Stratton Sclavos, Verisign CEO

The next big trends: Sclavos says security is the hot topic for 2004. We watch 10 billion network interactions on our DNS cluster and I can tell you where the viruses are and it is increasing. We’ve moved from low value hacking to concentrated attacks to accomplish theft (of identity and money).

I think the next three years of innovation in technology is about integration, where we take all the boxes we’ve bought and make them work together. We’ve underestimated the power of IP to be an integration point.

On his work advising the Department of Homeland Security: We are trying to prepare the country for that inevitable digital 911. When asked what the attack would look like he says “Did you think someone would fly two planes into the World Trade Center?” This strikes me as a profoundly unrealistic charge — he says we need early warnings, as though there is a realistic chance of throwing us back into the Stone Age. It simply can’t happen. Systems may go down, and the whole Net may be clogged, but the destructive attack he is describing would not be possible in a heterogeneous network — all he is doing is making an argument for diverse open source infrastructures.

There are enough security vendors in this room that make great technology that you can stitch together to protect your network, but it is a simple risk reward calculation. Yes the Net is inherently insecure, and we will created layered solutions and then it is a matter of calculating the risk and return.

Alex Vieux: How can you write down $14.5 billion and still have your job?

Sclavos: When we bought Network Solutions, we did it all for stock at a time when our equity was trading at north of $200 a share. Now it is trading at $17. We gave up 40 percent of the company to acquire an asset that generated 60 percent of our revenue for the past three years. That being said, we did not sell the Network Solutions we bought. We sold the retail storefront, the domain sales front end. We have a back end system, a directory technology, that we kept and has been as a core Verisign asset.

All the businesses we are in now are recurring services that rely on technology we own for differentiation.

We are growing. If you strip out the retail unit of Network Solutions we just sold we were growing for the past two years. We have managed firewall services that will grow. The second area is new directory services: we’ll be a player in RFID, VoIP, and we route half the calls in North America and will move that to the Internet in the next year.

There are a lot of point competitors in the space, but our largest customers and competitors are the same group, the RBOCs.

A key to Verisign’s business is being the directory outsourcer for the telephone industry. Four of the carriers have issued RFPs for backbone switching technology. The Vonages of the world have made their stand. The cable guys have said “Hey, I’m a carrier too.” I hope we are more realistic about the growth potential for that business [than in 1999]. But it’s all coming to pass.

Laughs when asked about ICANN. I’m probably the only CEO in the history of technology to go to the government and ask them to regulate us because we stand today in the Internet is a well-meaning policy that is poorly executed. ICANN was designed at a time that has passed. This is not your grandfather’s Internet. You got to be kidding me that we have volunteers running very important pieces of the addressing and messaging system of that infrastructure. It’s time to stop playing consensus builder and go commercial, like every other industrial revolution.

Asked about the SiteFinder address redirect trick Verisign rolled out. A group of “200 technical zealots” were against it and they got all the headlines. Did they misinterpret it? Of course. We’re not going to let this go. It is going to be the point where we answer the debate.

He then goes on to say that we need to move the complexity back into the center of the Net! He says the edge can’t be so complex. Get David Isenberg in here! Ross Mayfield, sitting in front of me, laughs out loud. I am dumbfounded. According to Verisign, the Net should not be open to any type of application, only applications that rely on single providers of services, like Verisign. This is troglodyte talk.

He says he’s laying the groundwork to bring SiteFinder back — exactly the consensus building he just condemned. So, the question is, why should he be able to politic and others who do should be labeled zealots?

SiteFinder was a way of monetizing DNS searches. He said eight of ten people clicked the Search box when the correct spelling of the site was in front of them. He says they will find new ways of monetizing DNS that they will talk about in the future.

Mitchell Kertzman session

Mitchell Kertzman is founder of Powersoft and web programming developer Liberate, now a partner in VC firm Hummer Winblad.

Kertzman is asked about the rumored run for governor of Massachusetts he considered after leaving Powersoft. He says that he did not want to become a full-time fund-raiser so that he could run negative ads to win office.

The VC business is in the midst of a shake-out. There is a generic problem in having too much money available. The long-term players have extreme discipline about the money they manage while young VC firms can make many mistakes, including giving young companies way too much money. They can hurt firms by encouraging overspending. Cites example of entrepreneurs who are primarily concerned with valuation to explain how smart businesspeople are much more concerned with building long-term business relationships.

