June 09, 2002

Barrons on Kleiner Perkins and the Internet Boom

Barrons snipes at John Doerr and Kleiner Perkins. The list of failures is long--Go (which Doerr swears would have been a success if not for Microsoft's use of FUD), Webvan, Healtheon, @Home, Homestore. But what Barrons doesn't highlight is that you expect 80 to 90% of ventures to fail, and that the astonishing magnitudes of John Doerr's successes make his overall record very good indeed...


Barron's Online - Barron's Cover

June 10th, 2002 Pied Piper of the 'Net: How John Doerr sparked the Internet boom and brought home big profits
By MARK VEVERKA

There's an old adage among stock peddlers on Wall Street: "When the ducks quack, feed them." Never was the quacking louder than during the Internet bubble of the late 1990s, and never did brokers have an easier time selling shares. In all, 439 dot.coms came public between 1995 and 2001 raising $33.5 billion, according to Thomson Financial.Central to this process was the West Coast venture capital firm Kleiner Perkins Caufield & Byers and its most visible general partner, L. John Doerr. As the Internet mania rose to its peak, Doerr maintained a steady drumbeat of enthusiastic predictions. Repeatedly, he told anyone who would listen, "We are participating in the largest legal creation of new wealth in the history of the planet." In 1999, when a few intrepid souls began to question all the hype surrounding the Internet boom, Doerr said, "Believe it or not, the Internet is actually underhyped."...

One thing's for sure: The Internet boom was very good for his firm and its clients. They invested early in fledgling dot.coms and then saw their holdings rise in value by as much as 350% a year, by one estimate, as the companies sold shares to the public at much higher prices. Among the Internet-era companies backed by Doerr's firm were Netscape Communications, Amazon.com, Juniper Networks, FreeMarkets, @Home Network and Handspring.

Of course, there were many other venture capital outfits in the dot.com game besides Kleiner Perkins. But Kleiner was one of the biggest and certainly had the gravitas that others lacked. Over the previous 20 years, it had provided startup financing for such success stories as Compaq Computer, Lotus Development, Genentech, America Online and Sun Microsystems. In a laudatory 1996 article about Doerr in The New Yorker magazine, Jeff Bezos, founder and head of the then-fledgling Amazon.com, explained why he opted to go to Doerr and Kleiner for his startup financing despite less favorable terms: "Kleiner and John are the gravitational center of a huge piece of the Internet world. Being with them is like being on prime real estate."

It's difficult to track exactly how well Kleiner's clients did on dot.com deals because as private investors, they aren't always required to disclose when they sell their shares. But according to filings with the Securities and Exchange Commission, Kleiner's $8 million investment in Amazon.com in 1996, at 20 cents a share, was worth $60 million, or $1.50 a share, adjusted for splits, at the time of the e-tailer's 1997 initial public offering. Kleiner investors, who may have sold their shares at or near Amazon's December 1999 peak of 113 would have scored returns of more than 55,000%. Kleiner declined to comment on its partnerships' returns. Nor would it comment on the prices it paid for investments or the price at which they were distributed to its limited partners.

Along the way, Doerr, now 50, personally received some 2.4 million Amazon shares from Kleiner, and he's never sold a single one. At a recent price of 18, Doerr's Amazon stake is worth more than $43 million.

Clearly Doerr's powerful position in the world of venture capital has helped a lot of people, including himself, become fabulously wealthy. Last year, Forbes magazine pegged his personal net worth at $1 billion.

An electrical engineer with an MBA from Harvard, Doerr joined Kleiner in 1980, after spending six years at Intel, where he was one of the firm's top-ranked sales executives. By the early 1990s, after shepherding investments into a series of tech successes, including Compaq, Sun and Lotus, he was beginning to receive rock star treatment in the press.

"Doerr has become arguably the finest venture capitalist of his generation," trumpeted Forbes in 1993. Five years later, Fortune called him "the industry's only celebrity venture capitalist," noting that "Doerr's so well-connected that he needs five phone numbers, a two-way alphanumeric pager, two cell phones, and two laptops, all of which he carts around in a chauffeured minivan stocked with several changes of clothing." Last year, Business 2.0 declared that Doerr "is to the venture capital business what Tiger Woods is to golf."

Nor are the plaudits limited to the media. "John is a larger-than-life figure," says Eric Schmidt, chief executive of Google, the Internet search-engine firm. Schmidt was recruited by Doerr to be head up software operations at Sun Microsystems in 1983, when it was a startup firm in Kleiner's portfolio. Last year, Doerr was instrumental in wooing Schmidt, then chief executive of Novell, to Google, another company in Kleiner's portfolio.

