see more clearly than its own economists...
...Picking winners is not only a numbers game...
...Spurred on by the well-publicized failures of Northpoint and Winstar, two widely followed Competitive Local Exchange Carriers (CLECs), and the near-death experiences of several others, investors have fled the entire new telecorn sector...
...Hardly.VC is headed for bigger and better days, 2001 and maybe 2002 notwithstanding...
...Don't forget to look at the basics like pedigree, quality of management, and bond price...
...But the 30-year trend is decidedly up...
...Rich patrons bankrolling wild-eyed entrepreneurs who promise to remake the world have been around at least since Queen Isabella's time...
...The word around Silicon Valley is that this year's inflow will plummet to about $40 billion, and may dip more in 2002 unless the intitial public offering market opens up later this year...
...Over-investment means that the returns generated by a business will be lower than is necessary to compensate the supplied the industry with too much capital...
...BOND PRICE...
...THE AMERICAN SPECTATOR 9 June 2001 63 to the amount of total long-term debt that it's carrying on the balance sheet...
...Rather, they raise funds from "limited partners" of which two classes dominate...
...But the new telecommunications companies are financed largely with debt~high-yield bonds...
...In leaner 2001, pension funds are inching back down to a 2 percent allocation...
...Laurance Rockefeller is now 88 university endowments...
...If you're "partners" with a group of serious and successful investors and operators who've got a lot at stake, that's a big plus...
...Consider that an opportunity...
...Often, they simply sell what they can sell quickly, leading to falling prices across an entire sector...
...Called Venrock, it deploys Rockefeller family money into technology startups such as Check Point and Doubleclick...
...But the pace of technological change has been staggering, data-trafficking costs to Picking winners is not only a numbers game...
...Look for VC to be a $250 billion global phenomenon when the economy recovers...
...Venture inflows, the world is learning again, can go down as well as up on a yearly basis...
...Short of world war or global depression, the long VC boom is likely to march onward...
...a well-respected management team has the credibility to put together difficult financing at crunch time...
...PEDIGREE...
...Prices of both the stocks and the bonds of most new telecoms are stuck in distressed territory...
...O n Wall Street, though, the pessimists are winning...
...Epoch Partners sees a coming paradigm shift that will "spur previously undetectable demand [and] unleash massive amounts of data...onto the broader network infrastructure...
...As more and more enterprises adopt technologies that significantly lower the cost of moving data, the growth in network trafficmand the demand for supporting services~will greatly surpass historical rates...
...So what else should you be looking at...
...If the overinvestment comes from equity investors, the consequences are unpleasant but not dire~the stock price goes down to the point where the expected return becomes adequate...
...The valuation that the highyield bond market places on the publicly traded debt securities of an issuer can be indicative of the odds of the company's survival with its current financial structure intact...
...Metromedia Fiber (MFNX) is a metropolitan fiber carrier and service provider whose investors and sponsors include Metromedia Company andVerizon Corp...
...QUALITY OF MANAGEMENT...
...Harvard allocates up to 20 percent of its $20 billion endowment to venture capitalists...
...When bond and stock mutual funds are hit with heavy panic-mode redemptions, as they have been for much of the past year or so, portfolio managers in a hurry to raise cash don't have the luxury of'making distinctions between, say, flawed businessplan CLECs on the one hand, and aggressive, well-managed next-generation IP carriersmlike Global Crossing (see "Golden Global" TAS, March 2001)~on the other...
...The American version got started in the 1930s...
...Profit on the Panic Telecom over-investment is over-hyped BY JEFF STAMBOVSKY A recent Business Week special report, entitled "Telecom Meltdown;' describes the likely ripple effects~none of them goodm from what its authors believe is too IPPORTUNITIE: much capital chasing too few opportunities, i.e., over-investment in telecommunications and technology...
...The underlying premise is that growth in demand for telecom services, which is driven by the growth in network data traffic, will be much smaller than the companies, their financiers, and their investors had originally anticipated...
...So has venture capital seen its peak...
...But most of the 1,200 or so VC firms in the country today don't play with family money...
...The telecom over-investment thesis implies that capital markets badly misjudged the size of the opportunity, and end-users are dropping precipitously, and extrapolations based on previously experienced patterns of demand will prove well off the mark...
