After the incubator

Raza Foundries nurtures broadband start-ups By all appearances, the incubator model may be played out. With their consumer Internet offspring out of favor on Wall Street, the share prices of well-known incubators have eroded. CMGI, Internet Capital Group, idealab and others now have to cut offices and staff and home in on only their most promising investments.

But the idea of the "metacompany," a business that produces companies, is just being tested in the broadband networking and communications realm. Raza Foundries, an incubator-like organization that is more than a year old, was founded by Saiyed Atiq Raza, former chairman of NextGen and former president of Advanced Micro Devices, and tries to differentiate itself from the traditional incubator.

"The idea of incubation comes from going from an egg to a chicken," Raza said. "It is rare for us to start with an egg. In most cases, we start with a chick - a full-fledged team that could have been funded by any VC."

Raza's emerging portfolio Maple Optical Systems www.mapleoptical.com Developer of multiservice optical systems that enable carriers to provision, scale and manage bandwidth over wavelengths Pacific Broadband Communications www.pbc.com Developer of ultra-dense, highly noise-immune broadband solutions that enable providers to deliver standards-based data, telephony and video over cable networks Princeton Optical Systems www.princetonnetworks.com Developer of carrier-class optical transport systems for next generation networks RedWave Networks www.redwavenet.com Developer of a multiservice aggregation platform for the metro market for delivering fiberless solutions at multigigabit speeds YuniNetworks www.yuninetworks.com Provider of scalable terabit switch fabric technology. Acquired by Applied Micro Circuits Source: Raza Foundries

What Raza Foundries start-ups require besides capital is company-building expertise: talent-spotting, strategic and technical guidance and product development and engineering support. That's not the bailiwick of a traditional venture capital firm. And although Raza Foundries uses experts from its 60 person staff to build out the infrastructure areas of a company such as accounting, human resources and legal, it rarely tampers with the executive management ranks.

For fledgling companies started by first-time entrepreneurs, Raza Foundries is filling a real need, said Chris Nicoll, vice president of telecom infrastructure for Current Analysis. "The key difference is that an incubator provides more brick-and-mortar facilities," Nicoll said. "[Raza Foundries] provides an engineering team that can help a company take an idea and accelerate its time to market."

Given its technical and product development expertise, Raza Foundries invests in companies whose proposition offers a high barrier to competitive entry and copious amounts of intellectual property. Its portfolio currently includes a broad swath of companies in optical networking systems and components, routers and traffic engineering systems, access devices for the network core and edge and systems and software for secure transport and access.

Raza Foundries is usually the lead investor on the first venture round but backs off in subsequent rounds to get the vote of confidence from venture capitalists and strategic investors. In exchange for start-up capital and its growth-acceleration services, Raza Foundries usually gets a 25% to 50% chunk of the company.

"We invest in almost every round - we are financial investors--but we don't validate our own valuation by setting the prices ourselves," Raza said. "We make sure that the price of subsequent rounds is determined by third parties that are credible investors."

Of course, Raza Foundries itself needs capital to fund its operations, and so far it has received substantial backing from industry heavyweights. The company's oversubscribed Series C round of funding in late October raised $125 million and gave the company a post-money valuation of more than $1 billion. Cisco Systems led the investment; Applied Micro Circuits, Infineon Technologies, LSI Logic, PMC-Sierra, Siemens, Virata and Xilinx also contributed funds.

Strategic investors hope that having their hands in the Raza Foundries till creates partnership and product OEM opportunities, early access to product plans and--when it makes strategic sense - the opportunity to acquire, Raza said.

"Raza provides a unique ecosystem vertically integrated throughout the broadband communication value chain," said Hanno Beisinghoff, manager of venture investments for Infineon, a supplier of integrated communications circuits. "They're significantly differentiated from other incubator models in that they are specific to broadband communications and are furthest ahead in that field."

Besides a financial return, Infineon expects to work with Raza Foundries and its portfolio companies on a project-by-project basis to develop systems and solutions for broadband equipment markets.

VC investors in Raza Foundries include Benchmark Capital, Technology Crossover Ventures and Bowman Capital. But why would a VC that could directly stake any member of Raza Foundries' start-up portfolio choose to invest in the company instead? "By investing in Raza, you're getting a piece of a lot of different companies - you're spreading your risk a little bit," Nicoll said.

"The principal benefit VCs see is the ability to aggregate the value that Raza is creating and gain opportunity to invest in companies that we are nurturing and maturing," Raza said.

With clouds looming over the incubator space, the critical question about Raza Foundries is whether it can produce high-quality start-ups that have the magnetism to go public and produce a profit. Raza Foundries plans to go public in 12 months, but its "output" has been minimal to date. Although Applied Micro Circuits acquired early Raza investment YuniNetworks for $241 million in April and Maple Optical Systems landed a Series B funding round of more than $50 million in October, the rest of Raza Foundries' portfolio is still in stealth mode.

But that might not be such a bad thing given the state of the IPO market, Nicoll said. "One of the key factors is that Raza is getting in early," he said. "They're not looking at companies that are two quarters away from an IPO. So current economic events are not likely to play a role in whom they're going to back - they're going to look a bit more long term."