©michael borrus, 2003 wisdom from the wizard of omaha “nothing sedates rationality like large...

©Michael Borrus, 2003

Wisdom from the Wizard of Omaha

“Nothing sedates rationality like large doses of effortless money.”Warren BuffetBerkshire-Hathaway Annual Report for 2000(Net profits rose 113%; earning/share rose 2X)

“Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge.”

Warren BuffetMarch 2003


The New Economy Viewup to March 2000

• The Internet changes everything• The economic model of every business will be

transformed• Move first, be the Biggest, Fastest• Spend and spend; Equity is currency• Emphasize marketing hype over real execution• Lay-off the risk onto the Public Market


US Venture Capital Investments1995 - 2000

1,174deals

1,676deals

1,840 deals

2,046deals

3,317deals

4,107deals

Source: PriceWaterhouseCoopers (PWC) MoneyTree Survey in partnership with VentureOne, 2000

$5,070$9,639

$14,350$19,177

$52,455

$99,626

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

$80,000

$90,000

$100,000

$ in

million

s

1995 1996 1997 1998 1999 2000


Mid-1990sVenture Capital Returns, Select Funds

Examples of Funds over 3 years old

Fund Name Inception IRR

Summit III 1991 64%

Kleiner Perkins VI 1992 39%

Mayfield VII 1992 25%

Sequoia VI 1992 110%

Accel IV 1993 79%

Battery Ventures 1994 23%

Summit IV 1995 101%

Kleiner Perkins VIII 1996 287%

Matrix Partners V 1997 516%


Mega VC Funds

Source: VentureOne, WSJ, 10/8/00

Venture capital funds that have "closed," or completed, raising funds with assets or $1 billion or more

VENTURE CAPITAL FIRM FUND NAME DATE CLOSED AMOUNT (billions)

New Enterprise Associates NEA X 9/15/00 $2.00TA Associates * TA / Advent IX 7/10/00 $2.00Spectrum Equity Investors * Spectrum Equity IV 5/15/00 $1.75Technology Crossover Ventures Technology Crossover Ventures IV 4/3/00 $1.64Accel Partners Accel VIII 6/13/00 $1.60Menlo Ventures * Menlo Ventures IX 7/19/00 $1.50Softbank Venture Capital Softbank Technology Ventures VI 5/10/00 $1.50CMGI @Ventures CMGI @Ventures IV 1/1/00 $1.50Redpoint Ventures Redpoint Ventures II 8/14/00 $1.25Patricof & Co. Ventures * APA Excelsior VI 8/1/00 $1.10Baker Capital Corp. Baker Communications Fund II 6/19/00 $1.10Meritech Capital Partners * Meritech Capital I 11/3/99 $1.10Summit Partners * Summit Ventures V 1/30/98 $1.04Battery Ventures Battery Ventures VI 6/13/00 $1.00Mayfield Fund Mayfield XI 4/20/00 $1.00Benchmark Capital Benchmark Capital IV 9/30/99 $1.00Oak Investment Partners Oak IX 9/15/99 $1.00

* Funds may be used for buyouts, public investment, or international investments in addition to venture capital


Venture Capital Investments in the Internet - 5 yr review

Source: PWC MoneyTree Survey Report, 2000

1995 1996 1997 1998 1999

Total Venture Capital Invested in $176 $1,012 $2,003 $3,391 $19,941Internet-Related Companies ($MM)

Percentage of Venture Capital Invested in 3% 13% 17% 24% 56%Internet-Related Companies

Average B2B Deal ($MM) $7.5 $3.3 $5.4 $6.4 $9.9

Average B2C Deal ($MM) $1.7 $2.9 $4.2 $5.8 $15.6

Average Access/Infrastructure Deal ($MM) $1.7 $6.5 $7.0 $6.2 $20.3


VC Investments by Stage of DevelopmentPercentage of Total Deals

1995 – 1999

Misha Petkevich:Misha Petkevich:

Source: PWC MoneyTree Survey and VentureOne, 2000

8%

36%

48%

8%

1%

7%

35%

50%

7%

1%

7%

31%

57%

5%0%

9%

30%

56%

5%0%

9%

28%

59%

3%0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Perc

enta

ge o

f Tota

l D

eals

1995 1996 1997 1998 1999

Start-up/ Seed Early Expansion Profitable Restart


From Capital Market Bubble to Tech Bubble

• Tech spending grew by 2x the ’90-’96 rate from ’97-’00; bandwidth by 130% year on year from ’98-’00

• Unprecedented venture and borrowing activity (next slide) = huge jump in tech spending, esp. comm infrastructure; amplified competitively as older firms responded

• Tech vendors exacerbated by vendor financing and investment in start-ups– Impacts on company financials for quarterly reporting– Compensation impacts

• Self-reinforcing, but ultimately unsustainable tech-capital market cycle


Size of Telecom Fiasco

$0$20$40$60$80

$100$120$140$160$180$200

1996

1998

2000

2002

(es

t.)

BondsIssued

• From 1996-2001, Telecom, a $300 Billion industry:– Borrowed $1.5 Trillion in

bank/non-bank lending

– Issued $630 Billion in Corporate Bonds

• Creative Accounting exacerbated impacts– Use of bandwidth swapping to

generate phantom revenue

– Sales inflation, fraud

$$--Billions

Source: Thomson Financial; WSJ


• The bursting of the equity market bubble changes everything

• Maybe the New Economy isn’t so New– Amazon and B2C E-tailing – What assumptions were wrong?– B2B – What assumptions were wrong?

• Financial Markets: PROFITS and CASH FLOW, not Marketing hype

• Venture Fund Practice: Conserve Capital– Kill/Dispose of clear losers in existing portfolios– Reinvest to support rest of portfolio

• Pray for recovery

The New New Economy View


$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

($ in

mill

ion

s)

1995 1996 1997 1998 1999 2000 2001 2002

US Venture Capital Investments1995 - 2002

1,840 deals



$0

$5

$10

$15

$20

$25

$30

($ in

Billio

ns

)

1995Q1

1995Q4

1996Q3

1997Q2

1998Q1

1998Q4

1999Q3

2000Q2

2001Q1

2001Q4

2002Q3

US Venture Capital Investments1995 – 2002, by Quarter



US Venture Capital Investments by Stage of Development 1997-2003

26%

23%

26% 16%

16%

14%

37%

39%

44% 56%

56%

57%

33%

36%

28%

25%

25%

27%

0%10%20%30%40%50%60%70%80%90%

100%

1997 1998 1999 2000 2001 2002

LaterExpansionB/C roundsSeed/A round

% of total deals


Shifts in VC Industry Sector Focus

• Shift to “safer” investments

• Shift out of tech to bio• Shift to enterprise

value creation from infrastructure (x-wireless)


Venture-Backed IPO and M&A activity by quarter

Source: Venture Economics and the National Venture Capital Association

Quarter

2000-1 90 81 171 23,506.1 8,616.8 32,122.9 2000-2 89 50 139 26,259.9 3,959.8 30,219.7 2000-3 68 76 144 7,840.0 6,880.7 14,720.7 2000-4 53 23 76 9,802.6 2,183.3 11,985.9 2001-1 70 9 79 8,046.0 650.1 8,696.1 2001-2 87 9 96 2,339.7 710.5 3,050.2 2001-3 85 5 90 3,201.7 279.9 3,481.6 2001-4 82 14 96 1,840.9 1,447.7 3,288.6

2002-1 60 4 64 1,588.2 376.3 1,964.5

Total 684 271 955 84,425.1 25,105.1 109,530.2

Total IPO Offer Size ($M)

Total Value of all Exits ($M)