Alex Vieux: Is the VC industry returning to the poor practice of herd investing?

Mitchell: What you see today is the companies that should have failed have failed. So, most VC firms are no longer in triage mode and have returned to building. In social software, we see a kind of mini-bubble. We haven’t pulled the trigger on a social network investment, because we can’t see the business model.

Just because you can’t see the revenue model, doesn’t mean there won’t be one. But because you can’t see a business model also doesn’t mean one will appear.

Alex Vieux asks about Google: Kertzman responds that every company doing business with Google thinks it is easier and better than working with Microsoft.

Refers back to the bubble years and the tendency of the press to focus on “visionaries,” which distracted them from running their business. The Google attitude, that there is no way to know the future, will serve it well.

Market caps (like Google’s projected valuation), are set by buyers not sellers, so the price is what it is…. When Kertzman was at Liberate, which never had revenues of more than $80 million and was never profitable, the market cap was $12 billion — “that number scared the hell out of me and I expect it will scare the hell out of [Google CEO] Eric [Schmidt], too.”

I think the reason we’re seeing an increase in deals is that there are some terrific companies out there.

This year there is a year-end rush in venture capital. That’s driven by companies.

HummberWinblad is focused on very early stage companies. So, when we invest we are not thinking in terms of short-term liquidity. But the economic environment is much better and companies are planning to grow, which is driving deals.

Geographic investing: It has to be a great deal to make us go outside the Bay Area, but we’d go anywhere for a great company.

In the 1970s, you could start in the U.S. and sell only in the U.S.. Then, a year or two later, you could go to Europe. That’s because the Europeans knew nothing that was going on around here. This has changed — when companies are global by their very nature.

Kertzman thinks private companies should not have to disclose information about confidential decision-making.

Today, if you are a public company the best thing to do is not talk to the market. The market has been dumbed down to the lowest level.

Too much money in the market eliminates the Darwinian function of the market, companies that should fail don’t fail.

Sachio Semmoto, eAccess

Co-founder of KDDI, the second-largest telephone company in Japan, Sachio Semmoto’s eAccess has gone public and now sells $100 million in product a year and is valued at more than $1 billion. He is an academic while acting as an entrepreneur.

He’s doing slides on the broadband market in Japan…. In one of those curious moments, he has to figure out how to operate the slide controls.

Japan is the largest ADSL market in the world — about 10 million subscribers. This accounts for 17.7 percent of the population, compared to 14.6 percent in Korea and 16.4 percent in the United States.

In total, there are about 12 million broadband subscribers in Japan. NTT offers fiber to the home, but has only 600,000 customers. Interestingly, there are only 2 million cable data subscribers.

Semmoto says the reason is that Japan’s is the fast and cheapest ADSL service in the world. In Japan, ADSL service is 14 Mbps. Korea offers 8 Mbps. Here in the U.S., ADSL is available only at 1.5 Mbps. The cost for the service in Japan is $26 a year, half the average U.S. cost.

If I were getting that kind of speed for that price, I’d be a happy camper.

The eAccess model is roughly the same as Covad. It provides IP services over existing lines through partnerships with carriers, including NTT. SoftBank, another competitor, is losing $1 billion a year because they provide physical connections. Being the provider of logical connections on other companies’ cables is a viable and profitable business. eAccess has more than 4,000 co-lo facilities with NTT today. Provisioning time has plummeted from three months for a new line to about seven working days today.

eAccess has lobbied for unbundling of dark fiber, which has allowed it to develop an infrastructure that links its POPs without significant capital expenditures. This has allowed eAccess to become the largest IP backbone owner in Japan. They partner with ISPs to get service into the market at a low cost to eAccess.

A key cost savings was achieved by having consumers set up their connection themselves.

People in Japan are embracing VoIP services, which was more important to eAccess’ growth than wireless services for a long time. Now, the company is contemplating entering the content business now that it has such a large channel in place.

The discussion with Alex Vieux turns to SoftBank, which has spent several billion dollars on build-out, but never achieved profitability. Alex presses on whether SoftBank will collapse under the debt of the past few years.

Semmeto suggests that SoftBank spends $200 to acquire a customer. Then, there is the question of reach. eAccess has local presence, with perhaps 800 co-lo facilities where SoftBank is in 2,200 co-lo facilities. The addressable market for eAccess is much smaller than SoftBank.

