The true nature of the initial public offering market lies in its euphoric highs and its depressing lows. Rarely, if ever, is the market in balance. As we head into 2001, the tone of the IPO market hasn't been this somber since the fall of 1998 -- the issuance of just 41 high-tech IPOs in the fourth quarter was the lowest level in two years, while the number of companies that pulled offerings during the quarter (67) has never been this high.
Talk of a recession has put the chill on the private markets. Only 33 technology companies filed for proposed offerings in the fourth quarter. "The market goes through manic environments where you see a lot of similar companies getting funding at the same time," notes Revell Horsey, managing director of capital markets at Banc of America Securities. "Then, all of a sudden, the markets have to go through a rationalization process."
As sobering as these statistics may sound, it would be foolhardy to proclaim that the IPO market will not come back in 2001, for three reasons: a healthy pipeline of companies with innovative technologies; an abundance of technologies that will provide cost savings to traditional business; and the lack of retail buyers in the aftermarket makes for a rational investment environment. In short, after a cathartic cleansing, the cycle is starting all over, and those investors willing to venture into the market will be rewarded.
WHERE TO LOOK IN 2001 In our opinion, the key areas of strength will lie in the metropolitan-access portion of networks (namely companies affecting how optical components are manufactured), providers of business-to-business collaboration platforms, and extensions of the application service provider (ASP) model.
"One of the things that has become very apparent is that with a decrease in the growth rate of technology spending, we think companies are going to be very focused on technologies that are going to take immediate costs out of the system," says George Bischof, a general partner at Charter Growth Capital.
Indeed, after a heavy dose of spending by telecommunications carriers on their long-distance optical networks, venture capitalists are placing heavy bets on technologies that will not only leverage those investments but also extend optics into metropolitan-access and enterprise portions of their networks.
Centerpoint Broadband Technologies and Novalux are examples of private companies whose technologies will further enhance the performance of long-haul optical networks. Cisco Systems (Nasdaq: CSCO) is an investor in both companies (for more on these firms, check out our story on Cisco's IPO investments).
METROPOLITAN CONGESTION Telecommunications carriers spent much of their 2000 capital budgets addressing the long-haul optical transmission capabilities of their networks but their focus is now expected to shift to access points at the metropolitan level. That focus has not eluded venture capitalists, who have aggressively funded companies developing solutions to expand the transmission capacity and bridge the gap between legacy, Sonet-based networks and optical solutions. VCs have also backed metropolitan providers and equipment that use Gigabit Ethernet networks to circumvent less-scalable Sonet-based infrastructure.
"Because the metropolitan-access markets are traditionally five to ten times bigger than the core of the network, metropolitan-access equipment companies are going to be really important in 2001," says Jim Boettcher, also a general partner at Charter Growth Capital.
Take, for example, metropolitan transport companies that are hoping to replicate the success of ONI Systems (Nasdaq: ONIS), which went public in June and now has a $7.3 billion market capitalization. Zaffire, Broadband Networks, and Alidian Networks all landed significant private rounds of funding this year and will likely pursue IPOs in 2001.
The Sonet multiservice provisioning platform (MSPP) market is even more crowded. The importance of the MSPP market can be clearly seen by looking at how much public companies have been willing to pay to enter this area. Cisco acquired Cerent for $7 billion; Redback Networks (Nasdaq: RBAK) shelled out $4.3 billion to acquire Siara; Lucent Technologies (NYSE: LU) paid $4.5 billion for Chromatis Networks; and most recently Ciena (Nasdaq: CIEN) anted up $2.6 billion for Cyras Systems.
Encouraged by the rich valuations, other MSPP players that may seek to go public in 2001 if they are not acquired include Astral Point Communications, Geyser Networks, Mayan Networks, and White Rock Networks.
CIRCUMVENT THE INCUMBENTS The buildout of the metropolitan networks should also pave the way for a new breed of local exchange carriers (LECs) focused on circumventing the Sonet-based networks altogether. Privately held, new-breed LECs like Cogent Communications, Intellispace, Telseon, and Yipes Communications have already rolled out networks in major metropolitan cities that provide 100 megabit-per-second Ethernet services at roughly the same price as a traditional T-1 (1.5 mps) connection.
However, even for early leaders like Cogent, which has partnered and secured investments from Cisco and Williams Communications (NYSE: WCG), it may be a race against the clock -- will the company be able to gain the economies of scale needed to support its infrastructure investments while it awaits a reopening of the public markets?
That uncertainty is clearly weighing on companies that supply switches and other equipment to Ethernet network operators. They include Juniper Networks (Nasdaq: JNPR) and Extreme Networks (Nasdaq: EXTR), as well as private companies like Appian Communications, Atrica, Force10 Networks, Lantern Communications, Luminous Networks, and Packetlight Networks.
While telecommunications equipment is by no means the only sector that will be important, the predominance of telecommunications companies in the pipeline does highlight the extent to which venture capitalists have leveraged their future on the capital budgets of carriers, both large and small. Whether or not these carriers continue to spend heavily in order to improve their networks may hold the ultimate key to the IPO market in 2001.