Milestone Matters Newsletter
Winter 2006

"The broad and rich foundation of the Internet will unleash a “services wave” of applications and experiences available instantly over the Internet to millions of users . . . This coming “services wave” will be very disruptive . . .. The next sea change is upon us. We must recognize this change as an opportunity to take our offerings to the next level".  Bill Gates, excerpted from his Oct. 2005 memorandum to senior level Microsoft executives.

Dear Friends, Investors and Associates:

The recent holidays and the advent of the New Year have given rise to interregnum reflections on 2005 and prospects for the 2006. The rise of a new breed of economists and sociologists has come to the fore. It is gratifying to note that the media do not make reference to them within any ideological or narrow political context. In fact, some of these academics state bluntly, “I have no politics.” I attribute this to the quantitative approach of this new generation whose mantra seems to be, “show me the data.” So one does not find in their texts inspiring Churchillian rhetoric but what they offer up - an overwhelming array of statistics, which, they believe, illuminates. Although I am a great fan and something of a student of the great British Prime Minister, these young intellectuals are, in their own way, refreshing. I commend to you, by way of example, Freakonomics by Steven Levitt, a young economist at the University of Chicago.

Since there is much lamentation among the chattering classes and since I have been accused by friends and strangers alike of Panglossian tendencies, I have tried to simply look at the data which makes me feel good about the year past and very optimistic about 2006. During 2005, the U.S. economy created 2 million jobs and a total of 3.5 million in the past 16 months. Unemployment has fallen to just 4.7%. Meanwhile, inflation has remained at a low 3% while GDP grew at 3.5% for the year ending December 2005. Although it did not receive headline treatment, it was reported in the fourth quarter of 2005 that U.S. family wealth recently reached an historic high of 51.1 trillion dollars. Most of this value is in real estate assets but more than 50% of U.S. households also own stocks and the Dow Jones is now nudging 11,000.
Alan Greenspan, who has been accorded almost unanimous approbation in the press, stirred consternation when his intention to retire became evident. Despite the return of this presumably indispensable public man to private life, the appointment of the able, but not well known, Ben Bernanke to the post caused not a ripple in economic or political waters.

All this is extraordinary, and particularly so during a year marked by the rise of oil prices to over $60 per barrel, the ongoing struggle in Iraq accompanied by acrimonious political debate, continuing acts of Al Qaeda terrorism and the horrific disruptions and tragedies attendant to the Asian Tsunami, the Pakistan earthquake and hurricane Katrina.

Despite all these misfortunes, the fundamental health of the U.S. economy is evident and a comforting context within which to conclude the investment cycle of MVP II and contemplate the opportunities to be seized by Milestone’s prospective fund - MVP III.

The "new economy," derided after the bursting of the 2000 Internet bubble has regained its footing and is growing apace. Google has become, justifiably, a metaphor for this cyberspace vitality. The king of search engines which went public in August of 2004 with a market capitalization of $23 billion, now boasts a market value of $112 billion. Google’s advertising business alone had earnings in 2004 of $400 million while for the nine months concluding September 30, 2005, advertising revenues were $5.2 billion and earnings were $1.3 billion.

In the hallowed but somewhat insular halls of Silicon Alley, Yahoo has become a kind of "Third Way" to liquidity for venture capitalists. These investors are seeking to finance young Internet-centric companies which they hope to position as attractive acquisitions for Yahoo and its giant Internet peers.

Here in the East Coast Corridor--Milestone’s turf-- we have only admiration for the Internet behemoths but we are wary of trying to anticipate buyout strategies and acquisition appetites. Furthermore, we don't believe that venture investment businesses can be built on once-in-a-decade seminal companies. There are too few of them and they are too difficult to identify. But we see that Google, Yahoo, eBay, Salesforce.com and Getty Images, to cite a few, have demonstrated a variety of business applications enabled by the Internet. At Milestone, we believe that, over the next several years, an array of additional web applications will proliferate to accelerate business development in additional markets and in some cases will, per se, create new markets.

We are far from alone in our bullishness. Recently John Chambers, the CEO of Cisco, forecast a 500% growth in Internet traffic over the near term fueled by the rapid growth of online video transmission traffic.

At Milestone, we seek to identify and to finance our fair share of the young companies that will emerge to satisfy rising demand for Internet-linked solutions.

With gratitude for your support,

Edwin A. Goodman
General Partner
 

In November 2005, MVP II invested in Massachusetts-based Gene-IT, Inc. Gene-IT, the fund’s eleventh investment, provides software and information services to the pharmaceutical industry. Gene-IT's flagship product offering, Genomequest, helps bioscience researchers and IP lawyers conduct large-scale genetic sequence data mining. For example, Genomequest helps biologists interpret the results of experiments and enables IP lawyers to assess licensing opportunities.

