February 28, 2007

SOMETHING VENTURED: Blade Server Start-Ups Get VC Attention

By Donna Fuscaldo, Dow Jones Newswires

Space constraints, increased interest in application hosting and rising energy costs are driving more demand for "blade servers", which in turn is prompting more venture capital dollars to flow into that market.

While blade servers, or server chassis that house multiple thin circuit boards, have been around for years, a shift toward hosted software applications coupled with rising energy costs and limited space in data centers have made them more attractive.

International Business Machines Corp. (IBM), the 800 pound gorilla in the technology market, is aiding blade start-ups with its Blade.org program, which provides partnership opportunities and development aid.

IBM has chosen to partner with blade companies instead of taking an equity stake because IBM, which makes blade servers, wants to grow the market and boost its revenue.

According to Armonk, N.Y.-based IBM, more than $1 billion in global venture capital has flowed to companies focused on the blade market since Blade.org was started a year ago. Long gone are the days where start-ups can get VC funding without having any revenue, said Claudia Fan Munce, vice president and managing director of IBM Venture Capital Group, noting the ability to partner with IBM makes Blade.org start-ups successful.

Andrew Kau, a managing director at VC firm Walden International, credits the Internet boom of the late 1990s and early 2000 for the rising popularity of hosted applications that can be accessed over the Internet. That increased demand has taxed data centers that host applications but are increasingly running out of space.

Enter blades, which Kau says is the most cost-effective route for data centers rather than having hundreds of standalone servers. He adds that blades are easier to manage.

"Those are big advantages," Kau said. "As VCs, we like that because there's a paradigm shift going from the PC to the data center."

Kau's Walden invests in everything from start-up companies creating software for blades to hardware companies developing blade servers.

"We've invested in a whole variety of companies in and around blades," Kau said, although noting that more VC dollars are going into the software side of the business than the hardware.

One of Walden's investments is Narus Inc., the Mountain View, Calif.-based Internet infrastructure security and surveillance company. Narus, which helps protect the Internet for telecommunications carriers, corporations and even countries, makes security software that runs on blades.

Another investment is Teak Technologies, the Orange County, Calif.-based hardware company that makes hardware that helps data centers optimize their data center traffic on blade servers. Kau noted that Teak and Narus are members of Blade.org, which the VC said is helpful.

"By definition start-up companies have no track record and building something new is much easier to get customers comfortable with a big partner and ecosystem," said Kau, whose firm has invested hundreds of millions of dollars in blade companies but declined to specify the amounts invested in the companies mentioned. Meanwhile, Kevin Fong, a managing director at Mayfield Fund, which first started looking into the blade market about three years ago, said the interest from VCs is also being driven by the popularity of virtualization.

Fong said that while the initial focus on blades was to save space and power, the market became more interesting to the VC community thanks to virtualization.

He pointed to the success of EMC Corp.'s (EMC) VMWare as an example of demand for virtualization. EMC is spinning out a stake in VMWare.

The way Fong sees it, the best investments in the blade server market are in the ecosystem, not the actual server blade hardware companies. He said the hardware market is a tough area for investments, even though Rackable Systems Inc. (RACK) of Milpitas, Calif., was a ventured-back company that eventually went public.

Like Walden's Kau, Fong has also made an investment in Narus. While Fong declined to name any new investments the VC firm is getting ready to make in the blade market, he did say he's looking.

"Its a huge market," said Fong. "We are talking about the reinvention of the data center."

-By Donna Fuscaldo; Dow Jones Newswires