Doerr has parlayed his celebrity into political relationships, including a close one with former Vice President Al Gore. Two years ago, he helped finance a successful ballot initiative in California that makes it easier for communities to issue school bonds to improve public education facilities. And earlier this year, he spent three weeks in China extolling the virtues of capitalism and the role of venture capital in creating jobs and wealth.

In a recent interview with Barron's at Kleiner's Menlo Park, Calif., offices, Doerr maintained that Kleiner's legacy of building lasting companies is just as important as earning stellar returns for investors. "KPCB's partnerships have had more success backing more durable global companies than most other venture firms," he says.

But a close examination of the Doerr-led venture investments of the late 1990s indicates that some may have been doomed for having been brought to market to soon. Indeed, while Henry Blodget, the former Merrill Lynch Internet analyst, has become a symbol of the excesses of the dot.com era, an even greater responsibility for pumping up the bubble may lie with the venture capitalists -- Kleiner Perkins and John Doerr included.

The ebb and flow of the venture capital business often moves in big cycles. In 1983, with the personal- computer revolution in full blossom and the initial public offering floodgates wide open, venture capitalists shoveled nearly $2.9 billion into startup companies, or more than five times the amount that was invested just three years earlier.

As the market for Internet IPOs grew even hotter, money poured into venture investments at a rapidly accelerating rate, with $104.9 billion invested in 7,656 deals at the peak in 2000, as the chart above so vividly illustrates. The problem was that too much money was chasing too few good startups -- a situation destined to come to no good end. Indeed, Doerr says he sometimes issued "flood warnings" when he thought that too much capital was whipping up the froth on the market.

Maybe so. Yet Kleiner, which has always been more promotional than the Wall Street firms that preceded it in the business and also contributed to the mania. Says one industry insider: "Having John Doerr on your board in 1998 and '99 was an instant IPO."

Venture funds raised by Kleiner in 1994 and 1996 hit the sweet spot, financing not only Netscape and Amazon, but also Cerent, a maker of optical equipment that was sold to Cisco Systems in 1999 for $7.2 billion. The sale, masterminded by Kleiner's other star partner, Vinod Khosla, allowed Kleiner to turn an $8 million investment into $2 billion.

When Kleiner puts together a venture capital fund, it collects an annual fee of 2% of the fund's committed capital. It also takes 30% of the fund's net profits after payment to its limited partners of all of their invested capital. That's 5 to 10 percentage points higher than the industry standard. Profits are booked based on the price of the shares at the time they're distributed to Kleiner investors. "Our job is to distribute the shares," says Doerr. "After distribution, our limited partners decide to sell or hold the shares."

Given that a fund put together by Kleiner in 1996 was posting annual returns of more than 300%, the firm had little trouble lining up takers for new funds in 1999 and 2000 that were originally intended to raise a combined $1 billion. Indeed, the company rapidly gained commitments from its existing investors, including Harvard University, the Ford Foundation and Stanford University, as well as wealthy individuals such as Michael Dell and Steve Case. (The 2000 fund has since been scaled back to $475 million from $600 million.)

The size and the timing of these two new funds shows how caught up in the Internet Kleiner had become. Previously, Kleiner waited about 2 1/2 years between funds. What's more, the two new funds were substantially larger than any of Kleiner's previous funds.

Doerr is quick to defend his firm's boom-era investments. "The Internet ventures we backed usually became market leaders," he says. "We didn't back ventures where we thought the business wouldn't work. We did a thorough examination of all sectors of commerce, trying to figure out, after Amazon, what new commerce ventures would make sense.

"We didn't invest in any online pet stores," Doerr continues, referring to the now-defunct Pets.com, which had no trouble raising money from Kleiner rivals. "Selling bags of dog food online doesn't make sense."

But a look at seven firms that were financed by Kleiner in the late 1990s suggests that turning a quick buck may have been as important as building companies. Kleiner funded several startups that could be dressed for a quick sale to the public. Departing with its stated mission, the firm also made big bets on companies that were already on the verge of going public. One result: Kleiner got involved with some shaky firms that later came under the scrutiny of the SEC for overstating revenues. John Doerr lent stature to all seven of these companies by serving on their boards.

