By Mike Angell
Investor’s Business Daily
Q&A
Erel Margalit
Jerusalem Venture Partners
Managing partner
39 years old B.A., philosophy MBA, Hebrew University;
M.A., philosophy, Columbia University
It used to be that the dot-coms got most of the hype. Now, it’s fiber optics. Fiber optics use lightwaves instead of electrical signals to send voice and data over the Internet, boosting speed. In the first quarter, more than $600 million was invested in fiber-optic start-ups, up 300% over the year-ago, says San Francisco-based researcher VentureOne Corp. Erel Margalit staked much of his money on fiber optics, and hit the jackpot recently. Two years ago, his Israeli venture capital firm, Jerusalem Venture Partners, paid $10 million for a 15% stake in Chromatis Networks, a maker of fiber-optic network gear. Two weeks ago, that investment became worth some $675 million, as Lucent Technologies Inc. bought Chromatis for stock valued at $4.5 billion. Not every investment hits it so big. But Margalit says his $95 million fund has averaged annual returns of more than 100% since it began in 1994. He recently spoke with Investor’s Business Daily about Chromatis and his investment strategy.
IBD: What attracted you to Chromatis?
Margalit: When we first funded Chromatis, (gear maker) Ciena started getting attention for its dense-wave division multiplexing products. About a year later, the folks at Chromatis were thinking about how to bring DWDM to the metropolitan market. We thought it was a very ambitious proposition at the time. We spoke to AT&T and Bell Labs, and they both said that there’s a need for this type of technology.
IBD: DWDM is used mostly in long-distance networks. How is it used in short-distance metropolitan networks?
Margalit: In long-haul networks, DWDM boosts the amount of data that goes down a fiber-optic cable. But all that data goes to one point. In metropolitan networks, you actually use the different colors of light to send signals to different locations. So if you want to get from point A to point B, you use one type of color. If you want to get from point A to point D, you use a different color. You can distinguish different types of services.
IBD: What’s that mean for customers?
Margalit: Another one of our ventures, Cogent Communications, is building the first all-optical Internet service in the 13 largest U.S. cities. Chromatis gear meansthose cables come right into the cities and connect to the largest buildings. So you can get service at your desktop that’s 100 times faster than a T1 line (a digital communications line much faster than a standard phone line) at the same price.
IBD: What customers does Chromatis bring to Lucent?
Margalit: Qwest has just finished testing Chromatis products. Chromatis is in serious discussions with other Internet service providers and with Bell Atlantic. So, Chromatis brings a full range of important customers to Lucent.
IBD: How do you choose which companies to fund?
Margalit: With the dot-coms, it’s hard not to submit to temptation to fund almost anything. But we go after clusters of technology that we understand well. Once you’re in a field you’re familiar with, you want to not just focus on technology, but also have active discussions with customers in that field. We get a good feel for the next big need. We have people who are living and breathing this field.
IBD: What do you think of the fiber-optic start-ups that are out there?
Margalit: In many of these cases, small start-ups wouldn’t survive as independent companies because they can’t own their customers. In many cases, some other start-up can come along and take away business. It’s difficult to come up with a unique product. Just as we saw dot-com inflation, right now that could very easily happen in the optic area.
IBD: What should someone interested in investing in fiber-optics companies look for?
Margalit: You have large players like Cisco and Lucent, people that already have a major presence in the market. So you want to look at who’s doing innovative things with their business and acquisition strategy. With small companies like Sycamore Net-works,you want to look at how deep their hold on customers is and what kinds of customers they have. They should have three kinds: baby Bells, new data networks and big carriers.
IBD: What are the next major investments in network products?
Margalit: Edge routers, where long-distance networks meet local networks. We also see routers moving from combining electrical and optical to mostly being optical.
