Friday, February 22, 2008

Are VCs All Hardware Haters

What a strange 12 months its been in the enterprise equipment space. Last summer, a crop of relatively young but fast growing public equipment companies were being aggressively valued in the public markets. Riverbed, Aruba Networks, Acme Packet, F5 and Isilon and were all trading at multiples of 5 to 15 times sales. VCs took note. Most of these companies had recently gone public. Many VCs, myself included, thought the public markets were once again embracing the enterprise IT investment theme.

There were lots of reasons to believe the valuations of these small cap businesses would maintain their attractive levels - at least for a while. All were growing revenues at 25% to 100% annually. Gross margins were 50% to 70%. Most importantly, the enterprise IT market seemed like a relatively safe bet for the next 2 to 3 years. Following the tech recession of the early 2000's, business IT investment shrank significantly. But after 5 years of belt tightening, it seemed a new investment cycle for IT was due. Sadly, the past few months have shown otherwise.

With fears of recession and certain high IT spending verticals, like financial services and retail being hard hit, growth in enterprise IT spending in 2008 is now in doubt. This cloud of uncertainty has leveled the market caps of the enteprise equipment sector. Many of these small cap companies have seen their valuations cut by 50% to 75%.

So what do VCs think about all of this? Theoretically, VCs are not to supposed to care about the day to day price gyrations of the stock market. Practically speaking, however, the retrenching of the enterprise equipment sector will have an adverse effect on venture funding. With many of these companies needing $100 million or more to reach breakeven, a dip in the public market comparables makes it harder to justify an initial investment.

So what should entrepreneurs - or CEOs of existing equipment companies - do about all of this? More on that topic in my next blog post.....

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