Beware the Venture Capital Herd: It's Overgrazing in Wireless - TheStreet

Beware the Venture Capital Herd: It's Overgrazing in Wireless

The same crowd that thundered into B2C and B2B and then lost interest may be repeating the pattern.
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The way they invest, you might think that venture capitalists have achieved a higher form of social thinking, tapping into each other's thought processes. It could be that so many VCs are clumped together in office parks on Sand Hill Road in Palo Alto, Calif. Or maybe they just sync up their Palm Pilots.

However they manage to coordinate their moves, venture investors continue to march in lockstep from one sector to another. After plunging hundreds of millions of dollars into business-to-business and e-commerce in late 1999, VCs early this year began deserting those categories

en masse

in search of greener fields. Where? Wireless.

The Magic Word

By now, VCs are slamming the door on any hapless entrepreneur still seeking funds for B2B or (god forbid) business-to-consumer start-ups. But those who show up with business plans containing the magic word wireless get the fatted calf treatment. "There's this sense that wireless is what comes after e-commerce and B2B," says Seth Goldstein, a principal at

Flatiron Partners

in New York, which established a fund for so-called pervasive computing in late 1998.

In the first quarter of 2000 alone, some $622 million in venture funding flowed into wireless-communications equipment and service providers, almost half of the entire amount invested in that category in all of 1999, according to

VentureOne

. And there's no sign of a slowdown.

Last Tuesday,

Informio

, a spanking-new wireless-services company that allows customers to get access to Internet voice and data from any telephone, announced a $42 million first round of financing. The Lexington, Mass.-based company is still testing its technology with carriers, and has no customers.

Tantau Software

, a mobile e-commerce player, raised $40 million in a second round of financing on June 13.

And, in a still-choosy IPO market, wireless companies remain shoo-ins.

Handspring

(HAND)

, a maker of mobile devices, went public on June 21 with solid first-day gains of 35%.

OmniSky

, a company that offers a wireless portal for customers of Palm Pilot and other mobile devices, filed on June 16 for an initial public offering, despite only two months of real operating history (see earlier

coverage). That comes on the heels of a whopping $90 million "C" round of financing from powerful backers including

News Corp.

(NWS) - Get Report

,

PSINet

(PSIX)

,

Akamai

(AKAM) - Get Report

, and

AT&T

(T) - Get Report

.

Still, the Palo Alto, Calif., company, which just launched its service in May, faces fierce competition from the likes of

Research In Motion

(RIMM)

,

Sprint PCS

(PCS)

and other wireless-service providers. In its S-1, OmniSky states that it lost $8.6 million for the first three months of 2000, and expects "to continue to incur losses and to have negative cash flow on a quarterly and annual basis for the foreseeable future."

When Wireless Became Hot

The love affair with wireless has been building for years, particularly in Europe. But only in the past few months has it really blossomed in the U.S. You can almost trace the exact moment to late February in New Orleans, the scene of the

Cellular Telecommunications Industry Association's

Wireless 2000 conference. There, top executives from

America Online

(AOL)

,

Microsoft

(MSFT) - Get Report

,

Sun Microsystems

(SUNW) - Get Report

and other companies proclaimed that wireless devices would overtake PCs in just a few short years.

Wireless startups: Too much, too soon?

Market research firms backed up these assertions with bold projections: U.S. wireless subscribers would grow from 68 million at the end of 1999 to 143 million by 2005, says market research firm

Yankee Group

.

Data services, however, are the next frontier -- turning all those cell phones and handheld gizmos into mobile Internet terminals. Spending for wireless data services, Yankee predicted, would balloon from practically nothing to $8.4 billion in the same time frame.

Cap Gemini

is projecting that Internet access from mobile phones will explode from 3% of U.S. Internet users today to 78% in the next 12 months.

No one is disputing that the wireless Internet is going to be big -- really big. The problem is, the herd-like mentality of the investment community practically ensures that wireless -- or whatever the next big thing is after that -- will suffer from too much money going into one sector, producing too many companies for even a huge market to support.

Backlash A-Comin'?

