August 2002

A Battered Telecom SectorChaos Or an Opportunity ???

Shastri DivakaruniGeneral Partner

Continuum Venturesshastri@continuumventures.com

August 8, 2002.

August 2002

Operations of a VC Fund

August 2002 3

Stages of a VC Fund

• Formation – Partners, Roles, Equity, Niche etc.

• Fund Raising – Road show, Validation and acquire LPs

• Investing

• Deal Flow, Screening, Selecting and establishing a value

• Term Sheet and Equity negotiations

• Agreements on Governance

• Building Value for the Portfolio Company

• Harvesting – Design & facilitate an exit

• Liquidate and Distribute to partners (LPs + GPs)

August 2002 4

Positioning for a Fund

Size/Stage

Expansion & Consolidation

Growth

Development

Early Stage, Seed, and Start-up

Investor Risk

Minor Minor Majority Total Control

NurtureInfluence/Facilitate

Guide Control Role

< 10% 10 – 25% 25 – 50% > 50% Ownership

• Special Situation Playerseg: Bowman

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Market & Execution

Execution

Product, Market & Execution

Technology, Product, Market

& Execution

• Merchant Bankers• Madison Dearborn• Soros Group

Levered Buyout(KKR, etc.)

• Private Placements(Several)

• Large VC firms• Institutional VCs

Public Markets

ML, GS, CSFB, etc.

IPO Markets

• Angels

InvestmentFocus

August 2002 5

Investment Focus: An Example

System & Subsystems• Routing & Switching• Transmission Systems• Access Loop (Last Mile)• Media Gateways• SAN/NAS Systems

Infrastructure Software• Enabling Platforms• SAN (Virtualization)• Network Middleware• QOS• Multimedia Content Handling• Security

Next Gen Integrated Circuits• Security• Wireless- Multiprotocol Chips• SAN Protocol Chips• Special Purpose ASICS• Multimedia Integration• Power Saving Devices

Breakthrough Applications

• Enterprise Productivity• Integration of ApplicationsTechnology & Tools

• Process Technology• CAD/CAM Tools

35%

25%

10%10%20%

August 2002 6

Understanding the Value Chain

Chips Subsystems SystemsComponents

Infrastructures/w

OperationsManagement

EfficiencyEnhancers

Next GenerationService Operators

• Philosophy:• Leverage broad trends in industry

• Focus on attractive segments (target areas)

• Invest in multiple areas of value chain

Euphoria&

Bullish Markets

Gloom&

Bearish Markets Ride the Value Chain

August 2002 7

Multi-Stage Investing: Investor Expectations

Formation Seed Series A Series B Series C Series D

Seed & Series A• Feasibility

• Core Team

• Engineering

• Marketing

• Biz Dev

• Positioning Advantage

• Sustainable Competitive Advantage

• Customer Validation

• Create barriers to entry

Series D & Mezzanine• Market Acceptance

• Product and Sales Scaling (expansion)

• Multi-Functional Teams

• Organization

• Product Margins

• Production

• Financing

• Customer Satisfaction

• Financial Integrity

Series B & C• Product / Productization

• Customer Acceptance

• Operations Infrastructure

• Execution

• Engineering

• Sales

• Marketing and BD

• Financial Controls

• Product shipments

• Revenue Forecasting

Mezzanine Exit

August 2002 8

Forces Influencing Investment Decision

InvestmentDecision

TechnologyTrends

Market Pull &

Needs for Products

Status of Financial Markets

Portfolio Intrinsic Value

Competition

August 2002 9

Screening Criteria:A Template Approach

Prioritized Components Weight

100 max.

Team (Founders & Mgmt) 15 points

Market Timing - Exit View 15 points

Space - Idea (Mapped to fund Focus) 15 points

Financing Risk (Co-investors) 13 points

Intellectual Property and Patents 12 points

Investment Leverage & Intangibles 10 points

Valuation 10 points

Competition 10 points

A minimum of 70 points needed for consideration.Criteria varies per investment stage.

August 2002 10

Deal Flow

Appraisal

Due Diligence & Approval

PartnerContacts

Extended NetworkVC ReferralsTAB

Partners/Industry Experts/TAB

Rigorous Methodology

Investment Committee Approval $$$

Governance & Nurturing

Board Of Director and/or Operational Participation

$$$

Investment Process

Syndication & Funding

Spin Ins

August 2002 11

A Fund’s Advantage:Designing An Exit

•Knowledge Network in Action•Early Stage: High Leverage•Network of experts: SME•Proven Methodology

Investing

•Rigorous process forQualification•Syndicated Investments•Value oriented approach•Milestone based financing

Nurturing

•Operating expertise•Entrepreneurial history•Leverage extended networkin industry relationships•Continuous refinement

Harvesting

•Relationships with bankers•Relationships with strategic buyers•SBIC leverage enhances return

Continuous Improvement

Dealflow & Screening

August 2002

Selected Market Data & Dynamics

Source: CSFB

August 2002 13Source: Factset based on data from 4/9/90 and 10/31/2001.

