VCs snub network hardware startups

Venture capital investments in network hardware startups plunged last quarter, as private investors balked at funneling money toward formerly hot areas, such as core routers, specialized switches and fiber-optic systems.

Altogether, venture firms invested US$633 million in 57 networking and equipment start-ups during the second quarter of 2002, according to a special analysis of the MoneyTree survey compiled by PricewaterhouseCoopers LLP, Venture Economics and the National Venture Capital Association.

The latest figures are down 26 percent from the first quarter of 2002, when venture firms invested $859 million in 62 networking and equipment start-ups. And these figures are down by half from the second quarter of 2001, when 80 networking and equipment startups received a total of $1.2 billion.

"Companies have stopped spending money on anything IT-related," explained Tracy Lefteroff, global managing partner of the venture capital practice of PricewaterhouseCoopers. "So, if you're not spending on IT, you don't need core routers and all the other kinds of network hardware."

In a related move, venture capital investments in semiconductor start-ups developing optical, opto-electronic and wireless components also dropped significantly. Semiconductor investments fell 31 percent, from $411 million in the first quarter of 2002 to $284 million in the second quarter of 2002.

Investments in both semiconductors and networking equipment dropped more than the other categories. The other categories are: computers and peripherals, IT services, software, and telecommunications.

Altogether, the six network-oriented categories of the MoneyTree survey attracted $2.8 billion in the second quarter of 2002, down 14 percent from the $3.3 billion invested in the first quarter of 2002.

"This trend will continue to force companies out of the market or into bankruptcy or mergers," Lefteroff predicted. "We're going to continue to see contraction in the number of players in the network industry. The bright spot at the end of the tunnel is that when the market finally comes back there will be a lot less competition. The companies that survive will be very profitable and very vibrant."

Of the 57 network hardware start-ups that did receive funding last quarter, the vast majority -- 84 percent -- were receiving follow-on funding, versus first-round funding. Of these companies, 15 received second-round funding, while 12 received third-round funding. Another 21 companies received their fourth or higher rounds of funding. The oldest company was StarVox, a San Jose maker of IP telephony gateways that received its ninth round of funding.

Only nine of the network hardware start-ups were new companies that received their first round of financing. The biggest of the first-round deals were a $16.7 million investment in Arriso Networks, a Richardson, Texas, maker of convergence equipment for carriers, and a $15 million investment in Hammerhead Systems, a Menlo Park, Calif., maker of next-generation data communications equipment.

Despite the venture capital industry's declining interest in network hardware, two start-ups managed to attract the kind of eye-popping investments common during the heydays of 1999 and early 2000. The biggest network hardware deals of the quarter were: a $75 million, fourth-round investment in Mahi Networks, a Petaluma, Calif., maker of optical network products for regional metropolitan networks; and a $49 million, third-round investment in Movaz Networks, a Norcross, Ga., maker of optical routers.

Another handful of start-ups managed to attract $20 million or more during the spring of 2002. These include: Picolight, a Boulder, Colo., fiber-optic component manufacturer that attracted $27 million; BigBand Networks, a Fremont, Calif., maker of broadband routers that attracted $27 million; and Ample Communications, a Fremont, Calif., maker of optical connectivity systems that attracted $25 million.

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