Clouds and mobile apps are hot with VCs; telecom is cold

Matt Walker, Principal Analyst, Ovum

AUSTRALIA: Venture capital (VC) investments in telecom have fallen recently, as detailed in our report Telecom Industry Health Check (3Q10): Financial Deals Tracker.

In 3Q10, VC funding of telecom service providers and hardware vendors plunged to $220m, half the 3Q09 level, spread across just 22 deals; VC spending on just the vendors was down 47 percent to $192 million.

Innovation from hardware start-ups is central to telecom’s progress, so this trend is disconcerting. A review of 3Q10 data shows that VCs are eagerly funding services and software-centric ventures in areas closely related to telecom: “cloud” (including online storage, file transfer, smart computing, data virtualization, WAN optimization, etc.), mobile applications, and “green” (energy efficiency, smart grid, etc.). Nonetheless, telecom hardware-centric start-ups need more support.

Telecom hardware markets are commoditizing
The recent decline in VC spending on telecom has coincided with the financial downturn, but that can’t be blamed entirely: investment in other tech segments hasn’t fallen as badly, and some sectors have even seen growth. There is no lack of exits for successful vendors: the IPO market has improved, and vendor M&A activity is ongoing.

The decline in telecom hardware investment has come at the same time, though, as the big Chinese vendors Huawei and ZTE have really made a splash on the world stage. Since these vendors were once positioned as ”me-too’’ suppliers of cheap hardware, their rise to the top of global rankings has increased fears of commoditization.

Competing vendors have repositioned their portfolios around applications and services, de-emphasizing networks and hardware. Likewise, VCs have steered resources towards start-ups positioned to play in telecom through software/applications and services. This means that hardware-centric innovation may come increasingly from the big established vendors, while start-ups will play much more to the “new” side of telecom: services and software applications.

Services and software spending rises in 3Q10; future VC investments will concentrate on the ‘cloud’

While Ovum’s quarterly financial deals report focuses on telecom, a review of the larger deal database indicates that telecom has been neglected recently. In 3Q10, the software and services segments attracted significantly more VC dollars than a year ago, up 60 percent and 15 percent, respectively. Meanwhile, 3Q10 investments in telecom vendor start-ups were down 47 percent over the same period.

This does not mean that venture firms are ignoring telecom, but their interest has morphed away from “boxes” (hardware) and towards businesses built on software/application and services expertise.

Analysis of our database indicates that the telecom-related tech start-ups now attracting venture financing are involved in online video and content delivery networks (CDNs); network optimization and wide-area network (WAN) acceleration; smart grid/energy efficiency; data centers and storage; and technologies that somehow tie into the ”cloud.”

Since “cloud” is becoming an all-purpose buzzword for high-capacity, distributed IP wide-area networks, many ventures can be positioned as enabling or leveraging the cloud. To stretch the point a bit: social networking is another hot segment, and while we would certainly not call it “telecom,” without the telecom infrastructure underlying the cloud – the value of social networking would quickly go to zero.

Let’s not forget the nuts and bolts
Users are putting enormous pressure on telecom networks across the globe – fixed and mobile, terrestrial and undersea. Business ventures and social networks require a high-performing, reliable physical telecom network (a cloud) to function. You can’t simply throw bandwidth at all your network problems; even if you could, your CFO may not allow you to.

Many of the best ideas for improving the capacity and efficiency of telecom networks come from outside the confines of big corporate R&D departments. Hence there is a need to refresh the flow of VC funding into telecom vendor start-ups, especially the hardware players – from chips to systems.

In 3Q10, we had good news from two disparate locales: Juniper and ZTE separately launched their own small VC funds, about $50m each. Like many larger tech firms before them (Cisco, Motorola, Google, Intel, etc.), Juniper and ZTE aim to fund complementary innovation. Given the dearth of cash available for hardware-centric telecom start-ups lately, let’s hope that others follow.