Alex asks about the move from KDDI to eAccess: Why go from a $22 billion company to a startup?

Semmoto: My wife said I shouldn’t do it, but I say the broadband trend. Nobody stood up. KDDI is still moving too slowly and bureaucratically, so we started eAccess. The company will become the #1 data oriented content company in Japan, Semmoto says, achieving revenues of $10 billion.

Logitech session

Alex Vieux begins this session pointing out that 25 percent of CEOs in the Fortune 500 are foreign born, which tells us the United States is a great place, because it welcomes people and gives them opportunity, and that the IT industry is globalizing.

This session begins with an interview with Guerrino De Luca, CEO of Logitech, who says he was really excited about addressing the last inch problem.

20 percent of Logitech’s business is in Asia. Home penetration of the PC in the home in Asia is a key to Logitech’s recent growth. “We are very Chinese in culture — a third of our engineers are in Asia” even though the company is essentially European.

Alex asks: Will Apple survive?

Guerrino: No one asks that question anymore. Of course Apple will survive. While I was at Apple, I learned the cost of being arrogant. I also learned the enormous importance of products. Apple is the ultimate product company.

Alex: What is the mix of cultures in Logitech, technology or consumer electronics?

Guerrino: Consumers care about products. The key ingredient is not technology, but an understanding of what the consumer wants. So, I think we’re becoming more and more a consumer electronics company.

We’ve always used our products to build our brand. The band is an accessory and the product conveys what you stand for.

Alex: Are you threatened by competition from China?

Guerrino: We feel threatened from every angle. But…. our cost structure is Chinese. We can build these products as inexpensively as anyone on the planet. This forces us to keep running to stay ahead. We have to innovate all the time. That’s the nature of the business.

Microsoft has been in the mouse and keyboard business for 15 years and we’ve been hanging in there, sometimes ahead and sometimes right behind. We are also best buddies, because without the Wintel platform we would not exist — Microsoft is more of a partner than a competitor in the grand scheme of things. Microsoft decided to have mice and keyboards because they wanted to control the complete user interface experience.

Some companies, like Samsung and Sony, might become more interested in this space, but we have the scale to compete. Our market is not bigger than five or six billion dollars a year, and Logitech is a $1.2 billion company.

Compared to electronics companies, we are very competitive. The industry averages five or six points of margin while we average about 10 points.

Alex: Let’s turn to online gaming and the way people play changing — how does that impact the industry and the products.

Guerrino: We’ve chosen to connect with video game platforms, particularly PlayStation. Our business is growing, because gaming is going back to its roots through online, which makes gaming social again after a phase of development where computer gaming was largely solitary.

Sony is targeting girls and families, which are very important. Extending gaming beyond young men is an important trend.

Logitech has not invested in the applications and content in gaming and productivity, because it isn’t a good idea to diversify just for diversification’s sake. The company sells 100 million units a year, which is extraordinarily high volume in the IT industry. We will stay focused on devices and technologies that complement those devices. Logitech might provide services, but it won’t become a software product.

We try to be wherever consumers buy these kinds of devices. We’ve broadened our distribution over the past five years — 20 percent of product is sold by online retailers.

I believe acquisitions don’t work. We’ve made two acquisitions that worked, so we’re defying statistics. The reason they were successful is that we paid far less than the value we brought to the deal. It was not expensive for us, we were the right buyer. De Luca said he is looking at a few potential acquisitions.

Alex: Are you going to migrate from being a mouse company to being a Quickcam company?

Guerrino: The PC and mouse will be around for years. But more than 50 percent of our revenue comes from non-PC devices, especially in gaming.

Thomas Weisel presentation

Thomas Weisel Partners chairman says the recovery is real. Cites the advice of Michael Boskin, Bush I’s chief economic advisor, who says that growth will be around 4 percent in 2004. Expects to see growth in the market continue.

Inventories are starting to increase in expectation of demand. If the Fed hikes rates by two to three percent, we would have a very severe correction. But I don’t think that will happen. Until the election, the Fed will keep rates low.

The other interesting issue is China. China is the only other source of innovation and value creation in the world economy. They are poised for an industrial revolution. He names a number of industrial companies, John Deere and Boeing, among them, that will benefit from supplying China.