...And the pain might not be limited to investors in debt-laden companies...
...Guy Kawasaki, head ofPalo Alto's Garage.com, is telling his seedlings not to expect a "liquidity exit" until summer 2002...
...Between 40 and 80...
...With debt financing, the most likely outcome of over-investment would be a string of defaults and bankruptcies ultimately resulting in the wipeout of stockholders' interests...
...But that was then...
...Because at crucial juncturesmlike now m market dynamics can cause the good to be treated just like the bad and the ugly...
...OK, so what is over-investment...
...Barton's and any number of financial pages in newspapers running the gamut from the Sunday New York Times to USA Today, with headlines borrowed from the obituary section, echo the theme...
...Angels aren't new...
...and hisVC firm remains active today...
...CEO Daniel Akerson is a wellregarded veteran from MCI...
...Bonds trading above 80 cents indicate likely survival...
...If a company's bonds are trading much below 40 cents on the dollar, you'd better have some compelling reasons to continue to own the stock...
...Susan Kalla, writing in Barton's, expects an annual growth rate for data traffic of 50 to 70 percent over the next few years, compared to some industry estimates that look for a doubling every three to four months...
...Backers who've put in cash equity and who stick around when times are tough...
...More or less...
...In late April, Forstmann committed an additional $250 million on top of $1.25 billion already invested...
...Does the company have sponsors with a track record...
...Of course, just so you don't wind up backing any hopeless causes, it's a good idea to look at the company's current liquidity (cash plus marketable securities plus bank loan availability) relative The author may hold positions in stocks discussed in this column...
...The problem with the bears' projections of demand is that they are based largely on growth rates from the preInternet, pre-fiber-optical world...
...And you should consider whether the company will generate enough cash in addition to its current liquidity to fully fund its business plan...
...The bond market's thinking it over, and so should you...
...By 2010 it will be a trillion-dollar global industry...
...investors who financed it...
...But by 2000, there were some 1,200 firms, 64 THE AMERICAN SPECTATOR 9 June 2001...
...Up With the Angels Venture capital hasn't yet seen its peak BY RICH KARLGAARD M oney going into American venture capital firms rose fiftyfold in the last decade, from $2 billion in 1990 to $100 billion in 2000...
...Likewise, AT&T'S pension fund, another active VC investor, demonstrates it understands the future better than its own guys at the top...
...Pension funds, understandably more conservative than endowments, historically have rationed just 2 percent of their funds to VCs...
...Their appetites grew during the Internet boom of 1995-2000 and at the peak they allocated up to 5 percent...
...Spectator readers who use this information for investment decisions do so at their own risk...
...Unfortunately, because there are so many moving parts, this type of analysis is probably not going to be as definitive---or as accurate---as you'd like it to be...
...Rickenbacker used the funds to start what became Eastern Airlines...
...The reward for virtue: Returns to Harvard from its VC investments have averaged 30 percent per year for the last 20 years...
...This is critical, and not only from an operational point of view...
...One is pension funds, the other Of course back in 1990, when American venture capital inflows were about $2 billion, it was easier to be sure of the numbers.The universe was small, consisting of only a few dozen VC firms, and research firms like Cambridge Associates, which tracksVC fund returns for its limited partner clients, had their arms around it...
...Rich patrons bankrolling wild-eyed entrepreneurs who promise to remake the world have been around at least since Queen Isabella's time...
...Such boldness in capitalism proves that Harvard's asset managers, by ignoring the dismal bleats of IOTHING VENTURE...
...XO Communications' bonds trade in the 50s, yielding more than 24 percent...
...The bonds trade in the 60s, yielding more than 17 percent...
...Young Laurance Rockefeller, fresh out of Princeton, fell in love with aviation, and with the entrepreneurial blood of his oilbaron grandfather pumping through his veins, wrote a check to Eddie Rickenbacker, the World War I ace...
...Companies with debt-laden companies as customers will also get crunched if their customers can't pay their bills...
...XO Communications (XOXO) is a voice and data service provider whose founders and sponsors include Craig McCaw and Forstmann, Little, a highly respected buyout firm...
Vol. 34 • June 2001 • No. 5
