Ambition is the key to Israeli entrepreneurship in the telecommunications sector, and it is also one of the vital keys to success for venture capital funds. It can therefore be concluded that there are scores of ambitious men and women in these sectors in Israel. The most ambitious of all appears to be Jerusalem Venture Partners managing partner Erel Margalit.
Margalit, the managing partner and front man at Jerusalem Venture Partners (JVP), handled the ultimate exit in Israel's venture capital industry, even though in the past year, the jewel in his crown has wondrously become the greatest stain on his reputation. The jewel he sold to Lucent (Nasdaq: LU) was Chromatis Networks. The stain is the delay in the distribution of Lucent shares to JVP's investors, which cost them 77% of the original value of the sale. The value of JVP's share of Lucent has nose-dived from $736 million to $165 million.
Margalit, however, will not let setbacks distract him from pursuing his goal of establishing multi-billion dollar global communications companies. Over the past few months, he has labored to complete the financing of JVP IV, which will manage $350-550 million, while simultaneously making investments in new companies through the fund.
JVP's investment activities during the crisis have been quite different from those of its competitors in Israel. While its competitors are mostly marching in place, sitting on their money, and investing in dribs and drabs, JVP is carrying out a more aggressive investment policy than ever. Since the beginning of Q4 2000, JVP IV seems to have invested the largest amount by an Israeli fund in any three quarter period, with the possible exception of the Polaris III fund in the first three quarters of 2000. It is estimated that JVP's activities in the first half of 2001 amount to 10% of all venture capital investment in Israel.
JVP's uniqueness is not particularly surprising. JVP has had exits, with Netro (Nasdaq: NTRO), T.sqware, and others, in which it was the sole Israeli venture capital fund investing. Although other funds participated with JVP in investing in Precise Software Solutions (Nasdaq: PRSE), Jacada (Nasdaq: JCDA), Fundtech (Nasdaq: FNDT) and others, in the past year, JVP has differentiated itself from the other local venture capitalists more than ever. JVP's investment partner in SANgate Systems' $10 million financing round, for example, was Battery Ventures of the US.
Margalit, in fact, believes that JVP is not working with Israeli venture capital funds enough. In light of the increasing financing needs of portfolio companies, he notes, "There are five good funds in Israel, and we'll work with them more than in the past." In this context, it should be mentioned that Gemini Israel Funds is probably the fund that has cooperated the most with JVP, participating in joint investments in Jacada, Precise Software, and Ulticom (Nasdaq: ULCM). JVP has also cooperated with Mofet Technology Fund Management , and Polaris Venture Capital.
However, Margalit generally does not cooperate with local venture capital funds in JVP's core business. He prefers to carry out joint investments in large communications ventures with major overseas funds with deep pockets and worldwide connections. Lucent (Nasdaq: LU) used to be his most important contact, but in the wake of his disparagement of the corporation, JVP has new friends, such as Cisco Systems (Nasdaq: CSCO).
Cisco is a full partner in what seems to be the most ambitious project an Israeli venture capital fund has ever participated in – Cogent Communications of the US. Cogent's ambition is to provide 100 Mbps network hook-ups for $1,000 a month. The company currently operates a 12,400 mile (19,840 kms) network of fiber optic cables that reaches 20 US metropolitan areas.
This operation is less than two years old. JVP led the $26 million seed stage investment, and owns a major share of the company. Cogent has subsequently held a $90 million first stage financing round, and is preparing a secondary $100 million financing round. The money is not being used to build the network. This is where Cisco enters the picture; the company provided Cogent with a $300 million credit line. In other words, the startup company has raised over $500 million since being founded in August 1999. Less than six months after launching its service, the company has 3,000 paying customers, and hopes to post revenue of $100 million in 2002 and $400 million in 2003.
"Globes": You adore this project, but all it's just another communications provider, which isn't exactly a hot field these days.
Margalit: "In the present situation, total expenditures on communications services are declining, but data communication services are becoming more important. Long-term success depends on staying on one's feet over the next two years."
"The long-term winners will be the customer's owners: those who provide expanded IP networks to the end-users – mostly businesses in the first stage – and maintain direct communications with them. There will be two or such winners in the US, plus a few in Europe and the Far East. These will be the big carriers of the next generation."