Total M&A Deals

Total IPOs

Total Exits

Total Value M&A Deals ($M)


Exit Strategies for Venture-backed Companies

Number of Transactions--Acquired vs. IPO

0

50

100

150

200

250

300

350

1980 1983 1986 1989 1992 1995 1998 2001

# o

f T

ran

sact

ion

s

M&A

IPO

Source: Securities Data Corporation


Global M&A Activity(2000-2002)

• Global M&A Activity has cratered

• 1997-2000, headcount grew by 40% and remuneration by 88%

• 2001, revenues fell 13%, employment 8%

• Retrenchment is continuing – estimated 30K-50K investment banking jobs eliminated

$0.00

$500.00

$1,000.00

$1,500.00

$2,000.00

$2,500.00

$3,000.00

$3,500.00

2000 2001 2002(est.)

M&A

Unit = $$ Billions

Source: Wall Street Journal and P&P estimates


Venture Economics Post-Venture Capital Index (PVCI) Annualized Returns

Source: Thomson Financial & National Venture Capital Association. As of 2/28/03

PVCI 314 (2.5%) (37.5%) (37.9%)S&P 837 (4.8%) (25.9%) (15.6%)NASDAQ 1323 (0.9%) (31.5%) (30.5%)DOW 7884 (5.5%) (20.5%) (10.3%)

Index Value

Year to Date

One Year Return

Three Year


Net Returns of Venture Capital Funds

• A mature asset class?• $60-70 billion in un-

invested, committed capital• Limited partners are seeking

return of un-invested capital • More asset write-downs to

come• $4-5 billion in secondary

market sales estimated for 2002

-30%

0%

30%

60%

90%

120%

150%

180%

1991 1994 1997 2000

Net Returns

Source: Thomson Financial/Venture Economics & National Venture Capital Association


Recent-vintage Venture Fund Returns

Examples of Funds less than 3 years old

Fund Name Inception IRR

Menlo Ventures VIII 1999 - 34%

Softbank V 1999 - 30%

Oak IX 1999 - 34%

Worldview Tech. III 1999 - 50%

Sequoia IX 1999 - 4%

Battery Ventures VI 2000 - 34%

Kleiner Perkins XA 2000 - 15%

Accel VIII 2000 - 22%

Matrix Partners VII 2001 - 39%


Mega Fund Cuts


Fallout on Wall Street

• Lots and lots of suits by investors, states and SEC

• Basic conflict of interest between banking and equity research/brokerage functions

• Analysts recommended ‘buys’ to clients while their firms sold sold sold

• Other issues:– IPO allocations in return for

trading commissions

60%

65%

70%

75%

1997

1998

1999

2000

2001

2002

0.0%0.5%1.0%1.5%2.0%2.5%

1997

1998

1999

2000

2001

2002

Buy Recommendations as a % of all recommendations

Sell Recommendations as a % of all recommendations


Top 20 Countries by Investment(2000)

Source: PWC Global Private Equity Report

by US $ Billion


Top 20 Countries based on Investment Growth (1995-2000)

Source: PWC Global Private Equity Report

Over 5 years, by percentage


Asia Private Equity Bubble Tracks US with Lag

10,455

2002


Asia Venture Bubble Subsides

2002

2,990


Locational Composition of Asian Private Equity Investment, 2001


Asian Private Equity: Composition by Investment Stage, 2002

Source: AVCJ


Asian Private Equity: Industry Composition, 2002

Source: AVCJ


New York Venture Capital

• Prior to 1950s – Individuals in the finance sector• 1946 – Family funds begin operations• Early 1960s – Formal VC funds emerge• 1969 – Citicorp Venture Capital and its progeny • 1980s – Later stage investment for other regions• 1980s – Buyouts, refinancings, bridge financings• Mid 1990s – Silicon Alley

Source: Prof. Martin Kenney, Work in Progress, 2000


San Francisco Bay Area Venture Capital• 1958 SBIC Act prompts them to incorporate to leverage

Federal funds

• 1960s – Limited partnership form mergers to gather larger amounts of capital.