The most interesting part of the market remains small-cap. The PEG ratio for these companies is 1.1 times next year’s earnings, compared to the S&P average of about 2.5 times forward earnings. So, the markets are not overpriced.

65 percent of the NASDAQ has no analyst coverage or coverage by only one analyst. The reawakening of coverage of these companies will drive interest and valuations. Weisel has increased research coverage by 29 percent compared with the larger banks, which have contracted coverage by as must as 40 percent. The whole next wave will be a dozen small research firms in the Bay Area that try to fill that void. Weisel says it is cheaper for his firm to build coverage than to acquire those firms — most of this activity, if you ask me, will be done with licensing/publishing deals, where research is purchased without the old ties between compensation and the trading volumes research drives.

The IPO market is still dormant. You have to go back to the 70s to find a period of such slow IPO activity. I believe you’ll see an explosion of IPOs in 2004. We did 50 in 2003 and I expect we’ll see 250 or 300 in 2004, but that is still below the late 90s.

PIPEs activity (private placements for public companies) peaked in 2000, but we’re almost back to that level now. Public companies have not had trouble finding money, but the deals have been favorable for the investors with the cash.

Weisel makes an interesting comment: The relationship between companies and analysts will now take months, not weeks, to develop. This indicates that there is still a role for coverage in the investment banking relationship, which is the source of a lot of the problems the market had in the past. It would be much more comforting to hear that it is not simply a matter of taking more time to establish the link, that the link has vanished. If an analyst is going to do their job, they should do it for the public market or for the company, but not for both.

Alex Vieux asks: What happens to the banks that laid off most of their Silicon Valley staff?

Weisel: Many of these banks have downgraded the involvement of analysts in the investment banking business or, like Solomon, moved analysts to the retail side. They need to play a role.

Sarbanes-Oxley is harmful, because it costs companies so much to comply that they can’t be public. The level of accounting and oversight is way over done. We’ve changed all our policies in anticipation of what the regulations will look like.

I don’t think the kinds of services investment banks provide for companies has changed a bit.

There is a lot of consolidation yet to come in the tech industry — 10,000 private companies and 3,500 public companies. The logjam is starting to break. You are going to get a very large amount of activity in the M&A business.

A couple pointers on M&A activity:

Audience aggregation–Direct marketing M&A is way up in 2003, as companies seek to build up large audience blocks. The same is happening in television, both as a result of relaxed ownership rules and the urgency to keep a critical mass of audience members on the marketing hook.

It’s happening in software, too.

Weisel says the new EU rules for mergers, which impose a nine-month cooling off period in a merger deal, will virtually kill M&A in Europe.

Sitting in the conference by the bay

The Red Herring Fall 2003 conference, the first event hosted by Red Herring’s new owner, Dasar, begins today. I’m sitting in a hotel on the pier in Monterey. Alex Vieux, the new publisher of the Red Herring, is explaining that the Herring was acquired at auction and will extend its coverage beyond the early-stage companies that characterized the magazine, to provide a global perspective on the technology industry. The publication is currently only on the Web. The mailing list was sold separately, so the magazine will not relaunch until fall 2004, when the exclusive on the list expires. In the meantime, the new Herring will have a year of online experimentation before it publishes again.

[Rough notes — not to be taken as verbatim or for any dietary purposes]

Jim Daly, the editor of the Herring, is about to interview Sanjay Kumar of Computer Associates.

Jim starts with a question: What are the key issues your company is looking at.

Sanjay: I believe the recovery is happening, but I am not as bullish on it as many. Buyers have been making decisions on different terms than before and they won’t change that (they are used to buying cheap and will continue it). Security is the other big area of opportunity, that security is maturing. Wireless is important, but there are security and sustainability. Healthcare and what is happening with insurance create a lot of opportunities for tech companies. He concludes with digital rights management, touching on micro-payments.

Jim: This new parsimonious buyer–what do you do about that?

Sanjay: Here’s the way we look at the high-end buyer–they have the GE Syndrome. They say, “Last year we spent $100 with you, and this year we need to spend $90 to get the same thing.” So, we have to figure out how to sell more to these people, since a company cannot sustain itself on repeat sales alone.

Jim: How about outsourcing?

Sanjay: People who outsource for the wrong reason will fail disastrously. If you have an IT department that is a disaster where the CEO is abdicating responsibility through outsourcing are making a mistake. But, where there is a service that should be managed by an outsider, like telecommunications infrastructure, that makes sense.

