Move Over Y2K, B2B Is Here
By Adam Lashinsky
Silicon Valley Columnist
9/17/99 7:00 AM ET
Business-to-business e-commerce now officially is the Next Big Thing. Why? Because Goldman Sachs says so in a report it issued Thursday. 'Nuff said. Pay attention, though, to the details beneath the hype. They suggest it also is going to be the Next Big Disruption for tech-stock investors who get caught crosswise of the euphoria.
B2B, as the smart set calls it (yes, you're going to hear this every bit as much as Y2K), indeed is going to be big. Goldman's analysts estimate overall B2B industry revenue of $1.5 trillion by 2004. This means that revenue associated with commerce conducted over the Internet between and among businesses, as opposed to consumers, will grow more than 10-fold from an estimated $115 billion this year.
A few potential B2B problems bubbled to the surface, however, for those who listened carefully to Goldman's conference call with institutional investors immediately before its teleconference with reporters.
See, Goldman wants to hype B2B e-commerce because right now there are precious few publicly traded B2B stocks, a short list that includes Ariba (ARBA:Nasdaq), VerticalNet (VERT:Nasdaq), Commerce One (CMRC:Nasdaq), IntraWare (ITRA:Nasdaq), Internet Capital Group (ICGE:Nasdaq), pcOrder.com (PCOR:Nasdaq), Chemdex (CMDX:Nasdaq) and Healtheon (HLTH:Nasdaq). The combined revenue over the last year of those fledgling companies is just over $200 million, about 3 1/2 days worth of sales for Dell Computer (DELL:Nasdaq). If industry sales really are to explode within five years, there'll be tons of upstarts for Goldman to take public (see below).
The catch is that Goldman's hot-shot Internet analyst Rakesh Sood and veteran software guru Richard Sherlund dutifully point out the risks with B2B. For credibility, they must. Presumably, they're also beginning to establish the difference between a Goldman client and everyone else.
For one thing, it's a given that scores of inferior B2B companies will try to sneak through the IPO process along with the good ones. Business-to-consumer offerings started as a trickle before the floodgates opened this year. B2B stocks will skip quickly to the overkill stage. "We have to beware of the hype," says Sood.
The six-analyst Goldman report is more specific: "Regarding stock recommendations -- we believe that there will be a number of beneficiaries, but fewer long-term winners." Remember that when scrutinizing a specific IPO candidate being brought public by Goldman or one of its competitors.
Sood also touches indirectly on one of the fundamental problems of B2B: Automating slim-margined businesses creates automated slim-margined businesses -- not instant technology companies. He speaks of B2B companies having a "revenue blend." Translation: Many B2B companies won't be particularly profitable on most of what they do, even if they are extraordinarily profitable in some part of the business.
Sherlund is more specific. He notes, with envy, that the best of the companies Sood follows typically trade at 20 or 30 times their revenue. In contrast, Sherlund's top picks fetch a meager 50 to 60 times earnings. As established enterprise software companies like Oracle (ORCL:Nasdaq) and SAP (SAP:NYSE) gun for Internet-type valuations, they'll have to tear up their business models and start from scratch. And that, says Sherlund, will make for a difficult transition for many. He predicts more older companies will consider issuing tracking stocks for their B2B efforts and that the clashes between entrenched players and the "dozens" of startups will be tumultuous.
Another usually unspoken truth about the new crop of B2B stars is that they're actually software companies masquerading as Internet concerns. Unless a company has predictable, recurring revenue streams, like B2B standouts Yahoo! (YHOO:Nasdaq) or America Online (AOL:NYSE), it's just another enterprise software company, albeit in a new niche. This is relevant because software makers that make big-ticket sales to a handful of customers are famously susceptible to end-of-quarter deals that yield the dreaded hockey-stick sales curve. Back-end loaded quarters make for poor visibility, which makes for volatility in the stock.
Says Sherlund: "You don't want to pay 20 to 30 times revenue if you're unsure if they're going to make the quarter."
Thanks, I Needed That, Part 1
Raise your hands if your mother told you that nobody likes a showoff.
An item here Wednesday boasted that Fortune recently offered an "exclusive first look" at Internet Capital Group (ICGE:Nasdaq), when it traded for 80. This column, on the other hand, informed investors about ICG weeks before it "finished its first day" as a public company at 15.
"When did ICGE close at 15?" justifiably demands a reader who goes by the handle Johnyhoops. Oops. Internet Capital opened at 14 on Aug. 5 (Fortune says 15; Yahoo! Finance says 14) but closed that day at 24 7/16, its lowest close. ICG shares ended Thursday unchanged at 74 3/4.
Buying at 24 and change is still a helluva lot better than 80, but not nearly as good as 15, which was just plain wrong. Thanks Johnyhoops; getting the facts straight should be like making a layup, but even those don't go in sometimes.
Thanks, I Needed That, Part 2
Here's a letter worth reprinting in its entirety. It's from reader Bernard Ber concerning C.E. Unterberg Towbin analyst John Todd's quip here Wednesday about wishing Polycom (PLCM:Nasdaq) banked with his firm, especially as he has steadfastly supported the company's stock.
"As an analyst, why should he care whether Polycom has an underwriting relationship with his firm? Unless he gets paid bonuses in accordance with the underwriting of the firms that he covers perhaps? Quite frankly, it is because of this kind of garbage that I feel you can't trust the advice of most of these Wall Street analysts. If you really want to be provocative, you ought to do articles focusing on the relationship between Wall Street analysts, underwriters and the firms that they cover. I think more investors ought to be informed about this, because they take analysts' advice at face value."
These are excellent points. Good analysts walk a fine line between making intelligent stock calls and touting shares of their firm's clients. Though few analysts receive specific bonuses tied to deals, most are compensated based on the deal flow related to companies they cover and the brokerage business their traders do on their coverage universe. It's a filthy, conflict-ridden system where the so-called Chinese wall between analysts and bankers barely exists anymore. But it's also lucrative -- underwriting and trading are worth far more than pure research.
Again, good analysts make good picks that make clients money and save them from mistakes. But as Ber points out, anyone taking their recommendations strictly at face value is being naive to the ways of Wall Street. You don't have to like the system, but you do have to understand it.
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