newsletter - second quarter 2004

Ventures West News

Ventures West Continues to Expand Entrepreneur in Residence Team

In May, 2004, Ventures West welcomed Barry Allen as Entrepreneur in Residence.  Barry is the former President & CEO of VSM MedTech Ltd. (TSX: VSM) and will be involved in identifying and evaluating investment opportunities, with a focus on biotech and medical device companies. We now have a total of five Entrepreneurs in Residence in our Toronto and Vancouver offices, one of the largest EIR programs in Canada.  For more details, click here.

Ventures West Expands Biotech Investment Team

Ventures West is pleased to announce that Dr. Maha Katabi has joined the company as Vice President, Life Sciences.  Prior to joining Ventures West, Maha was Vice President Business Development of Chronogen Inc., a drug discovery company developing human therapeutics to treat age-dependent diseases.  Prior to joining Chronogen, she was responsible for managing investments in the life sciences field with T²C²/Bio, a prominent Quebec biotechnology venture fund.  She will split her time between the Ventures West Toronto office and our newly established office in Montreal.  To read the full announcement, click here.

Dr. William Hunter, President and CEO of Angiotech Pharmaceuticals, named the CVCA’s ‘Entrepreneur of the Year’.

Ventures West congratulates Dr. William Hunter, who was named this year's Entrepreneur of the Year by Canada’s Venture Capital & Private Equity Association.  Established in 1992, the purpose of CVCA’s ‘Entrepreneur of the Year Award’ competition is to promote, highlight and celebrate the achievements of entrepreneurs who lead venture-backed Canadian companies.

Dr. Hunter co-founded Vancouver-based Angiotech Pharmaceuticals in 1992. The Company was among the first to successfully discover the clinical potential of drug-coated coronary stents to prevent the excessive scarring that impedes blood flow to the heart.  With over 150 employees worldwide, Angiotech boasts a product portfolio of five approved products and a number of coating technologies which are featured in over thirty-five products produced by medical device manufacturers. Ventures West initially backed Angiotech in 1996.  The market capitalization of the company today is approximately $ 1.5 billion.

New Companies Funded

In the second quarter of 2004, Ventures West participated in five financings, both new and follow on, investing a total of $9.5 million. This is a substantial increase in activity over the same period in 2003.  The two new portfolio companies are NeurAxon Inc. and GaleForce Solutions Inc.

Biotechnology

NeurA xon Inc. is a drug discovery company, initially focusing on poorly treated areas of pain potentially amenable to treatment with drugs aimed at validated but as yet unexploited targets. To read the full press release, click here.

Information Technology

GaleForce Solutions has leveraged core Microsoft  customer relationship management technology to create GaleForce CRM for Financial Services. To read the full press release, click here.

 

Articles and Opinions

The Art of Valuation 

by Paul Kedrosky, Venture Fellow

Investment valuation is part science, but mostly art. But just because valuation is inherently subjective doesn’t mean we should throw out all the rules. Consider the case of the Google IPO.
 
How much is Google really worth? Cynics have a ready answer: Google is worth whatever people will pay. In other words, if investors are willing to accord the online search company a valuation of $32-billion, the mid-point of its proposed pricing, then so be it. That is what Google must be worth.
 
Admittedly, there is some screwy logic to this approach. Say you come up with a highly-detailed discounted cash flow model for Google, one that projects sales and earnings out ten years into the future. Say that you discount all those profits back to the present with your best guess of what a reasonable interest rate would be. And let’s say you come up with a valuation that implied $50 a share would be about right for Google’s shares.
 
Does that mean you should bid $50 a share for Google? You could, but you would get, at best, psychic satisfaction from bidding the “right” price, but not any corresponding stock. Google shares will have all sold at some much higher price, perhaps $120 or more. After all, the company has made it clear that it will be selling stock somewhere between $108 and $135. Pretending otherwise – even if pretending otherwise seems perfectly financially rational – is not very sensible.
 
