Milestone
Matters - Winter 2003 Newsletter
"Total expenditures
on homeland security by federal, state and local governments, as
well as the private sector, could range from $98 billion to $138
billion in 2003."
Deloitte Consulting Survey findings, June 2002
Editor's
Corner
Dear
Friends, Investors and Associates:
The coldest holiday season in recent memory has
been accompanied by accelerating "bad news" from various
quarters including the venture capital arena, (see tables below).
The highly respected Goldman Sachs Technology Survey recently
announced a marginal decline in corporate technology spending for
2003, a negative revision of their mid-Fall 2002 forecast.
The equity markets amble along aimlessly, presumably awaiting
more encouraging economic statistics, and the removal of the uncertain
shadows cast by the bevy of current crises - Al-Qaeda, Iraq, Israel,
North Korea and Venezuela.
There is no meaningful IPO market with promises of a route
to liquidity, and within the M&A marketplace, there is a plethora
of sellers and few buyers.
Aware of the risk that I might be labeled a Dr.
Pangloss, these gloomy times create an environment which does foster
opportunities if one is patient and knows where to look.
In the current “capital-shy” market, we have time to take
a very deliberate approach in assessing the companies seeking capital. These courtships frequently extend for many months, permitting
us to get to know management well, allowing a more in-depth scrutiny
of the prospective deal and a broader understanding of the addressable
market and the competitive landscape.
For their part, the entrepreneurs in the
field, tend to be hardened by these testing times, experienced and
steely in their resolve. They
are also realistic, and in response to the current climate, have
been abstemious with their capital and edited their business plans
in order to accomplish more with less money.
Consequently, they minimize the equity dilution they would
suffer were they to raise large rounds of capital.
Unlike some of our much larger fund peers, this plays well
to MVP's size and to our strategy of finding non-capital-intensive
companies raising modest rounds of financing, i.e. $2 to $4 million.
We are trying to enhance this general investing
proposition by identifying companies that are, to a degree, insulated
from current problems and in some cases stimulated by certain types
of adversity. Such
appealing target areas include companies that provide software-based
outsourced business solutions.
These companies still do well during difficult times because
their customers prefer not to create the expanded infrastructure
attendant to an internal solution.
Within the healthcare field, the pressures
to contain costs and to reduce time-to-market with respect to new
drugs, have opened up opportunities for firms like Medidata and
Octagon, that expedite the drug approval process.
Of arguably the greatest importance, is the emergence
of the large and growing market for database and communications
software-enabled security solutions.
This is a burgeoning market that has attracted many entrepreneurial
initiatives. We continue
to review prospective investments in this space and are confident
we will find some companies with exciting potential.
We will keep you apprised of our progress.
My partners and I hope that you enjoyed the Holidays
and wish you all the best for a happy and prosperous 2003.
Yours truly,
Edwin
A. Goodman
General
Partner
Milestone
II Portfolio News
Milestone invested
in Octagon
Research Solutions, Inc. of King of Prussia, PA on December
13, 2002. Octagon Research
Solutions ("ORS") is a healthcare consulting company (also
known as a Contract Research Organization or "CRO").
Its practice areas are clinical information management
and regulatory affairs consulting, which it provides to pharmaceutical
and biotechnology companies.
Octagon’s expertise is in managing electronic submissions
to the FDA. In addition,
ORS is developing document workflow software (known as Doc Reg)
which it intends to license to its consulting customers.
Milestone invested
$400,000 alongside Edison Venture Partners in a $3.8 million expansion
financing. Todd Pietri will serve as board observer.
Medidata
Solutions, Inc. completed the fiscal year concluding
December 31, 2002 with revenues more than tripling over 2001.
The company achieved profitability in the second half of
2002. In February of
2003, all the investors participated ratably in a follow-on financing
in the aggregate amount of $500,000 to support the company's expansion.
This capital will be used to bolster the company's software
development budget, to expand the sales force and to strengthen
the quality assurance department.
Milestone Adds Associate
Carl K. Oppenheimer
has joined Milestone Venture Partners as a Venture Associate.
Most recently, Carl was a business development manager at
Sears, Roebuck & Co. where he evaluated merger, acquisition
and divestiture opportunities.
Carl traveled and worked in Europe and the Far East.
For several years he worked for Surface Mount Technologies,
a Hong Kong-based technology company and at Carr Securities in New
York, as an analyst.
Carl
earned his B.A. in Government and French at St. Lawrence University
in 1992 and received his MBA from the University of Chicago in 1999.
Business
Process Outsourcing
When we launched
our fund in June 2001, we planned to invest in three areas:
enterprise software, technology-based business services and
information services. A
year and half later, we have invested in five companies but none
have been, strictly speaking, software companies.
