FTII Newsletter 20070122

Investment Opportunities in Software as a Service (SaaS), Virtualization and Web 2.0

The easiest way for investors, or entrepreneurs, to make exceptionally high returns is by being "in the right place at the right time."

Ted Rogers is good at this

Ted Rogers has become one of Canada's few technology billionaires by investing in three big trends:

FM radio (when almost nobody wanted stereo from their radio)
Cable TV (when most people thought 4 to 6 channels were enough)
Cellular telephone (when it was hard to imagine talking on the phone while driving a car)

Ted frequently says that when you get the big trend right, you can screw up almost everything else and still make a lot of money.

Computer technologies and stock market darlings

The computer industry has created more wealth for investors than any other innovation in mankind's history. This is partly because computers have evolved faster than any previous technology.

Each new phase has created more powerful computers and much lower costs. These in turn gave rise to previously unimaginable new applications and phenomenal market growth.

Each phase also spawned its stock market darlings - stocks everyone wishes they owned - and thousands of smaller entrepreneurial, and investor, success stories.

Investment opportunities in the computer industry

In the beginning, computers were so expensive that hundreds, or sometimes thousands, of people had to share one computer. In the mainframe era, investors loved IBM.

The mini-computer phase, in the 1970s, saw companies like DEC, Oracle, Sun and HP deliver huge returns for investors.

When Intel started to put entire computers on a chip in the early 1980s, the personal computer boom was born. Companies like Apple, Microsoft, Intel, Compaq and Dell produced incredible gains for their shareholders.

Investment Opportunities in SaaS, Virtualization and Web 2.0

As the number of PCs exploded, the amount of data they contained grew even faster. The next big investment opportunities were in networking these computers together so they could share data more efficiently. The best known investment of the networking era was Cisco, but there were thousands of other companies that also delivered outstanding returns to stakeholders in this era.

Almost nobody foresaw the next phase - the Internet. The web has continued to outpace everyone's expectations. Once we had local area networks that allowed us to share data and communicate effectively within organizations, it should have been obvious that the next step was to build a network that would cover entire countries and then the world.

To be fair, there were a few who did. Robert Metcalfe - often called the father of Ethernet and one of the founders of 3Com- did talk about the Ethernet protocol becoming ubiquitous. But even he could not imagine that the net would ever get as big as it has become. In fact, for a while in the mid 1990s, he kept speaking at conferences, and to the press, about how the Internet was going to "go spectacularly supernova and in 1996 catastrophically collapse." Metcalfe believed this because the network had never been designed to scale to the size it was becoming. He kept offering to eat his speech if the net did not crash. He ended up choking down the hard copy on a stage the next year.

What the Internet did, in the simplest terms, was to allow anyone to access information from anywhere. This was made possible by putting everything into the standard HTML protocol - giving birth to what is now called Web 1.0.

The web has transformed our lives more than any previous innovation - even compared to electricity, telephones and air travel. It really has changed everything.

Wealth has been created like never before. And it's not just Bill Gates, at one time was the world's richest man, or the mid-20s billionaires who found companies like Google and Skype. Millions of investors made trillions of dollars investing in the Internet phase.

And now, just like every previous era in the computer industry, the next phase will be equally unimaginable to most of us today. It will create even more computing power and even lower costs. These, in turn, will spawn more applications we cannot yet imagine - but will all want to have. This era, like each previous one, will create even greater new wealth for entrepreneurs and investors.

Each era was built on the previous one and one new technical innovation

Each new era was built on one fundamental, technical innovation that enabled everything else. Mini computers were possible because of transistors. Integrated circuits made the PC possible. Ethernet allowed PCs to be networked. HTML and http created the web.

Each new phase was also built on the foundation of the previous phase. Networks needed computers and the web needed the local networks. Amazon, ebay, Google and Skype all needed the web.

It all seems so obvious with the benefit of hindsight. So what's going to create the next big investment opportunity?

What we have all been waiting for: ubiquitous, reliable Internet

The Internet just sort of happened. In the early days, people accessed the net by using modems that 'dialed up' over standard telephone lines. That technology topped out at 56 kilobits per second.

In the vast majority of locations today, broadband Internet is delivered by one of two providers:

the telephone company - using twisted copper pair networks that have not changed much since the first world war, or
the cable TV company - using coaxial cable networks that have not changed much since the second world war.

This works... sort of. Most of us can get DSL or cable delivered broadband at speeds of 1.5 to 4 or 5 Megabits per second. That works well for browsing the web and sending e-mails. But these existing wide area networks (WANs) are just not fast enough, or reliable enough, to run entire businesses on or to allow all servers to be located in data centers.