So, does that mean you should abandon all valuation models and purchase Google at its likely valuation of around $32 billion and the corresponding trailing price-to-earnings multiple of more than 100? Does it mean that Google has abandoned all pretense of valuing a company, perhaps just picking this number based on some arbitrary multiple of Liechtenstein’s GDP?
 
No. The path that Google and its bankers took to this valuation is almost certainly very similar to the path that venture capital firms take in valuing firms before early-stage investments. Google and its bankers undoubtedly looked at how comparable firms were valued and relied heavily on that in coming up with an estimate for Google’s worth. What companies? Internet stalwarts like Amazon, eBay, and Yahoo would have headed the list.
 
With the preceding in mind, the following table summarizes the price-earnings ratios for four Internet stalwarts and their valuations based on twelve-month forward (FTM) earnings. You can see that Yahoo leads the list, trading as it does at 89 times next year’s earnings. Ebay is only slightly behind, sitting in at 63 times earnings, and so on down. Where would Google fit in? Based on reasonably defensible estimates, Google’s 2004 earnings could come in around $2.90 a share. If you assume a $122 IPO share price, that would put Google’s forward earnings multiple at 42, right between Amazon.com and Ebay.

Is that so bad? At face value, not really. After all, Google has better margins than Amazon, is growing comparably to Ebay, and is more profitable than Yahoo. It doesn’t seem unreasonable to value Google similarly to how those companies somewhere around where those firms are valued. After all, Google will have grown revenues almost 100% year-over-year from 2003 to 2004, so applying a 42 time earnings multiple to 2004 earnings isn’t completely implausible.
 
On the other hand, there are some pesky risk factors. For example, none of the above four companies have dual-class share structures like Google does; they don’t, in other words, entrench control in insiders despite having done an IPO. Some sort of discount needs to be applied to Google’s valuation for the share structure. Similarly, discounts should be applied to Google’s price based on the number of insiders and venture firms selling shares in the IPO, and also for the relative newness of the company. (Search engine firms seems to have the lifespan of bottle rockets, with successive generations launching and fizzing out in short order over the last decade.)  And there are other discounts worth applying. For example, there is a huge overhang of Google stock waiting to come crashing into the market. The company is only selling 10 percent of its shares; there are, in other words, nine shares waiting to come tumbling into the market for every Google share being sold in the IPO. And then there is the margin issue, with Microsoft and Yahoo poised to cause trouble in both the search and ad placement markets, thus making it unlikely that Google will be able to sustain its lofty current margins.
 
Where do we end up? At some number lower than the 42-times-earnings figure I suggested above. How much lower is impossible to say, but that is beside the point. Valuing Google in comparison to its peers is useful, but only insofar as you take into account both the things that make the company similar to its peers, and the things that make it different. Perhaps the real value in looking at Google in these terms is that we are now able to say that we now know why Google is valued the way it is valued – it is being valued based on how its peers are valued – and we can make a decision to invest, or not invest, on that basis.  Because relative valuations are not always correct. They are, in a sense, right until they are wrong. As the following figure shows, relative values oscillate around some norms, but they can also drift far from those norms. For example, price/sales multiples in the public markets have been almost everywhere except their long run average of about 1.7. That said, woe betide anyone who tries to use bubble era relative valuations in the current market, or vice-versa. You would have no takers, so it’s useless pretending that what everyone else thinks doesn’t matter.

In a sense, relative valuations represent the wisdom of crowds, to steal the title of New Yorker writer James Surowiecki’s recent book. We can be as clever as time allows in coming up with a valuation for a company based on their intrinsic financials, but it doesn’t really matter. The masses in the markets, whether it is public markets, as in the case of Google, or private markets, as in the case of most venture investments, will make their own decisions. As investors it is up to us to decide the basis for the valuations being accorded firms, and then to decide whether we want to play in markets where we don’t like the valuations. Because if we do play in expensive or seemingly mispriced markets, like the Google IPO, we are going to have to protect ourselves from those inevitable times when the crowds aren’t being very wise at all.

