GREGORY ROSS : Tracking Technology’s Tots : Medical Fields Are Raising Some Promising Youngsters

Gregory Ross keeps a close watch on Orange County’s growing high-technology industry from his spacious ninth-floor office in a Costa Mesa building.

Ross is a senior partner at the Orange County office of Arthur Young & Co., a national accounting firm. He is also director of Arthur Young’s local high-tech group, which provides financial and consulting services to technology companies. Arthur Young is one of several major accounting firms in the county with specialized high-tech services.

Ross has worked in Arthur Young’s Orange County office since 1977, when he was transferred from Boston to handle the firm’s account with Fluor Corp. of Irvine.

For the past 8 years, Ross’ office has been compiling statistics on Orange County’s technology industry. He has tracked the progress of growing technology firms and paid particular attention to how they got their start and where they got their financing.

Ross’ research shows that biomedical and biotechnology companies are attracting most of the venture capital financing coming into the county today. That’s a big change from 6 or 7 years ago, when computer and electronics firms attracted the most attention from outside investors.

In a recent interview with Times staff writer David Olmos, Ross discussed the county’s changing technology industry and where it appears to be headed.

Q. Is it difficult for Orange County technology companies to attract venture capital at this time?

A. It really has been difficult throughout the 1980s for Orange County companies to attract venture capital. If we look at the number of companies that have received financing in the county--and there are about 130 of them--they have varied from electronic and consumer-based companies getting most of the funding in the early ‘80s, to health care and medical device companies getting their financing in 1987 and 1988.

Q. How do you explain that shift in where the venture capital money is going?

A. As the computer industry has become more competitive here in Orange County and throughout the world, there have been fewer opportunities for venture capital companies to receive the kind of financial returns they demand on their portfolio companies. They’re seeking to branch out into the medical technology area, where the potential gains are much higher.

Q. How do the financial performances of computer and medical technology companies compare?

A. The gross (profit) margins in the medical device field range from 50% to 60%. Whereas, if you look at a typical manufacturer of IBM-compatible personal computers, the gross margins are about 30%.

Q. What’s the track record of county companies that have received venture capital funding?

A. If you look at Orange County companies that have attracted venture capital in the past 5 years, only six of them have gone public. I think that’s significant. There have been more than 15 acquisitions of Orange County companies that had venture capital backing and only six public (stock) offerings in the past 4 to 5 years. Of those 130 venture-backed companies, at least seven, and possibly as many as 15, have gone bankrupt. That’s a very poor record.

Q. How much venture capital money has been invested in county technology companies? And what type of companies are getting it?

A. The 130 companies have received about $649 million since 1982. There’s been a significant change in where those venture capital dollars are going. In the 1983-1984 period, 53% of the county companies receiving venture financing were computer firms, whereas 25% where in the medical technology and health care field. That contrasts with 1987-88, when 70% of the companies receiving financing were medical-related companies and 14% were computer firms.

Q. What’s the track record been so far for these medical technology companies?

A. They have not grown up to be significant Orange County employers, but instead have been acquired by many of the large county-based medical technology companies, with the attendant loss of jobs and loss of additional opportunities for growth in the county. In San Diego, they had a home-run company with Hybritech, which was acquired for $400 million by Eli Lilly and Co. We haven’t had a similar very large acquisition like that.

Q. Do any Orange County computer companies qualify as home-run companies?

A. AST Research is a home-run company, but we have not had many in the county. If you compare our track record with Silicon Valley’s, we aren’t close. They have had many more companies grow to $1 billion (in annual sales). It’s difficult to say why. If we look at the types of companies being started in the county, they aren’t significantly different from what you would see in Silicon Valley.

Q. Are there any smaller companies you see now as having the potential to be major successes?

A. The only significant public offering we’ve had in the county since the 1987 stock market crash has been a company called Medstone International, which manufactures medical devices for removing gallstones and kidney stones. Medstone (headquartered in Irvine) went public last June and has grown substantially. Its profits have increased significantly, and it is on very rapid growth rate. Another significant county company that received venture capital funding was FileNet, which raised over $35 million in venture funds. FileNet has grown since going public, but it is not yet rivaling Western Digital or other significant county companies. FileNet hasn’t showed the type of potential that the venture capital backers had hoped for.

Q. Does the the venture capital that goes to Orange County firms come from within or from outside the county?

A. There are now more than 30 venture firms represented in the county. Most of the money in the 130 deals has come from outside the county. Although the companies are here and doing business here, they still have to go outside the county for participation in their deals. Additionally, there are many more venture financing companies throughout the world than there are resident in Orange County. And a lot of those U.S. and international firms want to make investments in California.

