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Q2 venture capital survey

E-comm costs off; ASPs and optical net firms heat up.

By Carolyn Duffy Marsan
Network World, 08/21/00

The venture capital community remains bullish on the Internet economy, pushing a record $15 billion into business services, network software and telecommunications start-ups in the second quarter of the year, according to the most recent PricewaterhouseCoopers/Network World Venture Capital Survey.

Despite a downturn in the valuation of Internet stocks that began in March, the second quarter saw a 20% rise in network-oriented investments over the $12.5 billion spent in the first quarter of this year. Altogether venture capitalists have invested $27.6 billion in network companies this year -- $4 billion more than was spent during all of 1999.

Although overall investments were up significantly, the funding shifted dramatically away from e-commerce companies toward ventures offering Internet access and applications.

Among the hottest areas of investment were application service providers (ASP), broadband service providers and outsourcing companies offering enterprise-class Web-hosting and management services.

"The network area is still one of the bright spots," says Tracy Lefteroff, a managing partner of PricewaterhouseCoopers' venture capital practice. "This is going to continue to be a growth industry as everyone retools and re-equips their portion of the Internet backbone to accommodate new technologies coming out, like fiber optics, wireless and broadband."

The second quarter of 2000 was a record breaker on all measures.

Altogether, 960 network companies received an average of $15.6 million each during the second quarter. That's a significant increase over the first quarter, when 886 network companies received an average of $14.1 million each.

The biggest increase for the quarter was in Internet applications and tool providers, which captured $2.9 billion, up 35% over the previous quarter.

Business service providers such as Web-hosting firms snared $3 billion, up 24% over the last quarter. And access and infrastructure companies, including ISPs, captured $1.9 billion, an increase of 11%.

"For corporate network managers, the trend is toward outsourcing," Lefteroff says. "As they bring Internet tools into their own businesses, hosting and other services along those lines may be a better way to go than making all the investments internally."

Meanwhile, investments in business-to-business and business-to-consumer Web sites dropped to $1.6 billion and $1.4 billion from $1.9 billion and $1.5 billion, respectively.

"It's all about the business of the Internet, the business of networking," says Kirk Walden, national director of PricewaterhouseCoopers' Money Tree Survey, which tracks venture capital investments in all segments of the U.S. economy, including networking. "The companies that are getting funded are not companies that a consumer might see. In sharp contrast to a Pets.com, consumers will never know who these companies are."

The biggest deal of the quarter was a whopping $402 million invested in Carolina Broadband, a Charlotte, N.C., provider of broadband multimedia services, including cable TV, Internet access, and local and long-distance telephone services to residents and businesses.

Industry observers see no end in sight to the amount of deal-making in the network area. Indeed, PricewaterhouseCoopers predicts that the network segment of the economy will end up raking in more than $55 billion in venture capital funding by year-end - more than double the amount spent in 1999.

"We're going to see larger and larger deals," Walden predicts. "Venture capital firms have an incredible amount of money under management to invest, and it takes more money for them to do network deals, particularly telecommunications deals."

A growing number of those deals are for ASPs, including Asera, a Belmont, Calif., provider of hosted marketing and sales applications for manufacturers. Asera raked in $98 million in venture funds from a group of top-tier investors including Kleiner Perkins Caufield & Byers, Chase Capital Partners and Cisco.

Other ASPs that got funding last quarter include EyeCast. com, a Herndon, Va., firm offering interactive video services that raised $30 million, and Promptu Systems, a San Jose firm offer marketing services that raised $17 million.

"Content distribution networks such as Inktomi and Akamai are becoming part of the Internet cloud," explains Gus Tai, a general partner with Trinity Ventures, which has invested in several ASPs, including Promptu and Aventail. "There are going to be applications that are distributed on top of the Internet topology that enterprises are going to use to increase their interconnectivity."

Another group of companies that received a lot of money last quarter was providers of Web-hosting and management services. Two of the quarter's largest deals were $150 million raised by Inflow, a Denver Web-hosting firm and $100 million raised by Mainstreet Hosting, also of Denver.

"What the Exoduses of the world have been able to do is build out large-scale Internet operations, but there is currently a hole around value-added services," says Fred Wang, a general partner with Trinity Ventures, which has invested in SevenSpace, a Reston, Va., provider of outsourced management services for enterprise-class Internet applications.

Networking hottie

Another hot area of investment was optical network gear. Among the companies that got funding last quarter were Astral Point Communications of Chelmsford, Mass., which received $80 million; Tenor Networks of Acton, Mass., which received $93 million; and Quantum Bridge Communications of North Andover, Mass., which received $102.5 million.

Although these firms will sell their products to carriers, enterprise customers will benefit from the new and faster data communications services the equipment enables.

"If you look at the whole fiber-optics area - from components to wave division multiplexers - everything associated with that has just been on fire," Lefteroff says. "That area is going to be hot for a while because of the sheer magnitude of the job involved with upgrading the equipment along the backbone of the Internet."

Lefteroff adds that he is bullish on the network market for several years to come. "If you look at the successful companies in the public markets - Juniper, Avici, Foundry and Redback - and look at their sales growth, you can see that there's still a land grab going on in the Internet infrastructure," he says.