Press Release

October 3, 2001 - SOMETHING VENTURED: VCs Hope To Fix Last-Mile Problem

By Johnathan Burns

10/03/2001
Dow Jones News Service
(Copyright (c) 2001, Dow Jones & Company, Inc.)

NEW YORK -(Dow Jones)- Even with the slowdown in spending on fiber-optics networks, venture capital investors continue to spend to reach the last mile.

The "last mile" has been elusive thus far. Much spending has gone to the so-called long-haul networks, the major routes that carry data and communications under oceans and across continents. But lost in this has been getting all that data into individual homes. The analogy is often made that the lack of thick pipes at the ends of the networks is like attaching a fire hose to a straw.

Now, with long-haul spending slowed, the focus is on finding a realistic means of access.

"I think a lot of people are looking for capital spending to shift from long-haul to access," said Jim Jungjohann, an optical equipment analyst with CIBC World Markets. "Access is an area where startups have focused more than publicly-traded (equipment makers). It is one of the sweet spots."

To show how reliant the communications-equipment business was on the long-haul side of the business, look only at the decline of investor confidence in publicly traded optical gear makers like Lucent Technologies Inc. (LU), Nortel Networks Corp. (NT) and component makers like Corning Inc. (GLW) and JDS Uniphase Corp. (JDSU). All were tied to the long-haul game, and as spending on long-haul network equipment began to drop late last year, their stocks collapsed.

With many of those bigger players going through restructurings and keeping their cash close at hand, the creation of the last mile likely rests with a handful of startups.

Some, like Atlanta-based Wave7 Optics Inc., have developed equipment to link telecommunications networks to new homes. It was this technology, and the untapped underlying demand, that persuaded Lucent's own venture capital arm and Morgenthaler Ventures to seed the company with $9 million last September. Both have recently plunked down another $4.5 million apiece as part of a new round of funding targeted to total $15 million in the next two months, said Robin Bellas, general partner at Morgenthaler.

The heavy focus on the last mile marks a shift on the part of venture capitalists. "All the attention two years ago was placed on long-haul," he said. "I think the money is just starting to flow into the access side. People are just starting to think about access."

Indeed, Bellas admitted that part of the reason venture capital investment in the access segment has been slow is because North America's carriers have been hesitant to commit capital to the access area. Tearing up city streets, he noted, to run fiber optic lines to smaller businesses and residences is an expensive endeavor.

"There's a lot of skepticism on just how quickly the service providers will provide (fiber to the home)," Bellas said. "We thought this was going to be a slow revenue traction, and it will be slow in the United States, because cable is older and more established."


Heading Into The Suburbs

However, the same is not true in Europe. The cable service providers there - which would be Wave7 Optics' first target customers - are increasingly interested in running fiber technology to the home in new suburbs. Suburban development in Europe, Bellas said, has trailed such development in the U.S.
Michael Gorman, general partner with St. Paul Ventures, said cable and telephone companies are now providing access solutions to homes and businesses through their existing networks via digital subscriber lines and cable modems. But as the cost of deploying fiber drops, the day of an all-optical network draw increasingly closer.

"Most people believe we will have an all-optical network someday," he said. "The economics are such that it is compelling to deploy fiber (to the home). I think there's an enormous amount of opportunity in the metropolitan and access area going forward. There's been massive investments in the long-haul space and we've still got a lot of catching up to do on the metro and access portions."

Fiber itself provides at least 100 times the capacity to the home as does conventional cable lines. But the paradox is that few individuals enjoy the speed. "Capacity in the long-distance backbone network has grown over 12,000% since early 1997," Jungjohann and members of the CIBC research team recently reported. "At the same time, bandwidth-starved residential customers continue to use traditional dial-up connections as the leading access technology," offering slow connection speeds.

A recent report by telecom market research firm RHK Inc. estimates that the North American market for optical access equipment alone will reach $3.8 billion by 2004, climbing from $2.65 billion in 2000. That spending is expected to continue to increase as fiber technology replaces existing network technology.

A number of startups, including Wave7 Optics, AllOptic, Optical Solutions, Paceon and PurOptix, are working on last-mile solutions. "We look for multiple winners and solutions in this massive industry," Jungjohann said.

Of course, there stand to be multiple losers as well. The same risks that addled the long-haul fiber companies stand in the way of access companies. Many technologies seemed to have unlimited potential, only to peter out.

"I tell people to watch out," Jungjohann said. "Now you have a much smaller target (market) to address."

Morgenthaler's Bellas was so concerned, in fact, that he contacted Wave7 Optics' potential customers to verify their appreciation of the company's technology before making his most recent investment. "We didn't reconfirm our enthusiasm until after we made these phone calls," Bellas said. "We see this as a four- or five-year process, and we're only one year in. Unless everyone's lying to us, it looks relatively attractive."

Others are even more cautious. Jack Harrington, general partner of Advanced Technology Ventures, said many venture capitalists will remain on the sidelines until startups show traction with carriers.

"You need to see traction, legitimate traction, in the market," he said. "With this market, in all fairness, you can afford to wait a little longer. People are more cautious."

Harrington's own investments have been in the metropolitan and long-haul space.

"We're looking at access investments, but mostly looking for those (who would serve) enterprise customers," he said, also noting that spending in Europe and Asia on access equipment will outpace that in the U.S.

But he adds that some venture capitalists may see investing in access equipment makers as a safer bet, simply because "there aren't a bazillian of them out there."

-By Johnathan Burns, Dow Jones Newswires, 201-938-2020; johnathan.burns@dowjones.com

Copyright ¨ 2000 Dow Jones & Company, Inc. All Rights Reserved.

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