Category

> $1 Bn

$100MM - 1Bn

< $100MM

33

118

134

$194

$38

$5

322

582

759

$2,807

$210

$23

# Companies# Companies Market Cap ($Bn)Market Cap ($Bn)

# Companies# Companies

19901990 20012001AllAll

Market Cap ($Bn)Market Cap ($Bn)

285 $237 $3,0401663

Dramatic Growth in New Companies and Market CapTechnology Companies and Market Cap by Size Now vs. 1990

16.5% CAGR 24.7% CAGR

August 2002 14

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Moore’s Law of Nasdaq Ran Out of Gas in Y2K

January 1983 - Present

Doubles in 8 years

Doubles in 4 years

Doubles in 2 years

Doubles in 1 year

August 2002 15

Performance of Top IPOs of 1999 and 2000

Top 50 IPOs of 1999 Top 50 IPOs of 2000

1805%

78%-6%

-92%-72%

1004%

-200%

0%

200%

400%

600%

800%

1000%

1200%

1400%

1600%

1800%

2000%

IPO Priceto

12/31/99

IPO Priceto High

High to5/23/00

5/23/00 to7/17/00

7/17/00 toCurrent

IPO Priceto Current

328%

103%

-32%

-66%-62%

84%

-100%

-50%

0%

50%

100%

150%

200%

250%

300%

350%

400%

IPO Priceto

12/29/00

IPO Priceto High

High to5/23/00

5/23/00 to7/17/00

7/17/00 toCurrent

IPO Priceto Current

August 2002 16

Continued Volatility Results Multiple Short Market Windows

# of Negative Pre-Announcements (1)

(1) 3 weeks into each quarter

1Q 2001 2Q 2001 3Q 2001 4Q 2001

61 110 118 161

1/2/01 4/4/01 6/19/01 9/23/01- - - -

1/24/01 5/22/01 7/2/01 10/16/01

# Days 22 48 13 23 27 23

Trough to Peak 24.8% 41.2% 7.8% 21.0% 23.7% 22.9%

1/24/01 5/22/01 7/2/01 10/16/01- - - -

4/4/01 6/19/01 9/23/01 10/23/01

# Days 70 28 83 7 47 49

Peak to Trough -42.7% -13.9% -33.8% -1.0% -22.8% -23.8%

PEAKS Average Median

TROUGHS Average Median

August 2002 17

$153.0 $123.2

$318.9

$691.0

$33.8$10.0 $16.6

$111.1$97.3

$0.0

$100.0

$200.0

$300.0

$400.0

$500.0

$600.0

$700.0

$800.0

1993 1994 1995 1996 1997 1998 1999 2000 2001

M&A MarketTechnology Mergers & Acquisitions, 1993-2001

$ Billions$ Billions

YTD

Source: Securities Data Company as of 10/31/2001.Incl. Domestic and Int’l transactions, pending or completed,

with transaction value >$50MM, excl. share repurchases.

95 95 228228 833833

289289

120 120 164 164 48748765 65 3535# of

Deals

August 2002 18

THEN: MAY 1999 NOW: June 2002

Accretion/DilutionAccretion/Dilution

Acquirors willing to accept significant earnings dilution for promise of significant growth opportunity

Acquirors typically accept zero to small amount of earnings dilution in exchange for growth prospects

Little tolerance for cash burn

ValuationValuation

Many bidders drove up valuation Public market offered liquidity

events for startups, driving up valuation

Few acquirors in this market Public market more stringent;

therefore, fewer startups obtaining liquidity

Time to revenueTime to revenue

Revenue could be more than one year away

Revenue and Clear path to profitability

Must be at least in customer acceptance and scaling mode

Customer baseCustomer base

Potential for customers Small base, many in trial stage Highly concentrated revenue

Quality, well-financed and diversified customer base with recurring revenue stream

Perceptions Towards Strategic Transactions Have Changed in This Difficult Market Environment…

August 2002 19

Consolidation activity has slowed significantly from the torrid pace of early 2000

Operating issues have forced many traditional acquirers to focus internally

Market volatility has created uncertainty as to “true values” and hesitancy to make commitments

Current Status

Public MarketScrutiny

Public equity markets have become less forgiving of ill conceived or poorly executed transactions

Heightened scrutiny of both long term strategic and near term financial implications of any transaction

Integration plans must be well thought out and expertly communicated to the market at time of announcement

Earnings dilution is a major concern

Valuation

Uncertainty over proper valuation levels remains

Many sellers focused on last year’s valuations

Valuation analysis has returned to traditional earnings and cash flow based methodologies

Consolidators no longer playing with “funny-money”

Resulting in a Challenging Near Term Environment

August 2002 20

(90% ) (90% )

