U.S. venture capitalists and investment bankers have been shying away from Internet-related investments since the tech-market meltdown of 2000. Upstart companies such as Covad Communications Group, NorthPoint Communications, and ICG Communications cost their investors a bundle even as they signed up tens of thousands of new broadband customers. The lesson: Making money from exploding Internet traffic isn't a slam dunk.
FILLING THE GAP. Venture capitalists aren't the only ones leery of the communications market. Bond investors are also nervous after bankruptcy filings by NorthPoint, ICG, and other competitive local exchange carriers, known as CLECs. As a result, the flow of money to CLECs has been choked off, starving some worthy business plans, says Cisco Chief Strategy Officer Mike Volpi. "The capital market isn't operating efficiently right now. A lot of good ideas aren't getting funded." To pick up the slack, Cisco may take stakes in companies it does business with, something it hasn't made a habit of.
Cisco knows how to make money from Internet growth. So, with conventional investors sitting out the next generation of Net innovation, Cisco has stepped in. Last January, CEO John Chambers started talking about the possibility of Cisco's product-development costs increasing because the company would have to invest in product platforms earlier in their life cycle. Sure enough, Cisco bought almost as many companies in 2000 as it did in 1998 and 1999 combined. Many of them were early-stage companies.
Although Cisco is moving deeper into the venture food chain, the Softbank investment is the company's first $1 billion venture bet. Last year, it made an equal investment in the Internet-consulting unit of KPMG. With that business preparing for an initial public offering, Cisco is likely to reap a healthy return on its investment while keeping a minority stake in the company.
OILING THE ENGINE. Sources familiar with the Softbank transaction say that, should Cisco get back its initial $1.05 billion, it has an agreement to invest up to another $1 billion.
Making money on investments is nice for the balance sheet, but since Cisco excludes gains and losses from investments on its income statement, this investment won't have an impact on Cisco's earnings per share. To keep Wall Street happy, the company needs a growing market for Internet gear. The Softbank investment, which likely will be followed by other similar deals, is Cisco's way of oiling the engine when the usual lubricant runs dry.
When figures on fourth-quarter venture-capital investment become available, they're likely to reveal a noticeable slowing of VC activity. Some "phenomenally good companies will be passed over" as credit markets dry up, says Jess Reyes, vice-president for Venture Economics, which follows the venture-capital industry. But not if Cisco can help it. By John Shinal, with Linda Himelstein, in San Mateo