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Java fund looks to long term

Despite continued skepticism, Java Fund backers remain bullish about the strategic benefits of their investments.

It's been nearly two years since venture capital firm Kleiner Perkins Caufield & Byers formed its Java Fund, which came amid continued skepticism that Java technology would not take off as expected.

Nevertheless, fund manager Ted Schlein remains a happy camper.

"There were a bunch of Java-naysayers when we started the Java Fund. But it's real, it's here, and people are making money off it," said Schlein, who handles the $100 million venture fund.

The Java Fund, created in August 1996, was formed to seed companies that showed promise in developing a market for this nascent technology. The prospect of Java as an alternative software platform and as a fresh approach to application development proved alluring to KPCB, even though the investment opportunity meant it would be backing firms indirectly competing with software giant Microsoft.

The 15 companies in the Java Fund are expected to generate combined revenues in excess of $230 million in 1998, ranging from zero to $60 million.

Last March, KPCB's Java Fund watched the first of its companies, Internet Security Systems, go public. ISS's initial public offering soared on its first day of trading from its target price of 22 a share to close at 40-3/8.

Jesse Reyes, a Securities Data venture analyst, said the fund's performance has been as good as other top-performing new funds.

Both Reyes and Schlein cautioned, however, that it's still too early to determine the Java Fund's eventual success.

Although the run-up in the stock market could have provided the fund's limited partners with higher and quicker returns, they say they are pleased with their investment in the Java Fund. They assert that participation in the fund is based on strategic benefits, not a big, fast payback.

Netscape Communications, for example, said it invested in the Java Fund for strategic reasons. It wanted to align itself with fund partners such as Oracle and IBM, according to Quincy Smith, Netscape's director of mergers and acquisitions.

"We've been real happy with the Java Fund," added Natalie Egleston, director of business development for US West's MediaOne Interactive Services. "It recently took ISS public and that exceeded everyone's expectations."

However, most funds have a negative return on investments for the first few years to cover such items as management fees and operating expenses. But after four years, limited partners should begin to see some return on their investment as a fund's firms begin to launch IPOs or are acquired by other companies.

Superior funds return 10 to 11 times the invested capital, while a good fund returns 3 to 5 times the venture money, Reyes said.

KPCB's Schlein declined to release financial figures on the fund's current performance.

The fund has drawn some criticism as some investors and venture capitalists note that the Java Fund has stepped beyond its original charter: focusing only on companies that either are using Java or are furthering the acceptance of the technology.

"I think the fund has invested in good companies. But with ISS, I don't think it had anything to do with Java," said Mike Volpi, vice president of business development for Cisco Systems. "The fact that the fund is not all directly tied to Java...I don't think is a big deal."

He also noted that corporate partners are not always kept in the loop about Java trends or solicited for their views.

"We get quarterly reports, but we're not always kept informed on trends or potential investments or asked to be involved as corporate investors to aid the cause of the Java Fund," added Volpi. "But we're happy we invested in the fund, and I'm sure in the long term we'll be happy with the financial outcome."

Schlein contended that the fund has been true to its charter, which includes investing in companies that may not use Java but also promote its use. Moreover, the level of involvement "depends on the partner. Some are more in the loop than others." He added that the fund plans on holding annual briefing on its investments and trends. One such meeting already has been held.

Focusing on one technology also puts the Java Fund at more risk than other funds, because it's like putting all its eggs in one basket, Reyes said.

"Java is a marketplace where you have to set your expectations correctly," said Schlein. "Everyone wants this technology to mature overnight, and that just doesn't happen."

In sizing up some of the prospective winners in the Java Fund, industry analysts point to companies such as Active Software, which bridges a company's in-house applications with other software so they can work together.

"Businessware is roughly a $100 million market. Active Software has about 10 percent of the market and is doing well," said Ed Acly, an International Data Corporation analyst. "This [businessware] space is one of the most, if not the most, attractive software spaces. And we will see a few of these companies in this space going public or getting acquired by the end of the year."

But as with most venture funds, not every company in it will be a winner. The average fund sees at least 40 percent of its investments yield a negative return. Analysts point to Marimba as facing a tough time.

"They were never a market leader, and their near-term prospects of becoming a market leader do not look good," said Joan-Carol Brigham, an IDC analyst. "Software delivery will not be a huge market. Companies like Marimba will be part of a larger application...[so] an acquisition would be more likely."

But Schlein added Marimba is "doing great," noting that the company's Internet-based software distribution and applications management is something that has not yet captured the attention of other companies.

Within the next two years, Schlein said he anticipates another six of the fund's companies going public. "We gear most of our companies toward the IPO track. [Mergers and acquisitions] are sort of opportunistic--if it happens, it happens. But if you build a company with lasting value, you're better off."