Portfolio Companies' Financings, Acquisitions and Awards 
 
Chantry Networks is an early stage developer of Wireless Local Area Network (WLAN) infrastructure products.

April, 2004 - Chantry Networks announced that it has secured an additional $11 million in a Series B round of private equity financing. The round was led by Ventures West. Flagship Ventures, Primaxis Technology Ventures and Venture Coaches/ Skypoint Capital also participated in the round. 

June, 2004 - Chantry Networks received the award for “Best of Show” at the Wi-Fi Planet Conference & Expo in Baltimore for the category of best “Voice over IP (VoIP) Infrastructure.” The award was given to Chantry as a result of its unique Virtual Network Services (VNSWorks™) capabilities for Voice-over-Wi-Fi (Vo-Fi) communications. 

Convedia Corp. - the leading provider of IP media processing platforms.

June, 2004 - Convedia has been honored by SUPERCOMM with a 7th Annual SUPERQuest runner-up Award. Convedia’s Media Servers were recognized in the Application Layer Systems category for their strategic importance in the rollout of VoIP networks and their ability to help service providers drive cost out of their enhanced service platform while enabling new, highly differentiated network based services. Convedia was the only media server company honored by SUPERCOMM with a SUPERQuest Award. Last year Convedia was honored by SUPERCOMM 2003 as the winner of the SUPERQuest Most Promising Network Technologies award.

INEA Corp. - the financial services corporate performance management solutions company

May, 2004 - After a year of doubling revenues and its customer base, INEA announced that it has successfully secured USD $7.5M in Series B financing to support its next phase of growth. Prior investors Ventures West, Apax Partners, and RBC Technology Ventures were joined by new investor EdgeStone Capital Partners in this round. The funds will be used to fuel growth, enhance product breadth, increase customer support and advance European expansion.

NUVO Network Management Inc. is a leader in the remote management and protection of IT infrastructures

May, 2004 - NUVO Network Management Inc., (TSX Venture Exchange: NNM), announced that the Company has completed the acquisition of the all the outstanding shares of LINMOR Inc. (TSX: LIR).  NUVO purchased LINMOR for 5.6 million NUVO shares and $175,000 cash.  LINMOR's flagship product, Nebula®, is a real-time, plug-and-play performance management product that is easy to deploy, easy to use, easy to maintain, and easy to justify in terms of real, sustainable ROI. As a result of the acquisition, there are benefits to the customers of the Nebula product as well as significant strengthening of the NUVO IT Management Solution.

PolyFuel, Inc. is the world leader in membrane technology for portable fuel cells.

July, 2004 - PolyFuel, Inc. announced it has closed an $18.4 million, third round of funding, bringing total investment in the 5-year-old startup to approximately $40 million. This round, led by CDP Capital - Private Equity includes existing investors Mayfield, Ventures West, Technology Partners, Intel Capital, and Chrysalix Energy as well as new investors Conduit Ventures Limited, KTB Ventures, Hotung Venture Partners, Yasuda Enterprise Development, and BiNEXT, a part of the Daesung Group. The proceeds from this round are expected to enable PolyFuel to support its customers through their initial test market phases and into early stages of commercial production.

Spotlight - Dr. Maha Katabi

Each quarter, the newsletter will feature a member of the Ventures West investment team.

Dr. Maha Katabi joined Ventures West as Vice President, Life Sciences in 2004. She focuses on deal generation and portfolio management in the Life Sciences sector.

Prior to joining Ventures West, Maha was Vice President, Business Development of Chronogen Inc., a drug discovery company developing human therapeutics to treat age-dependent diseases.  Prior to joining Chronogen, she was responsible for managing investments in the Life Sciences field with T²C²/Bio, L.P., a prominent Quebec biotechnology venture fund.

Maha holds a Ph.D. in Pharmacology from McGill University.

Location: Montreal and Toronto

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