Lend me a dime?

The sight of borrowers queuing to withdraw their savings from a British bank last week showed how financial concerns – specifically sub prime mortgage lending in the US – can have an unexpected impact elsewhere. However, sub prime’s influence on technology’s notoriously sensitive financial marketplace is far from a given. There are concerns but, for now, these are matched by pragmatism and a sense of preparedness. George Scalise, president of the Semiconductor Industry Association, sounded a cautionary note. “At this stage, it does not appear that the fall out from problems in the sub prime mortgage arena has had a significant impact on consumer purchases of electronic products,” he said. “This is a concern that bears watching going forward.” Some analysts consider the health of US retailing to be a gravity defying act. However, there are questions over how the sector’s dynamics are being changed – potentially for the better – by the availability of advanced technology on a rapid ‘cost down’ price curve. “Consumer spending is a real wild card,” said Pascal Levensohn, founder and managing partner of Levensohn Venture Partners. “If you look at products like flat panel displays, production is healthy and prices are tumbling. That market continues to expand, although you might think it could be held back.” Several of Levensohn’s counterparts point to Apple’s ability to spring a surprise $200 cut for its iPhone before it had exhausted ‘early adopters’. With an iSuppli teardown analysis suggesting an initial production cost of around $250, the current $299 price tag still leaves room for profit, with further manufacturing ‘revs’ to come. Another potential risk is capital expenditure – but the structure of high technology manufacturing has changed significantly. “From the limited perspective of a semiconductor focused corporate VC, a weak electronics market would slow fab investments. Lower capital or R&D investments at the fab level could significantly slow the progress of our portfolio companies,” said Ruben Serrato, venture partner with Tokyo Electron Venture Capital. However, J Christopher Moran, vice president and general manager of Applied Ventures, the corporate venturing arm of Applied Materials, noted: “Companies have outsourced their production to contract manufacturers or foundries. This has shifted the capital burden away from start ups. It may indeed affect relationships as more expensive capital needs to be utilised more fully by filling excess capacity with the products of smaller companies.” Levensohn raised a further point. “An increasing amount of manufacturing has a ‘national’ factor attached to the financing – China is the typical example. Elsewhere, you’re looking at companies like TSMC that have very strong balance sheets. So, there is either some immunity or the power to manage the situation.” An easier area to call is the leveraged buyout (LBO), the multibillion dollar deals that have seen mature semiconductor companies (such as NXP) taken over by private equity investors, who then put much of the debt for the acquisition on the target’s balance sheet. “LBO funding has been outrunning VC funding by about 8:1,” said Levensohn, “but that looks like it’s over.” Sean Doyle, director at Intel Capital for Technology and Manufacturing Investments, broadly agrees: “Large established companies that are LBO candidates will be impacted by tight credit markets. Clearly, mature companies in certain areas of the semiconductor market segment fall into that category.” However, if the LBO business looks moribund, a more optimistic field is venture capital. Notwithstanding every sector’s vulnerability to a recession, equity thinks in a different way from debt – it looks much further ahead, for starters. “There are many well capitalised venture funds active in the market and, by definition, venture investors must take a long term view, regardless of short term market adjustments,” says Doyle. Another repeated comment from VC sources is there remains more money out there looking for a home than there are ‘right’ opportunities. Any across the board tightening will hurt and if VCs have concerns, they are much the same as those in any other economic sector. But there is also a clear sense of preparedness. “If credit markets dry up significantly beyond sub prime and collateralised debt in general, it will affect the overall capital structures of even early stage companies. That said, debt is never typically the largest piece of a startup company’s capital structure so my guess is that VC funds and VC backed companies will weather the storm,” says Bill Tai, general partner at Charles River Ventures. “For VC folks, returns have never really been driven by financial engineering, its always been about being in the right segment and being the winner in creating the leadership companies in new industries. Debt is rarely the 'ticket to success’ in that equation.”