Tech Giants Lose Big on Start-Up Ventures
Some of the biggest and most successful technology firms, including Microsoft Corp., Intel Corp. and Dell Computer Corp., are quietly losing billions of dollars in soured venture capital deals.
During the Internet-crazed late 1990s, the cash-rich tech giants watched established venture capital firms earn 100% or better on their investments. So they and their rivals jumped in, helping to push corporate funding to about 20% of all VC spending.
Intel, the world’s top maker of semiconductor chips for computers, has invested more than $3.3 billion in young companies since 1998, backing some 210 start-up firms last year alone. That’s more deals than any other funder, according to VentureWire.
During the Nasdaq Stock Market boom, that largess bolstered Intel’s bottom line in an unprecedented way. In the second quarter of last year, Intel reported $2.1 billion in realized investment gains, or a fourth of the company’s net profit. Without it, Intel’s much-vaunted earnings growth would have been negative for the period.
Now that Nasdaq has plummeted, Intel said its tech portfolio has dropped more than $7 billion in value, and the company booked no investment gains in the March quarter. Dell’s investment portfolio is down more than $1 billion, the company said. And Microsoft’s holdings appear to have fallen $3 billion from their peak, based on company filings.
No wonder: The companies threw money at hundreds of firms, from telecommunications start-ups trying their luck against AT&T; and Sprint to such video content Web sites as the defunct Digital Entertainment Network of Santa Monica.
“It’s almost like they went to the roulette table and tried to put a chip on every number,” said Deutsche Bank analyst Christopher Mortenson.
Because Santa Clara, Calif.-based Intel sold more of its successful technology investments, the company appears to have fared much better than Microsoft and Dell. But Microsoft, and some other major tech companies, won’t say how much they have invested in start-ups.
And unlike a mutual fund, which gives detailed listings of all investments, none of the big companies say how much they put into a specific firm or how much of it they have sold. And the companies have a lot of latitude in how they value what remains on their balance sheets, analysts said.
Some decline is to be expected, as Nasdaq has fallen by about 57% in the last 15 months. The biggest venture-capital gains come when the funded companies sell stock to the public for the first time, and the demand for such initial public offerings has all but evaporated.
But critics say the big tech companies were their own worst enemies. Many of them began investing in earnest when Internet valuations were at their highest. And though all of the companies say they invest mainly for strategic reasons--to build alliances or for access to new technology--and not for financial returns, the definition of “strategic” was surprisingly broad.
Microsoft, Intel and Dell all invested in Web sites offering video programs because they believed superior content would help drive demand for high-speed Internet access, which in turn would lead people to buy more powerful computers using newer chips and the latest software. It didn’t work out that way, and many of these sites are gone. The major tech companies were “making a stretch to rationalize what they were investing in,” said Dave Barry, senior editor of the Corporate Venturing Report newsletter.
Eleven companies in Microsoft’s investment portfolio went public last year, according to Barry’s analysis. But by December only three were trading above their initial price, leaving Microsoft with an estimated paper loss of $156 million, assuming the software giant held on to the stakes. And that figure doesn’t include the majority of start-ups Microsoft invested in that never made it to an IPO.
In the March quarter, Microsoft reported that before taxes it earned $110 million more from selling investment winners than it lost from selling or writing off losers. But during the previous six months, Microsoft earned $833 million before taxes from net realized investment gains, or 17% of the company’s income.
Not all of Microsoft’s losers have been sold, and deciding when to write off an investment in a private firm is fairly subjective, analysts said. At Microsoft, the catch-all balance sheet term including such holdings as “equities and other investments.” Last quarter, that figure stood at $17.5 billion, down from $20.5 billion in September.
Microsoft Makes Long-Term Investments
Microsoft declines to say how much of those billions is invested in struggling dot-coms and how much is in more stable holdings.
But clearly, Microsoft could have cashed in some big winners.
For example, Microsoft invested $15 million for 1% of Akamai Technologies in September 1999, a month before the company went public. Akamai provides a service that speeds the delivery of Web content. Akamai went public at $26 and traded as high as $345.50 the following January, although the stock now goes for about $10.
If Microsoft had sold at the peak, it could have reaped a $325-million profit. But there are no regulatory filings indicating that Microsoft sold its Akamai stake.
A similar lack of filings suggests that Microsoft rode a $5-million investment in Avanex Corp., a fiber-optic parts maker, from $13 a share up to $273.50--a paper gain of $95 million--and all the way back down to about $13 today.
“Should Microsoft have sold more? Of course they should have,” said Microsoft analyst Melissa Eisenstat of CIBC World Markets. “There’s no one on Earth who shouldn’t have sold everything” a year ago at Nasdaq’s record high.
