Crosslink Ventures Turn Into Hedge Fund Bet as Hybrid Firm: Tech
On the eve of its Aug. 11 initial public offering, Carbonite Inc., a Boston-based firm that provides online data backup, cut its offering price to $10 a share from a range of $15 to $17.
Presentations to attract investors had collided with a 2,000-point plunge in the Dow Jones Industrial Average during the previous 14 trading days. Carbonite was determined to go public, even though 10 other companies had postponed their debuts, Bloomberg Markets magazine reports in its November issue.
Michael Stark, who runs San Francisco-based Crosslink Capital Inc., knew Carbonite. He’d invested $12 million in January as part of a venture-capital deal.
After Carbonite lowered its price, Stark placed an order of 1 million shares at the IPO, doubling his stake to 8.3 percent, split between hedge and venture investments. By the closing bell, Carbonite had gained 24 percent to $12.35. The stock climbed further, giving Crosslink a 28 percent return in a month, trouncing the 3.3 percent gain for the Nasdaq Computer Index. On Oct. 3, the shares traded at $12.
Stark’s Carbonite investment is quintessential Crosslink. The firm, with $2.15 billion under management, tries to make money from a hybrid strategy of providing venture funding for private companies and hedge-fund investments to profit from public ones. The setup lets the firm double its bets when it perceives good opportunities.
In September 2005, Crosslink made a $13.3 million investment in Provo, Utah-based Ancestry.com Inc. (ACOM), a Web-based genealogy company, in return for 2.4 million shares valued at $5.60 each.
When Ancestry.com went public, Stark bought an additional 200,000 shares. He controlled 7.3 percent of the company by May 2010, reducing that stake to 3.7 percent as of the end of June. On Oct. 3, Ancestry.com was trading at $21.98.
“We look at growth companies and don’t limit ourselves to whether a company is public or private,” he says.
From his 22nd-floor Embarcadero Center office in San Francisco’s financial district, Stark expands on that thought. He points toward San Francisco Bay from one window and then motions toward another set of windows, where his gaze drifts over the city to the iconic Coit Tower.
“I can see what’s going on by looking both ways,” he says. “I can see the full picture and not a half picture.”
‘Looking for an Education’
Crosslink’s full-picture approach has largely paid off. Stark’s venture funds have $1 billion under management. Crosslink Ventures IV, which started investing in 2000, has returned an average of 28 percent a year since then.
The $510 million Crosslink Emerging Growth Fund, the flagship hedge fund, has returned an average of 13.4 percent after fees annually from September 1999 through August, according to an investor.
Crosslink’s crossover funds put about 40 percent of assets into venture deals and the rest into hedge-fund investments. Crosslink Crossover III, which started in September 1999, has returned an average of 13.6 percent a year through June, the investor says.
Crosslink’s strategy of getting an early peek at promising technologies gives it an edge, says Michael Weisberg, a Crosslink investor who runs Crestwood Capital Management LP, a $1 billion hedge fund in New York.
“Stark is looking for an education, to get a sense of where the technology is going,” Weisberg says.
Stark has barriers between his funds to avoid any regulatory headaches. He doesn’t trade in a company at which Crosslink has a board seat, which could provide access to insider information.
Although venture firms aren’t required to register with the U.S. Securities and Exchange Commission, Crosslink has registered as an investment adviser and has passed SEC audits, partner Isabelle Fymat says. The firm tracks stock trades of employees and their household members.
Stark has had his failures. His immersion in the world of technology trends meant he didn’t see the subprime crisis until it was too late. The Emerging Growth Fund lost 29 percent in 2008, even as it held onto Apple Inc. (AAPL), Google Inc. (GOOG) and Qualcomm Inc. (QCOM) It still beat the 38.5 percent tumble in the Standard & Poor’s 500 Index that year.
“We like to make long-term bets, but sometimes events surprise us,” he says.
