VALLEY TALK

Valley Horror Show: The Incredible Shrinking Engineer

FORTUNE.COM
Friday, November 30, 2001
By Adam Lashinsky

There used to be two truisms in Silicon Valley: Engineering talent is always scarce, and startups are worth buying strictly for their human capital. Sadly for the pocket-protector set, prices on their heads are coming down as quickly as stock quotes and airline ticket prices.

The evidence? The few deals cobbled together in the Valley in recent months carry relatively meager price-per-employee ratios--an investment banking yardstick that continues to be relevant, even after the dot-com meltdown. In mid-November telecom equipment maker Juniper paid $200 million for Pacific Broadband, roughly $1.3 million for each of its 150 employees. That sounds like a boatload until you compare it with the $26 million per employee Cisco paid for
switchmaker Cerent in 1999, or even the $5 million-plus it shelled out for startups as recently as a year ago.

The falling price of an engineer is one of the biggest stories in the Valley right now, and it's best told through Cisco, a pioneer in using stock to snap up promising startups. Last year the company opened its checkbook, on average, two or three times a month. At the time the strategy seemed to make sense--Cisco used the Valley as a giant research and development lab and kept talented engineers away from its competitors. It backfired in April when the company took hundreds of millions of dollars in write-offs, mostly to cover fired employees, unneeded facilities, and goodwill associated with the acquisitions.
Valuing companies based on engineers isn't as goofy as it sounds. Acquirers need a method to price a company with no sales or profits. Bankers use measurements like patents held or "engineering days"--the number of engineers on a project multiplied by the time spent on that product design--to determine values for acquisitions, says Ted Tobiason, an investment banker with Robertson Stephens in San Francisco. "These metrics have stood the test of time considerably better than page views," he says, referring to the now discredited
method of measuring the value of Internet companies.

Today, with "the Valley awash with engineers...there is less need to buy them in blocks," says Tobiason. The upshot is that the bounty on their heads will continue to shrink. In this era, entrepreneurs--as well as stalwarts like Cisco--need more than a golden Rolodex to fortify a company. They need smarts and a good business plan. "Over the last few years four guys with B-level credentials thought they could get together and start a company," says venture capitalist Atiq Raza, CEO of Raza Foundries in San Jose and a former president of chipmaker Advanced Micro Devices. "That won't happen again for a very long
time."

How much is that engineer in the window?

Here's how much an employee in Silicon Valley was worth over the past year, determined by dividing the value of a sample acquisition by the number of employees acquired.

Nov. 2000: $5.6 million
July 2001: $1.9 million
Nov. 2001: $1.3 million

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