Microsoft has plenty of money to spare, of course, some $30 billion in cash and short-term investments. And spokeswoman Katy Fonner said the company deliberately holds investment stakes longer than less strategic investors might. “Microsoft is able to make long-term investments and ride through the economic waves,” she said.
But some of Microsoft’s investments have been wiped out, including an undisclosed stake in Digital Entertainment Network (DEN); a chunk of 2nd Century Communications, an information technology service provider that folded last month; and $15 million in the office-building communications firm OnSite Access, which filed for Chapter 11 on May 16.
Intel Isn’t Afraid to Count Profit
Other Microsoft investments have been far more costly. Microsoft ponied up $900 million for a stake in wireless network firm Winstar Communications Inc., which filed for Chapter 11 protection in April and listed Microsoft as one of its top five shareholders.
And in May 1999 Microsoft put $250 million into Healtheon/WebMD, now known as WebMD, a much-publicized site offering electronic medical benefits processing and other services. WebMD has lost more than 90% of its value.
Intel has spread its investments even further, quadrupling the dollars it invested in the last four years, according to the company. But Intel has been less timid in cashing out, realizing gains of more than $4 billion in the last year and a half, the company said.
“Some of [Intel’s] returns have been spectacular,” said George Geis, an adjunct professor at UCLA’s Anderson School of Management who tracks Intel and Microsoft holdings.
Among Intel’s successes was a $2-million stake in Web site hosting firm Inktomi Corp. Geis figures that Intel invested in Inktomi at about $3.75 a share. Inktomi’s shares later soared to $241.50; now Inktomi is worth about $11 a share.
Like Microsoft, however, Intel has ridden most of its publicly traded investments up like a rocket and down like a rock. Intel’s investment washouts include DEN, failed online retailer EToys and CyberCash, an electronic payment firm in Chapter 11.
Intel said recently it expects no venture capital gains in the second quarter, again dragging down the company’s overall earnings growth. “This year I don’t think you’re going to see any gains [from investments] at all,” Geis said.
The value of Intel’s investment portfolio, meanwhile, has plunged from $10.8 billion early last year to $3.3 billion as of March 30, said spokesman Robert Manetta.
Dell Computer is in a similar predicament. The top personal computer maker began investing in outside firms in 1999, when it joined several other corporations to fund Linux start-up Red Hat Inc.
Since then, Dell has made 120 or so deals for about $1 billion, according to spokesman T.R. Reid. In the most recent quarter, Dell’s investment income, including venture gains, provided $58 million, or 9% of the company’s pretax profit, down from 17% a year earlier. The company’s venture investments have provided Dell with $846 million in profit in two years, Reid said.
Dell’s remaining venture holdings have dwindled in value by more than half, to about $900 million, Reid said. Among Dell’s troubled investments are Internet incubators Idealab and Internet Capital Group, online insurance marketplace InsWeb Corp., plus the failed DEN site.
“We’re absolutely ahead” in total return on venture investments, Reid said. “We still have unrealized gains.”
Cautious Investing Works Best for Some
Yet with the benefit of hindsight, some more cautious technology companies look smarter for steering mostly clear of the corporate VC craze. IBM, for instance, put a toe in by investing in traditional venture capital funds, then looked closer to see if any of those start-up firms merited a direct deal.
“We don’t run a portfolio sort of fund like Intel does,” said Gerry Mooney, IBM vice president for venture capital. “We’re interested in strategic relationships.”
IBM might talk first about reselling a promising company’s offerings to its corporate customers. “As we build that relationship, maybe in six months, when they do another [investment] round, we might put money in,” Mooney said.
As a result, IBM’s “investments and other assets” as of March 31 stood at $26.3 billion, nearly unchanged from $26.7 billion a year earlier.
Big Blue’s approach “sounds like a great strategy,” analyst Eisenstat said--one that more companies might do well to take up.
Microsoft President Richard Belluzzo, for one, said Microsoft’s investment strategy has changed. “Obviously, we need to be more conservative than we’ve ever been,” he said in a recent interview. “The bar [for start-up funding] is probably higher.”
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Shrinking Tech Profits
Some of the biggest technology firms have profited from investments in dot-coms and other technology start-ups. But as Nasdaq collapsed and the market for initial public offerings dried up, earnings from these investment portfolios have dwindled. Listed below is the percentage of quarterly pretax profit from realized equity investment gains:
*
Intel
‘01: 0%*
*
Microsoft
‘01: 3%**
*
Dell
‘01: 9%***
*
* First and second quarter 1999 and second quarter 2000 include interest income.
** First quarter 1999 includes bond sales.
*** All investment income, including dividends, bond and loan proceeds and interest on cash
Source: Times analysis of quarterly company income figures and company statements