Milestone likes Gene-IT's growth potential because 1) biological sequence databases continue to double every 15 months and 2) more sequences were published in patents in 2004 than in the previous 22 years combined.

Milestone invested $500,000 alongside Cross Atlantic Partners and Societe Generale Asset Management in a $4 million financing. Todd Pietri will serve as a director.


In the latter part of December 2005, MVP II invested in SkillSurvey, Inc., a company located in Hawley, PA, outside Philadelphia. Skill Survey is a Web-based job candidate reference checking service for employers. The company’s premiere offering is the eReference product suite, a web-based system that helps recruiters and managers assess whom to hire, develop or promote.

Working closely with another venture firm, Inflection Point Ventures, Milestone co-led the transaction and committed $600,000 as part of a planned $2.6 million financing. Of this latter amount, $620,000 was invested in December and an additional $1,980,000 will be remitted in late April conditional on the achievement of certain operating milestones. Edwin Goodman will represent Milestone on the SkillSurvey board of directors.


On January 5th 2006, CareGain, was sold to Fiserv Inc. (NasdaqNM:FISV) for an undisclosed amount of cash. We are happy to report that MVP II realized a return on this investment of just over 2.25x in 18 months. While there is an escrow and indemnity associated with the sale, these are expected to have no ultimate effect on the value of this transaction. The sale reflected the interest of large financial institutions in the opportunity represented by Consumer Directed Health Care and Health Savings Accounts as well as CareGain’s position as a technology and thought leader in these markets.

CareGain provides insurers and large employers a software platform and complementary consulting services which permit them to implement consumer-directed healthcare plans. Such plans maximize choice and control for the employee with respect to healthcare expenditures and they have resulted in significant reductions in employee healthcare expenses for employers. Milestone was represented on CareGain’s board by Richard Dumler.

When to sell your firm:

•You are doing nothing in China or India but your competitors are

•You are on your third CEO in three years

•You are not growing....the living dead

•There is no shareholder/board consensus on the future of the company

•Your investors’ commitment has waned

Wheeling and Dealing:

•Companies raised $16 billion of VC money in first three quarters of 2005

•Median pre money valuation was $15.6 million

•255 Venture-backed companies were purchased for $21 billion (a median of $47.5 million)

•There were 56 venture-backed IPOs in 2005

•The Four Horsemen of the Internet; Google,Yahoo, Microsoft and AOL continue to make strategic acquisitions

•SARBOX is dampening IPO activity as CEOs seek to be “404 compliant”

Social Networking is tricky:

•Friendster valued at $23 million in 2003 is now worthless

•Facebook is currently valued at $100 million

The Merry-Go-Round:

•Hedge funds sell to other Hedge funds 90% of the time

•Private Equity Firms sell to other Private Equity Firms 50% of the time

•VCs sell to other VCs less than 1% of the time

Source: Dow Jones Private Equity Analyst Conference, November 2005

•Notebook computer growth spurred by corporate employers mandating that their employees use them to facilitate and enrich communication.

•IT job market shift characterized by sharp fall in demand for IT specialists in favor of “versatilists” who handle a wide variety of assignments.

•Business Processing Outsourcing (BPO) to experience accelerated growth with particular penetration of Investment Banks, Banks and Insurance Companies which are struggling with outmoded legacy systems.

•Aging Baby Boomer demographics will continue to drive major IT spending within the Healthcare Industry. Such investments will expand by 50% by 2009.

•Regulatory compliance will drive IT investment through 2008. These IT investments are growing at twice the rate of overall discretionary IT budgets.

•The accelerated growth of VoIP telephony and cell appears inexorable as POTS (Plain Old Telephone Service) usage will continue its decline. By 2010, it is forecast, these new technologies will provide the only telephone service in 30% of U.S. homes.
Source: Gartner

 

Source:  Meketa Investment Group

Pensions & Investments, Hedge Fund & Private Equity Convergence, by Edwin Goodman, Q2 2006.
Excerpt: "The separate realms of hedge funds and private equity funds are eroding. It appears hedge funds are breaking down the barrier to convergence of these two alternative asset classes. But the implications aren’t necessarily upbeat for pension funds and other institutional investors and could greatly complicate their strategic asset allocation models."


About Milestone Venture Partners

Milestone is a traditional venture capital partnership. We invest in early stage, technology-enhanced service companies in the New York metropolitan area. The Fund targets companies that possess the nucleus of an exceptional management team, a compelling business model, and a large market opportunity.



Milestone Venture Partners
551 Madison Avenue, 7th Floor
New York, NY 10022 
V: [212] 223 7400
F: [212] 223 0315
www.milestonevp.com

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