OVUM: VCs may renew investments in Network infrastructure companies which have been off their radar screens!

Network Equipment accounted for only 1% of all VC investments for the past four quarters, according to Ovum.  They see the sector being ripe for a rebound in VC investments.

"Since the financial crisis, venture capital (VC) firms have been giving much of their tech cash to mobile, social, and OTT start-ups, showing little interest in telecom. VC support for telecom infrastructure start-ups has dropped from US$796m in 2009 to just US$270m in the 3Q11–2Q12 period. In a new report,* though, global analyst firm Ovum finds reason for optimism, concluding that “recent IPO and M&A transactions point to a rebound in VC interest in network infrastructure.”

While VC support for network infrastructure has declined, overall VC investments have recovered, growing from US$20.1bn in 2009 to US$27.8bn in the four quarters ended 2Q12. Some of the beneficiaries of this modest surge include Facebook, Groupon, Twitter, LivingSocial, Square, Lashou, Kabam, WhatsApp, and Spotify.

Matt Walker, Ovum Principal Analyst and author of the report, explains:  “A funding disconnect has thereby emerged between network builders and network users. Lots of innovation and venture capital is targeting the network users, such as mobile apps and OTT platforms. However, little of it is directly helping the network builders. With a weak start-up pipeline, the industry relies more on incumbent vendors to generate new ideas and products. Their budgets are bigger, but VCs are often better at funding ‘game changing’ ideas ignored by established vendors.

“Incumbent vendors’ internal R&D budgets are now nearly 90 times larger than VC investments in the sector, up from 30 times two years ago. This narrows options for service providers, who rely on both large and small vendors for innovation. The big vendors also need access to the start-up pipeline, to fill in gaps in their own portfolios through partnership and M&A.”

In response, service providers are getting more actively involved in funding and working with start-ups. Telefonica, Vodafone, Verizon, AT&T, KDDI, China Mobile and many others are now funding start-ups directly, often deploying products in the network or lab ahead of commercial availability. Earlier this month, Deutsche Telekom (DT) was the latest carrier to announce a new push on the venture side, revamping its T-Venture unit to foster purchase of majority stakes and accelerated disbursement of funds.

Walker adds: “Carriers really need help from suppliers, yet what they face is a vendor market in confusion. Most large vendors are now shrinking and reorganizing, even the Chinese suppliers. Several vendors are modifying business plans and selling assets in order to stay solvent. With the recent VC drought in networking, it’s not surprising that big telcos have become more directly involved in funding start-ups.”

Walker points out that, based on data from the PWC/NVCA MoneyTree Report, the “Networking & Equipment” share of total VC investments shrank to just 1.0 percent for the past four quarters (3Q11–2Q12), down from about 10 percent in 2003.

The good news is recent IPO and M&A deals do suggest that VCs are looking favourably on the telecom sector again, when telecom is defined broadly. For instance, VC-funded start-up Nicira Networks was recently acquired by VMware for US$1.26bn. “The tide seems to be shifting. With heightened investor interest and carrier need for solutions in such areas as small cells, network virtualization, and network optimization, telecom network infrastructure VC seems ripe for a rebound,” concludes Walker."

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If you check the graph in the PWC Money Tree summary report (url below), you will see almost no VC investments in network equipment or electronics/instrumentation:
https://www.pwcmoneytree.com/MTPublic/ns/moneytree/filesource/exhibits/Q2%202012%20MoneyTree%20Report_FINAL.pdf
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AJW Comment:  With the exception of the largest telcos, the carriers have essentially outsourced R&D to improve/enhance their networks to the huge vendors (Ericsson, Alcatel-Lucent, Huawei, NSN, ZTE, Samsung) they do business with.  The smaller vendors (Ciena, Telllabs, Adtran, Motorola Mobility, etc) develop specialized equipment for carriers, but don't do much research. 

One would think that would present a great opportunity for network equipment start-ups.  However, without VC or Angel investments, they can't obtain the funds to develop innovative products.  In some cases, the start-ups can make deals with incumbent network vendors, but most of them are in financial difficulty (e.g. NSN, Alcatel-Lucent, and even ZTE) so many not be able to invest.   Let's hope Ovum is correct and VCs start to once again invest in network equipment start- up companies with innovative new technologies!

References:

http://ovum.com/press_releases/ovum-finds-networking-start-ups-overdue-for-vc-rebound/

Also see: 

http://viodi.com/2012/08/23/zte-reports-huge-drop-in-profits-telecom-death-spiral-continues/

http://viodi.com/2012/09/24/summary-of-telecom-council-tc3-part-1-service-provider-investment-forum/

http://viodi.com/2012/09/25/entrepreneur-forum-carrier-perspectives-summary-of-telecom-council-tc3-part-2/