3i Q&A Part 1: 3i discusses investments in Vonage, Speakeasy

Investments in early-stage network ventures are at an all-time low, and one of the segments that has been hardest hit is start-ups developing new Internet services. One investor that’s bucking the trend is 3i, which is a key investor in two U.S. ISPs worth watching: Vonage and Speakeasy.

Vonage is an Edison, N.J., provider of VoIP services to residential and small office/home office (SOHO) businesses. In February, Vonage received $39.9 million from a group of investors led by 3i and Meritech Capital Partners.  This cash infusion represents Vonage’s fourth round of venture capital financing, for a total investment of $103 million.

Speakeasy is a Seattle, Wash., ISP that focuses on residential power users such as online gamers. In March, Speakeasy received its fourth round of venture financing, which was a $24 million investment led by 3i and BV Capital.

I spoke recently with Sanford Miller, managing director of 3i, about the firm’s investments in the ISP industry. Here are excerpts from our conversation:

Q. 3i is one of the only venture capital firms that invested in ISP start-ups during the first quarter of 2004. Why are you investing in this segment when others are not?

A.  We are huge believers in the fact that the Internet is an increasingly essential component of our lives. If you go back to the dot-com bubble, many companies had ill-formed business plans and were trying to appeal to customers. But unless somebody was a broadband Internet user, he was not a good customer. So you had a huge number of ill-formed business plans addressing the size of market I’ll call X. Roll forward four years and what’s happened is that the number of companies has dwindled. The ones with ill-formed business models have failed. And the audience is now 5X to 10X what it was then in terms of broadband users. We’ve moved beyond the hobbyists. It’s not surprising that Internet-related companies are becoming quite prevalent because they’re the technology companies with the best financial profiles. They’re trading on earnings now and not eyeballs.

Q.  Why is 3i investing in Speakeasy?

A.  Speakeasy is quite interesting because they focus on that subset of heavy users of the Internet in both residential and small office type of environments that are willing to pay a premium price for a premium service. Their customers are so dependent on having good Internet service that for them pricing is relatively trivial. Speakeasy is not intended to be the largest ISP in the country, but it is intended to be the one with the highest margins. It’s a niche market, but it’s not a tiny niche.

Q. Why is 3i investing in Vonage?

A. Users over the long term are going to want to have all of their communications facilitated by a single platform, and the obvious platform is the Internet. We’re believers of communications over IP, and more specifically VoIP. VoIP is extremely powerful. The costs are low and the service quality is high. It’s not a niche market. This is a mainstream play, but it will take a long time.

VoIP today reminds me of the early days of cable and the early days of cellular. VoIP is going to be very big. We saw that Vonage was off to an unbelievably good early start, but since we’ve invested, they’ve only accelerated. We think consumers are going to latch on to VoIP. AT&T has validated this market with a national rollout of a directly competitive service. We’re confident that there’s room for an independent, although we wouldn’t invest in another VoIP carrier. Vonage is the market leader today, with a well-established brand, good customers and traction. Investing in Vonage is part of the vision we have that the Internet will be the central communications vehicle.

Q. Vonage is focused on residential and small/home office VoIP customers. Do you see opportunities for start-ups like Vonage to provide VoIP services to enterprise customers?

A. Long term, yes. But that’s not the situation right now. Enterprise customers have such an entrenched infrastructure that VoIP is a different kind of sell there. Vonage has its hands full with residential and SOHO. Vonage sells in one of two ways: direct to users or through various channels. One of the most exciting things going on at Vonage is that we’re selling through retail chains like Radio Shack and Best Buy.

Q. Having invested in Vonage and Speakeasy, what is your view of where the market for Internet services is headed?

A.  I think we’re still in the infancy with Internet services. We’re doing so little compared to what people will ultimately want. I think there are more opportunities that people haven’t thought of yet. We’d like to find more investments in this space where we can build on existing infrastructures. We’re fortunate that with Vonage and Speakeasy, both models are not highly capital intensive. They’re more like conventional venture capital investments rather than investments in carriers that might cost hundreds of millions of dollars.

Q. Do you see opportunities for 3i to invest in other ISPs?

A.  I wouldn’t say we would search out for ISPs as a category, but as we find other service-type businesses related to the growth of the Internet we’d be very interested in them.

Look for more insight from Sanford Miller in the next ISP News Report.