Four of the companies (DPM,
ExpertPlan,
Octagon and Medidata)
provide outsourced services to either the pharmaceutical or financial
services industries and the other company (Knovel) provides online
engineering information to corporations and libraries.
The area we find
appealing in the business services sector is what analysts term
Business Process Outsourcing or BPO.
Traditional outsourcing, such as office cleaning, has been
around a long time. However,
unlike BPO companies, garden variety outsourcing concepts don't
dramatically improve efficiency through technology and centralization.
In addition, as Greg Gould of Goldman Sachs points out in
his research, BPO goes one step further than traditional data center
outsourcing, which CSC, EDS, and IBM Global Services have provided
for many years. In
data center outsourcing, service providers deliver more computing
power for the dollar by building economies of scale.
Over time, these services become commodities, which depress
gross margins to the 20% range.
On the other hand,
a successful BPO service provider (Affiliated Computer Services
-- NYSE:ACS - is the poster child of the space) takes over a specific
corporate function (for example loan or claims processing) and improves
the workflow with best practices, intelligently deployed technology,
and specialized labor. The
benefits thus mainly derive from intellectual capital, finding and
fixing "process gaps" and taking advantage of good software.
Customers not only benefit from dramatic savings (Exult -
Nasdaq:EXLT - reportedly saved BP Amoco 12% - 16% in worldwide human
resources costs) but their capital, time and energy are freed up
to focus on what they do best.
Because the expertise
behind the BPO service is usually difficult to develop, the gross
margins for BPO providers tend to exceed 40%.
The BPO space is also attractive to venture firms because
small BPO providers can successfully compete against large vendors,
as specialized process and domain expertise is more important than
scale or capital base. Finally,
the BPO business models tend to emphasize recurring revenue, which
we find attractive due to the stability and visibility it provides.
One central question
remains; should BPO providers build or buy their own software?
Each of our BPO portfolio companies has developed proprietary
software. However,
prominent public companies, such as Bisys (NYSE: BSG), openly deride
this strategy. Executives at Bisys argue it is too hard to be good at two
things simultaneously i.e. delivering a service and developing software.
They would rather buy the "best-of-breed" packages
openly available on the market.
When those packages become outmoded, they argue, they can
buy the next wave of software that becomes available.
A number of analysts ostensibly agree, as they like Bisys'
low capex. Certain
venture firms that focus exclusively in this area, such as Accretive
Technology Partners, also would argue that customers are buying
an outcome and while technology enables the process it doesn't drive
the outcome.
However, the most
interesting companies we see do in fact develop their own software.
This is because constant process improvement today is as
much about software modification as it is about non-technology process
reengineering. One
could in fact make the case that if you are dependent on an outside
vendor's software to deliver your service, you are inhibited from
constantly improving your service.
These are all interesting
questions and deserve to be studied.
In the meantime, we are going to be searching for niche BPO
providers and hope to make several more investments in this area
in 2003.
---Todd
T. Pietri, General Partner
| Venture
Funds Raised |
|
Year/Quarter |
# of Funds |
Venture
Capital ($ Billions) |
| 1997 |
240 |
18.1 |
| 1998 |
292 |
31.3 |
| 1999 |
449 |
61.4 |
| 2000 |
632 |
97.2 |
| 1Q
’01 |
116 |
12.1 |
| 2Q
’01 |
92 |
11.2 |
| 3Q
’01 |
69 |
7.0 |
| 4Q
’01 |
92 |
5.5 |
| 1Q
’02 |
44 |
1.7 |
| 2Q
’02 |
36 |
2.1 |
| 3Q
’02 |
33 |
1.7 |
| 4Q
‘02 |
31 |
1.2 |
Source:
National Venture Capital Association
| Companies
Financed |
|
Year |
# of Companies Financed |
Total
Venture Capital Invested ($B US) |
| 1994 |
996 |
4.2 |
| 1995 |
1,558 |
7.7 |
| 1996 |
2,141 |
11.7 |
| 1997 |
2,628 |
15.7 |
| 1998 |
3,524 |
21.6 |
| 1999 |
4,545 |
55.4 |
| 2000 |
6,256 |
107.2 |
| 2001 |
3,931 |
41.8 |
| 2002 |
3,012 |
21.2 |
Source:
PWC/Thomson Venture Economics/NVCA MoneyTree Survey
Milestone
Venture Partners
Investing
in early Stage Enterprise Information Technology Companies in the
New York
Metropolitan
Area
551
Madison Avenue, 7th Floor, New York, NY 10022 V: [212] 223 7400
F: [212] 223 0315
www.milestonevp.com
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