• 1970s – Larger deals still dependent on East Coast for funds

• 1970s – Technology industry veterans join the VC industry

• 1980s – SV begins to achieve financial independence due to pension fund monies

• 1980s – Deal making accelerates and all prominent VCs must have office in Silicon Valley

– East Coast VCs establish branch offices– San Francisco-based VCs move to Menlo Park

Source: Prof. Martin Kenney, Work in Progress, 2000


Amazon’s Improving Margins

Sources: Company 10Q filings

Q1 00 Q2 00 Q3 00 Q4 00 FY 2000 Q1 01 Q2 01 Q3 01 Q4 01 FY 2001 Q1 02 Q2 02 Q3 02 Q4 02 FY 2002

"Pro Forma"Gross Margin % 22.3 23.5 26.2 23.1 23.7 26.1 26.9 25.4 24.6 25.6 26.3 27.1 25.4 23.5 25.2

Net Income % -21.2 -20.0 -14.0 -9.3 -15.1 -10.9 -8.6 -9.1 3.1 -5.0 -0.6 -0.5 0.0 5.3 1.7

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

Q100

Q200

Q300

Q400

Q101

Q201

Q301

Q401

Q102

Q202

Q302

Q402

Gross MarginNet I ncome


Amazon: Pro Forma earnings vs. GAAP Losses

Sources: Public filings

• Amazon’s “pro forma operating profitability” number is computed by ignoring lots of expenses

• Profit numbers exclude stock-based compensation, restructuring expenses, and investment losses

• Staggering $2.2 Billion in Debt

• Today, shares are down over 70% from the peak

2000 20012002

$0

-0.5

-1.0

in $ Billions

Pro forma Operating loss

Net loss


Has Amazon Turned the Corner?(Q/Q growth and Inventory Turns)

Source: Company Reports

Amazon.com's Year/ Year Sales Growth

2000 2001 2002

1Q 95% 22% 21%

2Q 84% 15% 21%

3Q 79% 0% 33%

4Q 43% 14% 28%

Revenue Growth LTM 2002 2001/ 2002 Inventory Inventory

Company 1Q 2Q 3Q 4Q (E) change (% ) ($MM) Turnover

Amazon.com 847$ 805$ 851$ $ 1,428 26% $202 19.4

Barnes & Noble stores 1,815 1,133 1,159 1,200 6% $1,395 3.8

Borders Group 751 763 749 1,200 3% $1,437 2.4

Sears 9,699 10,142 9,039 12,000 1% $5,961 6.9

Walmart 55,418 60,225 59,266 71,007 4% $29,500 8.3

Revenues


Has Amazon Turned the Corner?(Sales Efficiency of Capital Spending)

Source: Company Reports

Amazon.com's Year/ Year Sales Growth

2000 2001 2002

1Q 95% 22% 21%

2Q 84% 15% 21%

3Q 79% 0% 33%

4Q 43% 14% 28%

Revenue Growth Fixed LTM 2002 2001/ 2002 Assets Fixed Assets

Company 1Q 2Q 3Q 4Q (E) change (% ) ($MM) Turnover

Amazon.com 847$ 805$ 851$ $ 1,428 26% $441 8.9

Barnes & Noble stores 1,815 1,133 1,159 1,200 6% $2,060 2.6

Borders Group 751 763 749 1,200 3% $1,992 1.7

Sears 9,699 10,142 9,039 12,000 1% $12,709 3.2

Walmart 55,418 60,225 59,266 71,007 4% $79,570 3.1

Revenues

©michael borrus, 2003 wisdom from the wizard of omaha “nothing sedates rationality like large...

Documents

michael borrus

deals source

public market slide

new new economy view

capital market bubble

thomson financial wsj

tech bubble tech spending

us venture capital investments