(68% )(74% )

(100%)

(75%)

(50%)

(25%)

0%

PERCENTAGE CHANGE IN STOCK PRICE SINCE MARCH 1, 2000

Comm. Equipment eBusiness Internet Infrastructure

Semiconductors Optical Internet

Nortel Lucent Alcatel Cisco

(94% ) (98% ) (98% )

(72% )

(100%)

(75%)

(50%)

(25%)

0%i2 Ariba C1 Siebel

(96% ) (99% )

(80% )

(99% )(100%)

(75%)

(50%)

(25%)

0%Inktomi Akamai VeriSign InfoSpace

(56% )

(83% )(91% ) (88% )(100%)

(75%)

(50%)

(25%)

0%Intel BroadcomPMC-SierraConexant

(94% ) (98% ) (94% )(85% )

(100%)

(75%)

(50%)

(25%)

0%

JDSUniphase Sycamore Corvis

New Focus

(88% ) (93% )

(44% )

(23% )

(100%)

(75%)

(50%)

(25%)

0%Amazon Yahoo! AOL eBay

Note: Corvis and New Focus data is from IPO Pricing of $36.00 and $20.00, respectively.

Let’s not forget the companies that have gone bankrupt:

Many Potential Buyers Have Seen Their Share Prices Plummet

August 2002 21

With stock prices at record lows, the notion that cash is king is being reinforced

In particular, large cap companies with depressed P/Es are using cash as their preferred acquisition currency

Sellers prefer liquidity in these uncertain times

Interest rates are at unprecedented lows

Many companies are taking advantage of the convertible market’s tremendous appetite for technology issues to build “war chests”

Premium PaidAnnc. FD Equity NTM 1-Day 30-Days

Date Target / Acquiror Value ($MM) P/E Prior Prior Acquisition Currency

2/22/01 1,492 NM 89.9% 121.2% Cash

6/11/01 1,208 54.9 91.5% 101.9% Stock/Cash

4/24/01 1,000 - NA NA Cash

3/30/01 400 - NA NA Cash

10/2/01 200 - NA NA Cash

SELECTED ACQUIRORS USING CASH AS ACQUISITION CURRENCY

As a Result, Companies Have Begun to Use Cash To Fund Their Acquisitions

August 2002 22

Source: Venture Economics Information Services

VC Returns Under PressureCumulative Vintage Year Performance of U.S. Venture Capital

Funds

Pooled IRR average %

August 2002 23

There have been 5 recessions in the U.S. since 1969

The average recession lasted for 12 months and resulted in a 2% contraction in GDP

During recessionary times, the S&P 500 has not demonstrated significant drops, except in ‘73 - ’75 (-23%)

Markets begin to recover one quarter before the trough and gain an average of 23% in the following 6 months

Expected Timing of Recovery by Sector

Overviews of Previous Recessions

Peak-to-Trough3M Pre - 3M Post

Trough

RecessionLength of

RecessionDecline in

GDPPerformance Of

S&P500Performance Of

S&P500

Dec-69 - Nov-70 12 Months -0.6% -7.0% 18.7%

Nov-73 - Mar-75 16 Months -3.0% -23.0% 38.8%

Jan-80 - Jul-80 7 Months -2.2% 12.7% 19.9%

Jul-81 - Nov-82 17 Months -2.9% 5.6% 23.9%

Jul-90 - Mar-91 9 Months -1.5% 4.8% 12.4%

Average 12 Months -2.0% -1.4% 22.7%

Q4'01 Q1'02 Q2'02 Q3'02 Q4'02 Q1'03

Comm. Equipment

Semiconductors

IT Services

Internet Infrastructure & Services

PC & Hardware

Electronics & Contract Manufacturing

Software

Recessions Are Followed by Market Rallies

August 2002 24

2000 2002

Revenue in Sight $10M +

Time to Profitability 6 - 8 Quarters Profitable Now

Valuation Metrics Revenue Multiples P/E Multiples*

Revenue Base (in quarter going public)

The Bar is Set Higher for IPOs

* Depends on Industry segment and Supply

August 2002 25

Return to “irrational exuberance” any time soon Indefinite losses will be bankable Me-too, undifferentiated companies will be bankable Valuations on private financings will hold up

Don’t Count On:

Focus on business model, sponsorship, uniqueness, barriers Develop alternative financing plans, merger partners Shift business models to accelerate profitability and cash flow Finance ahead of needs when windows present themselves

Plan To:

Implications

August 2002 26

Summary

• We get back to the Basics of Venture investing

• Amid the chaos, it is an opportunity for those who understand the technology and the industry

• Our expectations should be realistic. Implied correlation between public and private market valuations

• We may have been set back to 80’s type of investing – with proper risk/reward structure

• Equity markets are still good – Private equities have higher reward for those who can tolerate higher risk

• This cycle will continue. Stay tuned……