Stark’s faith in technology growth companies makes Crosslink vulnerable when a boom he expects doesn’t pan out. The hedge fund bought a stake in Sunnyvale, California-based network security company Fortinet Inc. (FTNT) in August 2010 for about $8 a share. On July 6, the shares closed at a 52-week high of $28.17. Then, on July 19, Fortinet reported earnings that disappointed analysts. The stock fell 19 percent to $21.61 the next day. “Volatility in growth companies can be brutal,” Stark says.
Supporters say Stark has a rare talent: He unearths companies that may pay off in a few years while managing the daily ups and downs of his hedge fund.
“It’s hard to find someone who’s good at picking stocks, who can also pick stocks to short and understands industry trends to select startups for the venture side,” says Robert Manilla, chief investment officer at the $3.2 billion Kresge Foundation in Troy, Michigan. Manilla has invested in Crosslink since 2003.
“Stark and his team are thoughtful investors with a vision of where the world is going,” he says.
Stark’s skills are in demand as more technology startups plan initial public offerings. Groupon Inc., a Chicago-based discount coupon seller, and Zynga Inc., a San Francisco social- gaming company, have filed for IPOs. Crosslink’s marquee name, online radio service Pandora Media Inc., started trading shares on June 15. Overall, 135 U.S. companies had IPOs this year through the end of August, 21 percent more than at that point last year, according to Bloomberg data.
“Year to date, 2011 was the strongest year for tech IPOs since 2007,” says Kathleen Smith, a principal at Greenwich, Connecticut-based Renaissance Capital LLC, an IPO investment advisory firm.
Market turmoil since the end of July has made some investors pause. The average technology IPO fell 18 percent this year through the end of September, according to Renaissance Capital.
“The recent volatility has taken the wind out of companies that were not ready for prime time,” says Lise Buyer, an IPO consultant and founder of Class V Group LLC in Portola Valley, California.
Still, with more than 300 offerings lined up, the pipeline is strong. “There’s definitely a sense of renewed IPO optimism,” she says.
Stark is enthusiastic about social networking, Chinese Internet firms and infrastructure companies active in cloud computing -- using remote computers to store and retrieve information.
“You can have dramatic wealth building in a relatively short period of time, and that’s what we are trying to capture,” he says.
Beijing-based Baidu Inc., China’s largest Internet company, went public in August 2005. Its shares have soared an average 50 percent a year, rewarding Stark with more than 20 times his investments in the company started by Robin Li and Eric Xu.
“We like Chinese nationals educated in the U.S. who are entrepreneurs and go back home to set up their own companies,” he says.
Stark grew up in Quincy, Illinois, with old-school technology in his blood: His father was a technician for phone company Illinois Bell. His mother was a secretary. An only child, he arrived at Northwestern University as the first member of his family to attend college. After getting a civil engineering degree, he earned an MBA with honors from the University of Michigan.
Stark headed west in 1980 to join chipmaker Intel Corp. (INTC) just as the computer and semiconductor industries were on the cusp of exponential growth. He worked as a financial analyst and on special projects, studying potential equipment suppliers for Intel.
In 1983, that background helped him land an analyst position covering the semiconductor industry at what was to become Robertson Stephens & Co., the San Francisco investment bank that specialized in tech companies. In 1989, he was on a team that created Omega Funds, a venture fund within the bank.
The group later started a crossover fund to invest in public and private companies. BankAmerica Corp., now Bank of America Corp. (BAC), acquired Robertson Stephens and then sold it off.
Stark and Seymour Kaufman, an investment banker who co- managed Omega Funds, bought out the fund, with its $300 million in assets, in 1999. They changed the name to Crosslink Capital. Kaufman, a mentor to the firm, isn’t involved in the running of the company.
Crosslink offices, with prospectuses, annual reports and offering documents strewn across every working space, are far from the fabled VC mecca of Sand Hill Road in Menlo Park, south of San Francisco. Crosslink’s location makes its 37-person team work harder, says Jim Feuille, who heads venture operations.
Feuille’s group ferreted out Pandora only after spending a year making cold calls. The venture fund’s initial $33 million investment was valued at $500 million at the end of September, even after Pandora shares declined 8.4 percent since the IPO.
