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Venture capital veers away from fabless IC firms

Posted: 12 Sep 2008 ?? ?Print Version ?Bookmark and Share

Keywords:venture capital funding? initial public offering? fabless chip company?

Just as Europe was starting to get the hang of entrepreneurial risk-taking with several promising chip startups, the prospects for exits through initial public offerings (IPOs) seem to have dried up. It is the IPOs that give the venture capital companies the big home runs.

A turning away from fabless has been confirmed by one transatlantic venture capital firm, which said it plans to invest most of its funds in Internet companies rather than fabless chip companies. This raises questions as to how the next set of chip company startups will be funded.

Late in July, the partners of Partech International Inc. announced the buyout of Partech International Europe, the European arm of the venture capital firm. The buyout was done by the European managing partners Philippe Collombel and Jean-Marc Patouillaud.

Patouillaud, now managing partner, told EE Times that Partech's strategy is to invest mainly in Internet companies with only a minority of funds going towards electronics component companies. Partech's funds amount to $700 million and its European portfolio companies include DiBcom SA, Acco Semiconductor SA, Netsize SA, Alchimer SA, RealEyes3D SA and Dailymotion SA.

"Our goal line is quite clear," commented Patouillaud. "It is all and only about information technologies. Today, if I told you that we want to bet the majority of our capital on semiconductor component niches, you would probably be surprised."

He continued: "It is true that we tend to do more Internet deals, and although Partech will not exclude investments in companies such as Acco and DiBcom these will not represent most of the funds."

Early 2007, Partech launched the Partech V find with a strategy to invest 50 percent of the fund in Internet and 20 percent in hardware, including components, clean technologies and new materials, noted Patouillaud. The remaining 30 percent is dedicated to software investments.

"Partech V is already one third invested. We can consider that between 45 and 50 percent of the funds is already virtually committed, and the remaining 45 to 50 percent will be dedicated to investments in Europe and in the United States," stated Patouillaud.

Europe and the United States have a good positioning in the Internet segment, he specified. The Internet also has better capital efficiency and low barriers to entry but it has no industrial property and it is more difficult to build an international firm.

For hardware investments, Patouillaud said Partech favors a low capital vision. "This means Partech will fund, in this sector, business models with added-value services and lever effects so as to avoid deals where we have to put 50 million euros ($69.79 million) on the table without having the least idea if we will ever have a product," he explained.

Fabless dilemma
One of the major benefits of the fabless model was that it did not include the heavy costs of owning manufacturing plant. But the exponential increase in the cost of designing at the leading-edge of silicon is making even the fabless business model seem capital intensive.

Talk about Partech disengaging from the fabless business model is too strong but, according to Patouillaud, it is all about choosing the right technology. He stated: "We will rather go to a company that we could then sell to Broadcom rather than to a company that would, one day, compete with them."

The problem with investing in startups to sell them on is that they rarely produce the ten-fold returns or better of an IPO. In the traditional VC world industry sales for a limited return were seen as relative failures.

Commenting on Partech's vision, a European semiconductor company executive, who spoke on the condition of anonymity, declared: "If you have a breakthrough technology, you have a chance. If you don't, you will go head-to-head with Broadcom, Qualcomm, Intel or one of their divisions. If you were looking at investing, invest in something that Broadcom doesn't have and then you go to Broadcom."

According to Dow Jones VentureSource, Europe's venture capital sector recorded 167 deals across all industries in Q2 08, the lowest quarterly total in at least nine years. The 858 million euros (about $1.26 billion) invested, was a 35 percent drop from the 1.33 billion euros (about $1.95 billion) invested in 286 deals over the same period in 2007. Early stage rounds accounted for 44 percent of all deals done in Europe during the first half of the year. Dow Jones VentureSource commented that this may indicate the region may be nearing the bottom of its decline.

With a high ratio of early-stage funding it is logical that larger Series B and Series C investments are likely to follow in subsequent years. Unfortunately a lot of that early-stage money is drifting away from the traditional semiconductor industry and towards businesses which can tout buzz words like CleanTech.

"VCs are more cautious," noted the unnamed semiconductor executive. "This has to do with the world economy. The global economy is a concern right now. Besides, Europe is still an expensive place to operate, especially considering the United States and the valuation of the euro currency. Also, [a lot of] the VC money comes from the United States, and there are still cost boundaries issues with regard to the VC community in Europe. UK-based VCs only invest in English startups. That's a concern."

Economic condition
Just a few years ago, VCs were throwing money at fabless chip companies that promised to get a feature in silicon faster and consuming less power than the competition.

Companies such as Broadcom and Qualcomm have since fulfilled their promise by becoming multibillion dollar companies. Nevertheless, increasing mask and manufacturing costs of nanometer technologies, associated with lengthy design cycles, and decreasing chip volumes have made it harder to start a fabless chip company in recent years.

For fabless chip companies, the source continued, it is a million dollars a mask. "That is just one of those economic factors you can't get away from. This is just to get the mask done, and the first mask is not necessarily the right mask. So, you are looking at large costs before even opening the doors to hire people."

Partech's Patouillaud added another element. There is consolidation in the industry due, in part, to an ever increasing integration of silicon. What was the added value of three companies "separately expert in digital, analog and RF" becomes the responsibility of one company with a single multifunction chip. That also contributes to price erosion and a limited number of big order givers. It is thus harder for a startup to access those order givers.

According to the semiconductor industry source the VCs are becoming segmented and specialized. There are angels, early-stage, mid-stage and late-stage VCs. One aspect of this is that VCs increasingly do not want invest in a company that does not have a product or a revenue stream.

According to Richard Vacher-Detournire, chief financial officer for fabless supplier of smart card chips Inside Contactless SA (Aix-en-Provence, France), because a fabless model is capital-intensive it needs to target high-volume markets to be viable, and not all VC funds have the financial ability to back such companies over time. Not all startups trying to raise a Series B succeed in closing such a round, Vacher-Detournire continued. It occurs that existing investors refuse to pump more money in because circumstances have changed and they no longer the see the upside.

Vacher-Detournire added: "It looks like fabless chip companies being capital-intensive and needing a long time to mature, require that you focus on very big markets in order for the companies to be viable and for the VCs to be able to recoup their money in a magnitude that will compensate the risk taken. It is true that by nature it is much more difficult to create a fabless chip company quickly compared to an Internet company that can grow quickly but whose revenues can be very volatile too."

Other sources in the semiconductor industry said they are confident VCs will never turn their backs on fabless chip companies.

"It is harder to get money and to get evaluation. But, VCs are always going to be there. These guys are sharks. They will always go where the money is. If they see somebody making money in fabless, they will go into that. If they see a breakthrough technology, they will go into that. Their job is to make money for their investors, and they are not going to shut that pipeline."

- Anne-Francoise Pele
EE Times Europe

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