"Cogent is the Oracle (Nasdaq: ORCL) of the revolution. The moment you provide a business with 100 Mbps, he'll begin using broadband applications. The company has the simple paradigm of net IP with bandwidth beyond anything being offered today, a simple billing model, and the objective of winning as many customers as possible over the next two years. When you offer 100 Mbps at $1,000, 80% of the people you talk with simply cannot say no."
Yet it is a carrier. What are the barriers? Why isn't everyone doing it?
"The barrier is basically financial. Fiber optics reach only 4% of office buildings. AT&T (NYSE: T), for example, bought TCI and wanted to deliver this amount by cable. You know the status of this project. Cogent has raised only $500 million, with Cisco providing the key loans. Cisco simply wants to see a fully functioning IP network."
We have seen big financial rounds and heavy falls.
"True. An operation like this has to organize a positive cash flow in a given time frame, and you need very deep pockets. Look who is investing with us: Oak Investment Partners, Worldview Technology Partners, the Texas Pacific Group, Broadview Capital Partners, Capital Research, and Comdisco."
You said there will be similar companies in Europe and the Far East.
"Yes. We've begun working on a similar project in Europe. This is no simple matter, because everything is different: Standards, suppliers, customers, and business partners."
How did a small Israeli fund like JVP end up leading an investment like this?
"We brought in partners, but they didn't know how to launch operations of this kind, and told us, 'You organize it'."
A lot of money is needed to get such a company off the ground.
"Correct. One of the most important parameters now is whom you work with. You also check out the investors who join you and the depths of their pockets.
"Setting up a systems company in the fiber optics field is a super-ambitious project these days. Super-successful managers are needed, (along with) investors with super-deep pockets and an ability to isolate yourself. Companies like these begin with at least $16-20 million seed stage financing rounds".
Margalit knows what he is talking about. In January, he invested $9 million in a $20 million financing round held by Petah Tikva-based KereniX. This company is less than a year old and has 100 employees. Market rumors suggest that the company will hold a $40 million financing round in the works.
KereniX is not one of JVP's more controversial investments. Controversy surrounds JVP's overseas investments. Margalit has often spoken about his ambition to make the fund less Jerusalem-focused and more global. JVP has opened offices in London, New York, and Tokyo to help accomplish this goal, but the most important move has been the aggressive investments in non-Israeli companies. Cogent is based in Washington DC. Other foreign companies in which JVP has invested include New Jersey-based Kodeos Communications, New Delhi-based Renka, and Paris-based T.sqware.
Meanwhile, SANgate Systems, which Margalit believes is one of the most promising cards in his hands, has a tenuous Israeli connection. SANgate operates in the storage field, one of the market's hottest sectors, and plans to be the first company to enable the transfer of storage files between mainframe and open systems. Margalit believes this will be one of the most important broadband applications, especially since such systems are unable to speak to each other now.
SANgate was founded by ex-employees of EMC Group (Nasdaq: EMC), Wall Street's leading information storage company, which employs many Israelis, several of whom helped found SANgate. Margalit comments that such groups leaving companies -- with or without the company's consent, which in EMC's case was definitely lacking-- is a key factor enabling the rapid establishment of new companies with a core team of workers, which save quite a few headaches during the start-up process. Another example of such a group is Cyoptics, which spun off from El-Op Electro-Optics Industries, with its consent.
JVP regularly succeeds in creating most of Israel's trends. The wave of financing rounds for optic companies, in which JVP was a prominent participant, is known as post-Chromatis syndrome. JVP invested in Chromatis, Israel's first successful optic company, a couple of years ahead of the trend. JVP's policy of investing in foreign companies also preceded similar policies by other Israeli venture capital funds. JVP has even somehow succeeded in fields far removed from its core businesses, such as e-commerce infrastructure and software.
Above all, however, JVP is signaling that it has adopted a business as usual attitude, even during the toughest period ever experienced by Israel's venture capital industry. It is one of the few companies to adopt such an approach. JVP is based in Jerusalem, away from the Tel Aviv-Herzliya investment community, and its staff head out each morning to the office, even in 2001. This is also why when Israeli and non-Israeli communications companies start recovering – and it will happen one day – JVP will be one of the chief beneficiaries of the renewed boom.
Published by Israel's Business Arena on 21 June 2001