Web-centric IT start-ups in tough times

Venture capitalists flocked to Web-centric information services companies at a record pace in 2008, but the IT industry overall is making do with alarmingly low investment levels, according to a report issued Saturday by Dow Jones VentureSource.

The IT industry posted its weakest quarter since 1998 with 266 investment deals totaling $2.2 billion in the just-ended fourth quarter of 2008. That's nearly a 40% drop in dollar amount from the previous year’s fourth quarter.

For all of 2008, IT companies secured $11.6 billion in 1,237 deals, a 15% drop since 2007. Software investments hit their lowest point in a decade — but one silver lining was found in the information services sector, which includes social networking, shopping portals, media streaming and other Web 2.0 entertainment sites.

This information services sector attracted $2.7 billion from 357 deals in 2008, its highest annual total ever and up 17% over the previous year. Even this sector saw declines over the course of the year after a strong first quarter, but was still a bright spot in the flagging IT industry.

“Information services is kind of what kept this group afloat,” says Dow Jones research manager Valerie Foo.

A sharp drop was seen in electronics and computer hardware, from $548 million in Q4 2007 to $179 million in Q4 2008. Communications and networking performed better in the fourth quarter than it did in the same period in 2007, but for the whole year saw a significant decline in investment. Venture investments in semiconductor technology also went down in 2008.

While IT companies are struggling to get cash, Foo says the results are actually not as bad as she expected given the current state of the economy. Bright spots for IT include Open Range Communications, which is building a 17-state, 4G wireless broadband network; and another wireless company called Pocket Communications. Each of these companies secured $100 million investments in Q4, Foo says.

One of the troubling signs is that only three venture-backed IT companies went public in 2008, none in the fourth quarter. Thirty-one IT companies did IPOs in 2007, Foo says.

IT companies were involved in 219 of the 325 mergers and acquisitions in calendar 2008, according to Foo. In 2007 there were 275 IT mergers and acquisitions out of 457 overall. The decline in liquidity is certainly worrying to investors.

“If there's not a viable exit option, investors probably are going to think twice about their investment choices,” she says.

The dropping investments in IT mirror the country as a whole, as total venture capital investment dropped 30% from the fourth quarter of 2007 to the fourth quarter of 2008, hitting its lowest levels in three years. Nationwide, there were 554 deals totaling $5.5 billion in Q4 2008.