Companies like MetroBridge - one of our portfolio companies - are building, for the first time, ultra high speed, very reliable wireless data networks that are completely independent of the legacy (telco and cable company) providers. This is now possible because of an exciting new technology called WiMAX.

MetroBridge can provide data connections at speeds of up to 1 Gigabit per second (1,000 Megabits per second.) These networks are so fast that if you were working on a large file on your desktop, that was stored on a remote server connected by one of these networks, when you hit "file, save" you would not notice any delay.

These networks are also incredibly reliable. MetroBridge advertises their reliability at 99.999% uptime. This means, statistically, that their connection will always be available except for five minutes per year.

While that is impressive, what's really enabling this new era is that these new networks are completely independent of the legacy providers. For the first time, companies can have two connections, one wireless across the rooftops and one through the legacy carriers underground. The chances of both connections failing at the same time are, for all practical purposes, just about zero.

Businesses can now be connected at speeds that are as fast as their internal networks, and with reliabilities that are effectively perfect.

This changes everything.

Transforming a trillion dollar industry

Just think about this. Almost every company today has a server room. In the server room is a rack filled with computers. Those computers are running operating systems and applications that the company has purchased as capital assets. Those software systems require continuous maintenance by computer geeks (i.e. IT professionals) who are either on staff or on service contracts.

This is extremely inefficient because each company has to incur the full cost of the hardware, operating system and applications software, maintenance and security updates, etc. After building and maintaining these expensive systems, most companies only run them at a small percentage of their capacity.

None of that makes economic sense anymore.

It's also what will make this next phase even more exciting for investors than the last one.

The global market for computer hardware, software and service is over $1 trillion per year. This next trend will completely transform that industry.

The next phase: Software as a Service (SaaS) and Virtualization

The simple fact that we now have very high speed, very reliable Internet means:

Software will increasingly be sold as a service not a capital asset (SaaS)
Servers no longer need to be in server rooms in almost every company. Instead they will be housed in data centers where they will always be able to be accessed - with no perceptible change in performance. These resources will be much more efficiently utilized because they will be shared by multiple companies.
IT professionals will no longer need to be on companies' payrolls, or even on contract, they will work in, or near, the data center with the servers (instead of stuck in traffic in those little red Volkswagens). This will dramatically reduce support costs - the biggest part of that $1 trillion per year.
Companies will have more powerful, more economical, virtual computer infrastructure (Virtualization) that they will pay for in a simple, completely scaleable, predictable monthly amount.
Instead of the mainframe era, when hundreds of people shared one computer, now each of us can use hundreds of computers at effectively the same time. We already do this every day. Google, probably the prototypical example, is architected this way.

Backbone Systems - another company in the FTII portfolio - is offering full business solutions delivered by a SaaS model. They can provide everything from Microsoft's Office suite, Exchange, Blackberry integration, along with full remote backup and 7x24 tech support and even relatively specialized applications like Quickbooks and Microsoft CRM.

Why this will happen

SaaS and Virtualization just make economic sense. Businesses are rational. When the realization spreads that businesses can now have better quality IT capabilities, that are also more reliable, with fewer management headaches and a cost savings of 20 to 40% - this will just happen.

Web 2.0

Up until very recently, people were still debating what Web 2.0 was, or was going to be. Here's one way to think about it: now that we are all connected, all the time, and we can just as easily send data as receive it through our browsers, the information can easily flow in both directions - from the web to us and from us to the web. This is obvious, and we have all been doing it for a while now. What is not so obvious, but much more interesting, are the incredible new opportunities this creates for entrepreneurs and investors.

Who could have imagined that a small company in Vancouver built on the idea of sharing photos over the web (Flickr) would be sold to Yahoo for a rumored $30 million just a couple of years after it was conceived.

Or that a similar company, built by a couple of entrepreneurs to share videos, would be sold to Google for $1.65 billion a year after it launched. One of the two founders was only 19 years old!

SaaS, Virtualization and Web 2.0 are all facets of the same, very exciting, next phase in the computer industry. These next opportunities are all possible because now we can all be connected with outstanding speeds and close to perfect reliabilities.

Investment opportunities

Some of you have asked me to let you know about technology investment opportunities that I like. Backbone Systems is doing an angel financing this quarter (more information is available on their investor web page - the log on and password are both 'investor' - just the word, not the quotes.) If an investment in Backbone might be of interest to you, or someone you know, just send me an e-mail at basil at peters dot ca. (Sorry I cannot provide live links, the spam bots are just too good at harvesting e-mail addresses now.)

I would also be grateful if you would let me know about any investment ideas you come across in the SaaS, Virtualization or Web 2.0 space. I'll reciprocate by continuing to share my new investment ideas with you.

Thanks very much,