VCs Host Big Spam Sale – Get It While It’s Hot! –

Venture capitalists are losing their appetite for spam. Just as quickly as they invested in anti-spam startups, they are putting their offerings on the block, hoping for a quick, juicy exit before the rest of the market gets indigestion.

Among those that have already cashed in are Fractal Capital, O’Reilly & Associates, Opticality Ventures and Sequoia Capital.

The number of VCs who cash out successfully is sure to grow, but the list of investors who get caught holding a cold plate of pork will be much longer. There are 150 anti-spam vendors vying for attention, according to Osterman Research, but “the market simply cannot support this many players,” says Steve Munford, president of Sophos Inc., a maker of anti-spam and anti-virus software. “Leading anti-spam companies will either raise significant rounds of financing or look to an IPO to provide them the ability to build out their solutions or acquire other companies.”

For example, Brightmail in March filed for an $80 million IPO. The 6-year-old anti-spam company has $53 million in funding from Accel Partners, Technology Crossover Ventures and others (see chart, next page). With the cash from its IPO, plus its stock, a publicly held Brightmail could bulk up with a few acquisitions and distance itself from competitors. That, in turn, would force other anti-spam companies to do their own acquisitions if they want to remain competitive.

There are rumors that Brightmail competitor Postini is planning its own IPO. The company has $26 million in backing from AltoTech Ventures, August Capital and Summit Partners, among others. Like Brightmail, it provides spam and email filtering to businesses worldwide. Also, both companies have partnerships with prominent anti-virus vendors – Brightmail with Symantec and Postini with Trend Micro – to deliver bundled security services.

Goin’ Fast

Several players have already staked their spam claims with acquisitions in March. Publicly traded software developer Tumbleweed Communications announced that it would buy privately held Corvigo for nearly $40 million – $3 million in cash plus 4.7 million shares of Tumbleweed stock, which closed at $7.72 per share on April 6. Corvigo sells a Linux-based anti-spam filter. It is backed entirely by Sequoia Capital, which led a $5.5 million Series A round in the company last September.

Also in March, privately held MessageGate, which provides spam filtering and Internet security software, announced that it acquired MessageFire for an undisclosed amount. MessageFire is a 2-year-old privately held anti-spam service provider. MessageGate spun off from The Boeing Co. last August after receiving $7 million in funding from Polaris Venture Partners, Northwest Venture Associates and Boeing Ventures.

Sophos also made an acquisition in March. Initially positioned as an anti-virus software maker, the company paid $23 million last September for ActiveState, a Vancouver-based anti-spam company. ActiveState had $2.5 million in backing from Fractal Capital, Opticality Ventures and O’Reilly & Associates.

It’s no wonder there’s so much attention being placed on spam. Spam and its new offshoot – “spim,” which is unsolicited instant messaging – is a consumer headache and a corporate nightmare, costing U.S. companies an estimated $1 billion per year in security, human resources and productivity, according to some estimates. Last year, the United States enacted a law, known as the CAN-SPAM Act, which outlaws bulk e-mailing. While this law won’t do away with spam altogether, it may help to reduce it. Still, unwanted email remains a big problem.

But is the problem big enough to justify a wave of IPOs and M&A? Sure, Postini and Brightmail are attracting a lot of buzz these days, as is FrontBridge Technologies (VC-backed with $17.3 million), MailFrontier ($15 million), IronPort ($50 million) and CipherTrust ($48 million). CipherTrust in March announced a $42 million Series B funding, the largest VC round for an anti-spam company in more than three years. Battery Ventures and Greylock co-led the oversubscribed deal, with U.S. Venture Partners, Noro-Moseley and return backer Silicon Valley Bank also participating.

Spam Bubble?

Some in the sector don’t think the recent activity is justified and suggest that the anti-spam business is the next tech bubble waiting to get popped. “The VCs have already over-invested,” says Scott Weiss, CEO of IronPort, which is backed by Allegis Capital and Menlo Ventures, among others, and which counts Brightmail as a strategic partner. “The anti-spam market will probably only support three or four main players, which is why we’re seeing so much activity lately. After this current shakeout, a handful of leaders will emerge.”

After all, the technology behind anti-spam is not so much a sector by itself, but rather part of an overall Internet security fix. That may be one reason why various anti-spam companies have been acquired recently.

Alan Weinfeld, a security software analyst with Fulcrum Global Partners, says the public market will support no more than four or five major anti-spam companies. Brightmail, CipherTrust, Postini and Tumbleweed stand the best chance of remaining independent after the shakeout is over, he says.

Besides Symantec and Trend Micro – which have partnered with Brightmail and Postini to include anti-spam technology in their offerings – Microsoft has started its own spam-fighting tool and has strategic ties with Brightmail. Meanwhile, network security and spam-blocking is becoming a bigger area of focus for networking equipment companies like Cisco Systems and Juniper Networks, which recently agreed to acquire firewall security provider NetScreen Technologies.

Indeed, some experts say that all the recently funded spam startups may not be able to survive on spam alone and will have to merge with other email and security companies. That’s why more mergers, as opposed to more IPOs, are probably needed to weed out the weaker companies in this fragmented industry, says Michael Rasmussen, an information security analyst for Forrester Research.

Rasmussen says he’s not sure if being a pure-play message security company is a viable business since larger public rivals – such as Microsoft – are increasing their presence in this area.

“Spam is part of whole range of issues, such as corporate compliance and messaging platforms, so ultimately it makes sense for companies that solely deal with spam to merge and grow,” says Tom Simpson, managing director of Northwest Venture Associates and an investor in MessageGate. “You’re going to see more acquisitions and activity as the shakeout continues .”