That sets the wireless sector up for the kind of backlash seen in e-commerce and B2B, where the once sky-high valuations of many publicly traded companies have been eviscerated in recent months. "We think wireless is a huge opportunity, but you have to be sophisticated as to where the opportunities are," says Alex Nigg, a senior partner at

EuropAtWeb

, a global venture capital firm. But he adds, "Some of the funding may be on the indiscriminate side. U.S. wireless companies are getting valuations based on the opportunity in Europe."

Mark Lowenstein, executive vice president of the wireless research group at Yankee Group, says the seeds of a shakeout have already been sown. "There has been an absolute

tsunami

in venture funds focused on wireless and in wireless business plans," he says. "The market cannot support this many."

It would be useful for investors to begin to suss out which of these companies might survive post-IPO. Useful, but unlikely at this point. One reason the money seems so indiscriminate is that the opportunities are ill-defined. For instance, Yankee estimates that of the 7 million Web-enabled mobile phones in the U.S., only 1 million of them are used to get information from the Net.

Indeed, no one knows yet how consumers and business professionals will use mobile Internet devices -- or what the killer apps will be. Yet start-ups and their investors are willing to take a flyer on all sorts of guesses -- for example, that you will want your cell phone to ring to inform you that a near-by store is having a sale. (That's when I'll cancel my service.)

Companies such as Informio and

TellMe

are betting big that the interface of choice will be voice in an attempt to get around the tiny screens of cell phones and PDAs; people will use voice commands to summon data from the Net. But at rich valuations -- AT&T-backed TellMe is said to be valued at more than $500 million -- that's a big bet for companies that have yet to generate revenue.

The wireless picture is further complicated by the soup of competing standards for wireless transmission and display. In Europe, short messaging service, which is well suited to smaller screens, is very popular for sending messages between mobile devices. But U.S. carriers are expected to leapfrog over SMS to more advanced network standards, known as 2.5G, which in turn will quickly be eclipsed by third-generation services.

In Europe and the U.S., WAP -- short for wireless application protocol -- has become all the rage. The technology allows Web content to be tailored to the smaller screens and low transmission speeds of today's mobile phones. But, says Nigg, "WAP is very much overhyped. Just because WAP enables you to do things on your cell phone doesn't mean that you'll do it." For example, because of the tiny screens, you're probably not going to want to shop for books on

Amazon.com

(AMZN) - Get Report

from your cell phone or mobile device. WAP is also off to a slow start, particularly in the U.S., where it is sometimes better known as "Where are the phones?"

Another sector in which too many players are trying squeeze through the same door is wireless portals. A host of start-ups here and abroad are attempting to become the

Yahoo!s

(YHOO)

of the wireless world, delivering customized news and information to wherever you are.

Not surprisingly, portal giant Yahoo! has a similar ambition, as do AOL and other major Internet players. The incumbents are likely to dominate the wireless Internet as well, at least in the U.S., cutting off new wireless-portal players. In areas such as Europe, however, where mobile-phone culture is more pervasive than the Internet and people have not yet formed strong relationships with Internet portals, the field is more open to newcomers -- if the big carriers don't lock up the portal market first.

That said, there are many opportunities for companies with the right combination of skill, luck and timing. "There will be new devices, new form factors and new behavior," says Flatiron's Goldstein. "The 10- to 20-times returns vs. the 2- to 3-times are the companies that think more imaginatively about how people will use wireless -- and create the next generation of devices, applications, and infrastructure."

Like any high-risk market, the wireless sector promises to be volatile. Wireless darlings such as

Aether

(AETH)

,

Phone.com

(PHCM)

and Research In Motion have seen their shares see-saw with the broader market: Aether is trading at around 211, nearly a third off its March high, although it still boasts an $8 billion market cap. Phone.com, trading in the low 80s, is well off its highs of the year in March, when it was trading around 200. RIM is also off its highs this year, at 59. And

Vyyo

(VYYO)

, a provider of broadband wireless access that went public in April, is still trading well above its $13 1/2 offering price at 27.

The long and short of it? When it comes to wireless, choose your investments carefully. And beware the herds.

Amy Cortese is a New York-based freelance journalist. At the time of publication she had no positions in any of the securities mentioned, although holdings can change at any time.