Starent, BigBand and Infinera: Forget the IPO, Why Not an LBO?

The WSJ wrote yesterday about the recent tech IPOs and the new tech IPOs on the way. The focus of this post is the upcoming BigBand, Starent and Infinera IPOs. These companies have filed S-1s and want to join RiverBed (RVBD) and Acme Packet (APKT) as recently listed companies. Putting RiverBed aside, Infinera, BigBand, Starent and Acme Packet all share a few common characteristics. They are system level (or box) companies that sell networking infrastructure to service providers. I will be the first to admit that there is a difference in applications and targeted service providers, but I want to put the fine print aside for one minute and assume that the service provider market is consolidating and offering a common set of services.

As I am typing this post, Riverbed has a $1.98B market cap and Acme Packet has an $878M market cap. Not bad for companies who have quarterly revenues in the range of $36M and $25M respectively. I took the time over the past few days to read all three S-1s as well as talk to a number of people about BigBand, Starent and Infinera. When you read an S-1, they are full of risks, conditions, warnings and disclosures that can scare the most bullish investor. In practice, stating that you have competitors with a longer operating history and better brand name is not really news or risk that is going to scare an investor. Here is my take at separating the real risks from the stated risks:

Starent S-1

As I read through the Starent S-1, I noticed that on page 1 it states they sell direct and through OEMs. This is a positive, as I think that emerging companies who target large service providers as their end-market need an OEM channel to market. On page 5 I see revenues are not doubling year to year, but growing nicely and I also note that Starent has been profitable for two years. 2005 was basically a break even year with 2006 showing good growth and profitability.

Page 8 of is where the first of two real risks are identified. Do you remember back in December of 2006 when Nortel (NT) announced it was selling their UMTS business to Alcatel/Lucent (ALU)? It is my guess that Nortel’s decision to go forward with a focus on 4G (best long term strategic decision for Nortel), affected the relationship with Starent. The Starent S-1 states on page 8:

In 2006, we derived more than 40% of our revenues from our CDMA OEM relationship with Nortel Networks, of which more than half was related to one mobile operator, and more than 30% of our revenues from Verizon Wireless. We terminated our OEM relationships with Nortel Networks in December 2006.

There is a fairly long section on page 11-12 that provides some details on the Nortel relationship. If I was advising an investor in the DD process regarding Starent, I think it comes down to a level of comfort with three questions:

Will Starent replace, recover or sustain the 40% of revenues achieved through the Nortel OEM? (see page 11-12)

Can the company build a successful business in GSM/UMTS as it has done in CDMA? (see page 10)

Does the company need a partner in GSM/UMTS as it did in CDMA?

Infinera S-1

I am not going to devote much time to Infinera, because I have written about the company in the past. If I was advising an investor on the DD process regarding Infinera, I think it comes down to a level of comfort with one question:

Optical is a competitively intensive business that consumes capital and has a variety of global competitors. The business of selling optical networks is hard and there are no safety mechanisms on the nuclear weapons. Optical is not for the faint of heart. The key risk factor for an investor to be comfortable with is the competitive nature of the business and the ability of the leadership team to succeed? As a data point, Infinera has secured $315M in PE-venture money, compared to $98M for Starent and $105M for BigBand.

BigBand S-1

As with Infinera, I am not going to write expensively on BigBand as I have already posted positively on the company. There are three key questions that an investor must be comfortable with regarding BB:

Only one quarter of profitability and a big win at Verizon. Can they find another application at Verizon to broaden the business?

Will other service providers (i.e. Comcast, Time-Warner and AT&T) adopt a switched video architecture?

What is future of their CMTS business? Will the market rapidly adopt DOCSIS 3.0 and will BigBand win share greater share in a DOCSIS 3.0 market, then their current position in the DOCSIS 2.0 market?

PE Hypothesis

As I spoke to people about these companies, I commented that the negative aspect about filing an S-1 and going public is the secret aura around a late stage startup is no longer a secret. All the information on the company’s performance is public knowledge and it is refreshed every 90 days. I have posted in the past on how being a public company affects a leadership team and creativity. My comment lead one person I was speaking with to ask whether these companies should stay private and build their businesses.

When I look at each company, I can clearly see why they need to go public. They need to fund more resources at the point of attack in the market, although it appears Starent has not spent their last investment round. All three of these companies are basically undercapitalized in the market. My next thought was about the vast amount of money that flows into the PE-buyout firms. Wikipedia reports that:

Private equity fundraising reached new record levels in 2006, with data from Private Equity Intelligence showing that a total of 684 funds worldwide achieved a final close over the course of 2006, raising an aggregate $432 billion in commitments.

As a PE-buyout thesis to explore, perhaps one of these three companies should have explored having a PE-buyout firm, take them private by buying out the venture guys? The hypothesis is for a buyout of the PE-venture firms, use the capital that PE-buyout firms have to buy assets from larger public companies or buy public companies that have lost direction, but have legacy revenue streams. The objective is to build a big company that can compete on a global scale. All three of these firms could have formed the core business team of a really big company built on a rollup of legacy and emerging technology companies, which is just an idea on a Tuesday afternoon.

Full Disclosure: I do not own shares of any of the companies mentioned in this post.