We don’t have any clue about how big the move to outsource back office work, which presents a macroeconomic challenge for the United States.

Jim: Will the M&A market come back?

Sanjay: We were a firm believer that the industry had to consolidate by the end of the 90s. What we got wrong–what I didn’t see-was the bubble coming. We got to the year 2000 and we’d bought the companies that we wanted to buy, and we spent time digesting those purchases. We’ll likely come back to the acquisition market, but more conservatively. Here’s what we’re interested in:

  • Management software
  • Extensions for wireless
  • Security, specifically for the enterprise
  • Linux

Jim: You’ve been investigated and criticized by customers. How is that affecting your business?

Sanjay: In late 2000/2001, we went to a sort of subscription model. Our industry is going to go to utility model. CA took a leap of faith and implemented this early. The company has most customers on month-to-month payment.

Client-server is a model for the on-demand market. The market will provide increased efficiency. When you switch on the power, you don’t care if it came from coal, hydro. You just pay for what you use. In computing, we charge for something they may not use. The on-demand market will respond to customer demands for more fairly priced services.

At CA, the month-to-month business is predominantly in new business, both with existing customers and new customers. It lets people try new services. Existing customers are buying long-term contracts to lock in a cost for budgeting purposes.

Question from the audience: What happened to sales cycles when you went to on-demand?

Sanjay: We had to put ourselves in a position where we earned the business every month. Our revenues were cut in half. We lost money on paper, because the up-front revenue vanished. but the company still produces a $1 billion in free cash every year. Sales cycles were cut in half. The longer contracts require deep discounts that we’d rather not wrestle with; the on-demand business reduces the potential for obsolescence in later years of contracts.

The market has way too many competitors. Every other industry has consolidated and the computing industry will certainly do so — middle-sized companies are going to have a hard time surviving. There is always going to be room for entrepreneurialism, but a different kind of entrepreneur who does a lot of block and tackling and works the numbers will be successful.

People are willing to pay a 12 to 15 percent premium for CA to take the risk of licensing month-to-month.

The software industry is no different than any other industry. We have to build new products for less money all the time.

I am willing to go to a customer with 50 vendors or 60 vendors and say get rid of those vendors by selling them applications at a very low cost, which is very easy to do because it is found money for us.

Burying the lead

The Wall Street Journal, which trumpeted the productivity growth of the other day has buried the real story about unemployment, which the Bush Administration has only managed to move 0.2 percent in the right direction after three rounds of tax cuts. Here’s the page one summary of the story:

THE JOBLESS RATE FELL to an eight-month low of 5.9% in November. But employers added only 57,000 jobs, about two-thirds fewer than had been expected. Factory orders rose 2.2% in October.

At least they got to the real issue by the fourth paragraph of its story:

But the rise in payrolls was far below the 150,000 expected by economists according to consensus surveys, and it was also a sharp drop from the upward-revised increase of 137,000 in October. The economy needs to create about 150,000 jobs a month over time just to keep pace with the growing population. Significantly more is needed to produce steady declines in the unemployment rate.

Think about that, folks, we’re creating one-third the jobs needed on a monthly basis to keep up with population growth. Something about U.S. economic policy is seriously out of whack. In a word here’s what’s wrong: Bush. At this point, you cannot lay the blame for any of the failed stimulus packages at the feet of Bill Clinton or the bubble. Spending trillions on supply-side tax cuts is only going to accelerate the growth of the gulf in income between rich and middle class, while the poor are left helpless and unhelped, uneducated and unwanted. We should be investing in the American people, not the investment incentives of the richest one percent of society.

Words to sink into oblivion by…

If only President Bush meant what he said about the peril of national debt. The evidence here at home, where he has mortgaged the future on his voodoo economics today, certainly doesn’t bode well for Iraq’s debt situation. On appointing Carlysle Group partner James Baker to oversee Iraq’s finances, the President had this irony-laced statement to offer:

“The future of the Iraqi people should not be mortgaged to the enormous burden of debt incurred to enrich Saddam Hussein’s regime. This debt endangers Iraq’s long-term prospects for political health and economic prosperity. The issue of Iraq’s debt must be resolved in a manner that is fair and does not unjustly burden a struggling nation at its moment of hope and promise.”