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The Starting Line: Telecom start-ups look for a life raft

Where networking start-ups once were flush with VC money and possibilities, now many are just hoping someone will buy them out.

Chief Executive Robert Harvey held a group of institutional investors in rapt attention during a business pitch--that is, until he mentioned his telecommunications company's competition.

Start-up Codeon makes fiber-optic hardware that competes with products from Agere Systems and JDS Uniphase--two companies that are suffering from weak demand and a tumultuous financial market. Investors didn't hide their displeasure; if established public companies were struggling, how would Codeon fare?

"It's been quite a change," said Harvey, after his presentation. "A year ago, this space was white-hot. That's changed significantly."

At the Salomon Smith Barney technology conference, 20 companies--most networking or networking equipment start-ups--worked the floor to garner the support of institutional investors. For privately held companies, this task has become increasingly difficult--and the path to IPO almost impossible.

Companies like Codeon, which received plenty of VC funding amid a growing market, once had investment bankers beating down its doors. Now similar companies are building their businesses in hopes of grabbing one of the few opportunities to go public--or to be bought out.

"I think there (are) about 40 or 50 companies playing musical chairs with only five or six chairs," said Ciena Executive Chairman Patrick Nettles.

"It isn't a pretty picture from the point of view of wasted capital, lost dreams and duplicated technology. There are a lot of companies that want to be consolidated, but there aren't many possibilities."

The VC lag
Why would dozens of privately held companies vie to be competitors to Cisco Systems, Nortel Networks and JDS Uniphase, especially now? Call it the venture capital lag.

In the past two years, venture capital funding has poured into start-ups that sought to build next-generation networks. As Cisco, Lucent Technologies and Nortel cut staff and trimmed budgets, however, start-ups were still winning venture capital funding.

The numbers tell the tale. According to the PricewaterhouseCoopers Money Tree Survey in partnership with VentureOne, VC funding fell 21 percent sequentially to $8.2 billion in the second quarter, but communications and networking still received cash.

In 2000, venture capitalists provided a record $87.5 billion in funding, with communications and networking companies grabbing $22.5 billion--up 137 percent from 1999.

The funding binge created a glut of privately held networking companies. Telecom equipment IPOs used to be the closest thing to a sure bet, but not anymore.

Michael Christenson, managing director for Salomon Smith Barney's tech banking unit, said VC money is now starting to find other favorites, such as software companies. But the glut still exists.

"It wasn't our intention to highlight telecom equipment and component companies, but that's where the money went over the last two to three years," Christenson said. "These guys have received the funding and are the farthest along."

Prospects and a poll
The market for privately held companies is tough, but that doesn't mean that there aren't some solid prospects out there.

Of Salomon's panel of companies, which included Codeon, Centerpoint Broadband Technologies, Sitara Networks and BlueArc, a company headed by former Compaq Computer executive Enrico Pesatori, many had cash, a solid customer base and a viable business plan and market niche. More importantly, many expect to be profitable shortly.

Codeon's Harvey said his company will be "IPO-able" by mid-2002. He also said that the company could be profitable by the end of next year.

"The slowdown has impacted demand, but it hasn't impacted what we do," said Harvey.

Waltham, Mass.-based Sitara was another start-up at the conference that displayed growth potential. The company makes quality-of-service networking equipment that incorporates a host of technologies to manage bandwidth and save costs. Chief Executive Malik Khan said the company has 250 customers, no debt and plans to grow revenue at a rapid clip.

"We have profitability targeted for December of this year," said Khan, who is projecting $25 million in revenue for the year and $65 million in revenue for 2002.

But for every Sitara, there are a dozen companies trying to do and become the same thing--successful and public--Christenson said.

Indeed, the private company game has become such a grab bag that Salomon started a contest. Attendees could rank presenters based on what they thought their market value--based on IPO or acquisition target--would be within a year. The winner would get a free trip to the 2003 Wimbledon Championships.

"Last year this time, we, along with other private companies, were being hounded by bankers. We had tickets to the U.S. Open, and front-row center seats to the 'Lion King.' Now I'm watching (Andre) Agassi in my hotel room alone and vying for tickets to Wimbledon," said Dana Waldman, president of Centerpoint, a fiber-optic equipment maker, to laughter at his presentation.

"What a difference a year makes," Waldman said.

Staff writer Tiffany Kary contributed to this report.