For example, Kleiner invested nearly $25 million in Martha Stewart Living Omnimedia at $12 a share just three months before the company's October 1999 public offering at $18 a share. For its investment, Kleiner also received a warrant to purchase a 15% stake in an e-commerce spin-off from the firm, should there be one. Kleiner's specialty has always been technology, and there is no way that a retail and publishing play of this sort could be considered a Kleiner forte. Indeed, shortly before the deal was set, Doerr made several visits to Kmart, where Martha Stewart offers a line of merchandise, so he could better understand what he was investing in. Last week, Martha Stewart Living shares were trading at 19.

Kleiner Perkins also spent more than $14 million to buy shares at the December 1999 IPO of FreeMarkets, a company designed to help businesses procure goods and services over the Internet. Offered to the public and Kleiner at $48 a share, FreeMarkets' stock rose as high as 370 before falling back to a recent 15.

Doerr, who was added to FreeMarkets's board of directors shortly before the IPO, was personally granted options on 350,000 shares, fully vested and exercisable at $14.80 a share, according to a filing with the SEC. Doerr says these options, which were exercised in his name one month before the IPO, were "beneficially owned" by Kleiner Perkins.

Last year, FreeMarkets, under pressure from the SEC, restated its 2000 revenues to reflect that $7.9 million that it had previously reported as revenue had actually come from the sale of warrants.

Doerr says he believed fervently in the concept behind Drugstore.com, a company that was to allow customers to order drugs, cosmetics, personal-care products and the like over the Internet. His actions seem to indicate that he was a true believer. Doerr says that Kleiner funds have never sold a share of Drugstore.com, which recently traded at $2.50 a share, down from an July 1999 high of 70. Although Drugstore.com continues to post losses, Doerr insists that it is a durable retailing concept.

Even more troubled is Homestore, which offers nationwide listings of residential real estate. From a high of 138, Homestore has slipped to a recent 1.77. Under pressure from the SEC, the company this year restated its revenues for 2000 and the first nine months of 2001, indicating that some $160 million of revenues originally reported as cash had actually come from barter deals.

Last year, the company reported a loss of $1.47 billion on revenues of $325 million. The deficit included a $976 million charge for write-offs of goodwill and other intangible assets. Chief Executive Stuart Wolf resigned in January, and lawsuits charging that management enriched itself at investor expense are flying. The company had $35 million in cash left in its coffers at the end of March.

Two other boom-era companies, WebMD and Handspring, have been profitable investments for Kleiner, despite declines of more than 95% from their highs. Again, Kleiner shows a profit on these investments because the firm bought its shares at low prices before they were offered to the public. Though Handspring trades at just 1.48, down from nearly 100, Kleiner paid, on average, just 56 cents for each of its 18.8 million shares, according to filings with the SEC. And while WebMD trades at 6.44, down from 126, Kleiner got in at an effective price of 2.05 by funding Healtheon, a firm that later merged with WebMD.

Another Doerr-sponsored Internet firm, the food-delivery outfit HomeGrocer, merged with Webvan, only to go belly-up in one of the most highly publicized flameouts of the dot.com era. Likewise, Doerr's @Home, a highly vaunted effort to provide broadband Internet access via cable TV lines, merged with the search engine Excite, another Kleiner company, and filed for bankruptcy in 2001.

Clearly, Doerr and Kleiner were not the only parties to lose big on Internet investments. Far from it. But some people wish that such seasoned investors had done a better job of avoiding the excesses of the dot.com mania. Says one venture investor: "John Doerr was the high priest of the dot.com religion. He led us like sheep, and like lemmings we followed him over the cliff."

Given the punk state of the stock market, it seems unlikely that funds Kleiner launched in 1999 and 2000 will do anywhere near as well as the ones put together in 1996 and 1994, which caught the best years of the Internet boom. But don't expect John Doerr to fade away, or to stop pitching ideas.

In "The New, New Thing," Michael Lewis's 2000 book on Netscape founder Jim Clark, the author notes that John Doerr was floundering in the early 1990s. "Between 1991 and 1993 Doerr had persuaded a lot of people, himself included, that the future of the Valley was in Pen computing," burning "tens of millions of capital" along the way. From there, writes Lewis, Doerr "took to making futuristic speeches, the theme of which was that interactive television would transform the world." It wasn't until Doerr shifted his theme to the Internet that the Croesus-like riches began pouring in again.

Just last month, Doerr was pictured in Vanity Fair atop a motorized two-wheel scooter that was being hailed as the way people in cities will move themselves about in the 21st century. Investors might want to think twice before they hop on that idea.

Posted by DeLong at June 9, 2002 12:54 PM

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