venture capital

Over-the-top players: A race to the bottom

One of the forgotten truths of the current economic crisis is that while telcos worldwide will certainly be deferring some projects and obsessing even more about monetization, their competitors are likely to be even more concerned.

The guys at the greatest risk, in fact, are the darlings of the last couple of years—the over-the-top players. Many of these are still struggling to define any revenue model at all, and with advertising slipping and VCs demanding break-even performance, a lot of startups will die, and public companies will slump, shrink, be acquired, or disappear. In a race to the bottom, the guy with the lowest internal rate of return always wins because he can keep investing past his competitors’ pain point.

The issue is whether the telcos can take advantage of their opportunity. The recent interest in service mashups by Cisco and Alcatel-Lucent has the potential to allow the network operator to take control of the partnership with the OTT guys while the latter are down and out. Will they seize on that opportunity? That, according to our research, depends on how well the vendors (particularly the two we named) do to create the right ecosystem.

Network spending forecasts: Where’s the logic?

UBS and other Wall Street research firms are issuing fairly dire forecasts on tech and network spending in 2009. UBS has tech spending dropping a “minimum” of 6-11% in the year, and the consensus for networking (including the service provider space) is a decline of about 10%.

At the same time, the firms are talking about a mid-year recovery in GDP and saying that tech will lead by a quarter, which would mean this is all happening in one quarter of bad news! Wireless spending is expected to be off by 7%.

Frankly none of this makes sense.

• First, there are no credible indications from our Tier One surveys that any provider has actually planned to cut spending in 2009. What has happened is that they have decided to slow-roll projects through the end of Q1 to try to get more visibility on the impact of the economic crisis on their monetization.
• Second, there is very little chance that the spending would dip by 10% even if there were to be a protracted recovery period because operators generally spend in proportion to revenue, and nobody expects carrier revenue to decline at that rate.
• Third, we believe providers would be happy to increase capex in 2009 if they could get a handle on monetization, and it is in the mobile area where they have the best chance.

In the enterprise, we believe there may be more persistent and systemic problems, but again we doubt a dip of 10% would be likely under any set of conditions that have a reasonable probability.

Good season for start-up acquisition

Tellabs is indicating it may be willing to use its strong balance sheet for some down-market M&A, something that we think might be a very good idea for a lot of the larger players in the current market.

The industry is filled with small startups, some of which have good technology and strong roles in the network of the future, but little mindshare or account control. As investor fears mount, the price of these smaller players is dropping, making them a decent buy.

We believe that the deals will have to be made before the end of 1Q09, however, because it’s likely the new administration will be able to move forward enough that a recovery (not a full one, mind you) will be visible in the second half.

Obama economic moves strengthen financial markets

The Obama economic plan, and economic team, are both taking shape and the Street likes what it has seen. Obama is set to name NY Fed chairman Tim Geithner as Secretary of the Treasury and Lawrence Summers as chief economic advisor. The former set up a major gain in the Dow on Friday.

The Obama camp has announced it will pursue a broad infrastructure-modernization and works program stimulus that could involve more than $600 billion and take two years. Over the weekend, the government decided to rescue CitiBank, removing the risk of a major bank failure from the market and signaling the end of the apparent policy of non-intervention that allowed speculators to hammer stocks without fear of being trapped by good news. The deal will involve U.S. guarantee of certain mortgage-backed assets, totaling over $300 billion and including some commercial mortgage-backed securities that appeared to be the new problem with Citi. The government will also get $7B in new preferred stock.

Many believe that the move was generated by Obama administration intervention, and in particular Geithner’s relationship with Paulson, and this was the strongest signal that there might not be a period of inaction between administrations. The auto industry, reluctant to agree to sweeping changes that Congress was likely to demand in return for a loan, is now lobbying for a loan program to automakers’ finance arms to spur demand again. The Fed is reviewing measures that would pump up the money supply via direct lending, and also lower long-term rates; these would presumably supplement the traditional rate cuts that are now nearly at an end as rates hit 1%. All this has made the markets happy; U.S. futures were higher this morning, Europe was strong and Asia mixed with Japan higher.

What are Yahoo’s options?

November 17 2008 regarding Yahoo.
The Economist has said in print what most people probably have been thinking: Jerry Yang must go. Their criticism is very much our own. Yang and Decker have not developed any meaningful strategy to replace the Microsoft deal they opposed. In fact, you could argue that their approach was to say that if the deal were not done, things would simply go on as before. If true, that type of progress would be unacceptable to shareholders. If not true, then what will be done?

We believe that many Silicon Valley firms believe they are still the “owners” of their own companies, when in fact they’ve done an IPO and are now responsible to shareholders. The problem is that there are few options for Yahoo. One good one that remains is a tight partnership with the telcos.

Regarding the fate of VC-funded web businesses

Analysts and venture capitalists (VCs) are joining forces to warn that the days of running a web business for years with no revenue are over. The latest round, generated by Gartner, is aimed at the social media players who are the latest in the net-company crowd to get funded and are still largely unprofitable. We believe that the whole venture process is tainted by hype-based promotions that border on pyramid swindles, so winding back in VC investment will likely have little real impact on the market. However, it will certainly have an impact on employment in Silicon Valley and elsewhere, and there may be a period when even good startup ideas have little access to capital, especially in the first half of 2009.