Q. It’s quite difficult for a high-technology company to complete a public stock offering now, isn’t it?

A. Since the October, 1987, stock market crash, there have been very few venture-backed companies that have gone public, in Orange County and nationwide. Nationally, 98 venture-backed technology companies went public in 1986; 81 companies in 1987; but only 35 in 1988. So the decrease has occurred nationwide. What has happened is the underwriters have been unwilling to take a company public and have found resistance in the marketplace. We would expect this to reverse some time in the early 1990s.

Q. What effect would a recession have on all that?

A. It would delay the rise out of the trough that we are currently in. What’s needed is stronger (demand) from the investment community for new public issues. The market now is unwilling to take on high-risk, high-tech companies. If you look at the returns on Orange County-based high-tech companies to their investors since the stock market crash, you find the Dow has risen about 18% since the first quarter of 1988, whereas county technology companies are up about 28%. So, there’s a 10% higher return from county technology companies compared to the Dow. That would lead one to believe that the underwriting community will eventually recognize Orange County technology companies as having some potential, and will be willing to take more of them public.

Q. Are there a lot of Orange County high-tech firms ready to go public when the time is right?

A. In 1988, there were more than 37 companies in Orange County that obtained venture financing. Most of those are still quite small. The appetite of the public marketplace has varied over time. There was a time when new companies with barely a product on the street and little sales history were considered a good investment because of the future potential, to times when only more mature companies with a history of sales and profits were in favor. No one really knows where we will come out of this depression in the public marketplace. If it comes out on the side of younger, smaller companies, then there are a number of Orange County companies that are ready.

Q. How many small county companies would you expect to go public?

A. Probably dozens of them.

Q. Where are those entrepreneurs coming from?

A. They are coming from the aerospace companies and from the ASTs and Western Digitals of the community. They are also coming from the health care and medical device companies such as Allergan and American Hospital Supply. These large companies are spawning people who come out on their own with product ideas. Oftentimes, these products simply were not viable for the companies they worked for, so they left to pursue their ideas on their own.

Q. Why is it important for Orange County to have spinoff companies and for employees of large firms to quit and form their own ventures?

A. If we look at employment trends in the county and nationwide, the majority of new jobs are created by small companies, not large ones. In the county, we see a large number of small companies in the Irvine Spectrum area and the industrial parks. They are the growth potential for the county.

Q. How does Orange County compare to Silicon Valley or other high-tech areas as far as nurturing these entrepreneurial companies?

A. The county has a number of the types of support organizations you would see in Silicon Valley, such as the American Electronics Assn. and UC Irvine, which has initiated a corporate-university partners program to bring Orange County companies on campus to explore joint research projects.

Q. What are some of the advantages that Orange County has that favor growth of its technology industry?

A. I think the county has recognized the need for specialized services and has grown those kind of services, such as public relations firms, lawyers, accountants and others to help nurture start-up companies. Lately, we’ve seen more Silicon Valley-based professional service organizations move into the county to bring the expertise gained in other marketplaces to here. A number of Bay Area law firms have created offices in the county during the past 18 months, as well as public relations firms specializing in high tech.

Q. Is Orange County as far along in that regard as some other areas? For example, San Diego?

A. San Diego has been working at it longer and harder. Scripps Institute and UC San Diego have been quite active in the biotechnology field. We are ahead in the electronics area. They have a significant success story in Hybritech. They have an infrastructure of individuals associated with Hybritech, who have done it before and now are out helping individuals to try to do it again.

Q. What do you consider Orange County’s biggest success story?

A. AST Research, I think, is probably our most recent significant success story. Although lately we’ve seen some press stories that would lead one to believe they’re not as profitable as one would hope. But they have clearly grown over the years from a very small company started by three founders to a significant player in the world of IBM-compatible personal computers. AST is really the only significant, venture-backed company that has been a major home run in the county.

Q. You’ve been watching the Orange County technology industry for the past 8 years. What are some of the changes you have noticed?

A. We’re starting to see more home-grown talent than we used to have. Historically, there hasn’t been a strong infrastructure to support the entrepreneur-engineer who’s looking to come out of an aerospace, computer or medical technology company and start his own company. There have been strides in this area the past 5 years to give more support to those people. There has also been more of a history in the county of entrepreneurs who have started companies, grown them to a size where they were merged or acquired, and then gone out and started another company. That change has helped the growth of the county because those entrepreneurs now understand the complexities and pitfalls of the marketplace and can bring more experience into their second or third ventures.

Q. How is the county’s high-tech industry going to change during the next 10 or 15 years?

A. With the high cost of housing in the county and the difficulty of obtaining affordable labor, it is increasingly going to become an area for research and development operations and corporate headquarters. Intensive manufacturing won’t be done in Orange County. It will move to other states or offshore. But we will continue to attract the brain-trust people, the corporate executives, engineers and scientists.