Genesis of Pandora
The idea that led to Crosslink’s investment in Pandora came from an unexpected quarter. In October 2003, Steve Jobs, then Apple’s CEO, said the company’s iTunes service would be available for Microsoft Corp. (MSFT)’s Windows operating system.
Feuille predicted that digital music would take off because more than 90 percent of the world’s PCs ran on Windows. Stark bought Apple shares for the hedge fund, making almost 50 times his investment when he closed the position in February. Feuille later bet on Ecast Inc., a San Francisco startup that offered digital jukeboxes, for the venture fund.
“You see an idea and want to figure out what’s the next evolution,” Feuille says.
To sniff out more digital music opportunities, Feuille had an associate call dozens of companies before Crosslink spotted Savage Beast Technologies in 2005. The startup had developed a database and algorithms that let users customize music searches. If a listener liked Pink Floyd, the software would suggest other bands he might enjoy.
Savage Beast changed its name to Pandora in 2005 and embarked on a business to stream music over the Internet. Trouble was, it had begun a subscription model, offering members 10 hours of free music and then charging a $3-per-month fee.
“I told Pandora’s board there is too much free music out there,” recalls Feuille, wearing a blue shirt under a black sleeveless fleece with Crosslink’s logo of two interlocking Cs. The subscription strategy was unlikely to make much headway, he says.
“Good-enough free music will always beat a little bit better,” he says.
Feuille offered to fund the venture if Pandora’s board switched to a free radio service backed by ads. The board eventually agreed.
“Crosslink was pivotal to our success,” says Tim Westergren, Pandora’s co-founder and chief strategy officer. He says Feuille saw Pandora’s potential before its board could.
“Jim advocated for a free service, which at the time was far from obvious,” Westergren says.
Today, Pandora has more than 100 million registered users. Revenue for the quarter ended on July 31 doubled to $67 million. About half came from mobile devices, CEO Joseph Kennedy says. The company lost $3.2 million as it paid half of the revenue in royalties to record companies. Pandora makes 87 percent of its sales from ads on listener devices and the rest from subscriptions.
Stark has made other bets against prevailing wisdom. Equinix Inc. (EQIX), a Redwood City, California-based provider of data centers, had to restructure its debt and raise money in 2003. Managers held more than 80 meetings with private-equity, VC and hedge funds, Chairman Peter Van Camp says.
Crosslink was the only U.S. company that offered anything: a $10 million investment from the venture fund, which it exchanged for shares valued at about $3.34 each. On Oct. 3, Equinix shares traded at $84.27, producing a 25-fold return.
“They looked beyond the immediate economics of the company and could see where the technology was heading,” Van Camp says.
Stark figured that First Solar Inc. (FSLR), the world’s biggest maker of thin-film solar panels, would eventually find its technology overtaken.
“We knew technologies would emerge to make First Solar obsolete, but that would not happen in 2006,” he says.
Crosslink started buying after First Solar’s IPO that November, snapping up shares at $24 each. At the end of 2007, shares of the Tempe, Arizona, company were trading at $267.14.
“We got a 10 bagger because we understood the technology, we understood the situation,” he says, meaning he made 10 times his investment.
First Solar traded at $57.90 on Oct. 3; three other U.S. solar companies have filed for bankruptcy protection since August.
Stark is scouting for the next tech trend. On a whiteboard in his office, he reviews computer infrastructure companies he says are likely to succeed if cloud computing takes off.
Among them are private firms including Sunnyvale-based IronKey Inc., which makes data storage components. He’s also enthusiastic about such public companies as San Francisco-based Riverbed Technology Inc. (RVBD), which makes computer-networking products, and Houston-based BMC Software Inc. (BMC), which sells software to manage data storage.
“There’s a short cycle to technology investing,” Stark says. “We have to constantly reinvent ourselves.”
If Stark can do that, Crosslink’s hybrid strategy may be able to keep investors a step ahead of the technology curve.
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