How Killer B-to-B's Slid to the
Endangered List
Issue in Depth
The New York Times: Your Money
By BOB TEDESCHI
oing into the week of April 10, the shareholders of the Vignette
Corporation had more reason than most to be optimistic about its
stock price. The company's new series of e-commerce software
programs was about to be introduced, and a 3-for-1 stock split was to
take effect that week.
But the optimism evaporated quickly. The stock was pummeled as
technology shares continued their monthlong collapse that week.
It fell even further when the split took effect that Friday -- the day that
inflation worries knocked the floor out from under the Nasdaq. Vignette
finished at $42.25, down 37 percent for the week and 57 percent from
its high of $99 on March 10.
Jeff Wrona, portfolio manager of the $3.02 billion PBHG Technology
and Communications fund, watched the price dive and felt "painfully
sick" -- sicker than perhaps any other Vignette shareholder, save the
software maker's executives. Vignette, a company that Mr. Wrona said
has great prospects for both long- and short-term growth, represented
his largest e-commerce software holding "by far."
In the days that followed, Mr. Wrona and others asked themselves a
question: What exactly to do with the business-to-business e-commerce
stocks they had poured so much money into in the previous months?
Business-to-business, or b-to-b, Internet stocks had restored
e-commerce's good name in investor circles this spring. They did so
during an abysmal showing by business-to-consumer Internet stocks like
eToys, CDNow and scores of others that had basked in Nasdaq's glow
last year, but collapsed in value amid disappointing Christmas
performances. Indeed, a casual observer, looking at the performance of
the two stock groups, might have thought that investors were shoveling
the cash they had pulled out of eToys -- which fell by half from Dec. 31
to March 10 -- into the Vignettes of the world.
Just as quickly, though, the b-to-b group turned into the prime killing
ground for overvalued technology stocks. The Merrill Lynch B2B
Internet Holdrs Trust, a security that tracks 20 such companies, fell
68.6 percent from March 10 through April 14. Over that period, the
Nasdaq composite fell 34.2 percent.
There were a couple of reasons for the severity of the sell-off. One was
the outrageously high prices to which many of the stocks had rocketed.
The Internet Capital Group, an incubator for industry-specific b-to-b
marketplaces, went public at $12 in August and screamed to an intraday
high of $212 a share on Dec. 22. A dozen b-to-b stocks -- including
Internet Capital, Ariba, Commerce One and PurchasePro -- which
were not yet public before the middle of last year -- had soared to garner
$125 billion of market capitalization between them in roughly six months.
Another problem was the rising tide of skepticism that seemed to engulf
the sector, much of it was well-founded. In the mania, it seemed as if any
company that had ever sold a good or service over the Internet rolled out
a "b-to-b play," hoping to net a quick jolt in its stock price. In March,
Yahoo, the Internet portal company, announced the creation of a
business marketplace where industries could research and buy goods.
That came five days after eBay announced its own b-to-b exchange.
While bidding up the stock prices of the early marketplace leaders,
investors failed to account for the very real threat posed by industry
incumbents like General Motors, Ford Motor and General Electric,
whose entry promised to undermine the revenue dreams of so-called
pure-play Internet companies.
"These stocks certainly got way ahead of themselves," said Ed McCabe,
a Merrill Lynch analyst. "B-to-b addresses huge market opportunities,
but today there's still little traction, so these stocks are discounting a rosy
future. When you discount 20 years of good news, even slightly bad
news today can have a significant effect on the present value of those
stocks."
Investors had come to look at information through the rosiest glasses.
One of the most widely quoted statistics on the business-to-business
sector was one put forth by the Gartner Group. It estimated that a
staggering $7.3 trillion worth of global corporate spending would go
through the Internet in 2004, up from $145 billion last year.
Few people, however, cited the more salient figure in that same Gartner
report: that nearly two-thirds of that money would go directly from
manufacturers to suppliers, not to the b-to-b Internet companies
providing software, technology and the marketplace platforms to clear
the path for that spending.
Still, that leaves roughly $2.7 trillion for the b-to-b Internet market -- a
healthy number by any standard, even if not enough to justify market all
the euphoria. And the recent sell-off has done nothing to diminish the
prospects of the b-to-b sector generating that much business, analysts
and institutional investors said.
Indeed, according to Geri Spieler, a Gartner analyst, there will be
"enormous pressure from both buyers and suppliers" to adopt
e-commerce over the next five years because of the enormous cost
savings involved. Ms. Spieler said that in 2005, when the first round of
corporate technological buildup nears completion, "the entire supply
chain between suppliers and buyers will be automated."
"Any company will be able to order anything on the Web and have it
customized, whatever," she added. "That's nirvana."
Given such a picture, the stunning decline in prices could now be viewed
as a positive for investors who still have a taste for b-to-b stocks.
According to Andrew S. Cupps, portfolio manager of the $850 million
Strong Enterprise fund, the sell-off will benefit the larger players,
because smaller e-business software and technology companies may now
be unable to go public or make secondary stock offerings necessary to
grow their businesses.
"Certainly, some companies will grow and come public," he said. "But
fewer will do it, and they'll do it more slowly. It really creates a better
environment for those who've made it through the window."
Which is precisely why the early leaders -- and those with the strongest
cash positions -- were the stocks that held up the best in the April
deluge.
Skeptics say that one major correction can be followed by another --
and that the 250.99-point drop in the Dow Jones industrials on
Wednesday is evidence that markets remain extraordinarily volatile.
More important is the assertion that the promised profits of the b-to-b
marketplace are just so much pap -- that the reality will never approach
current forecasts.
But that ignores an unpleasant fact. If the b-to-b group does not pan out,
investors are unlikely to find any safety under the technology umbrella. So
important is the b-to-b group to the prospects of blue chips like Cisco
Systems and Intel that a failure of the new-business paradigm to live up
to expectations would almost certainly put a serious dent in many
technology companies -- high-priced as they still are.
But perhaps the spring massacre has served to make the job of picking
winners and losers that much easier.
Money managers and analysts who follow and invest in this class of
stocks say they remain convinced that each b-to-b Internet sector has
companies with extraordinary investment promise, especially for investors
who are willing to dig.
The B-to-B Taxonomy
One problem in picking a smart business-to-business investment, of
course, is that any small company armed with a T-1 line can pitch itself as
a business-to-business stock. And many do.
At the other extreme, established companies like Oracle, which sells
software that helps corporations manage their databases, and Sun
Microsystems, which makes servers, the workhorse computers behind
the Web, are now called b-to-b plays too, since so much of their future
growth is predicated on the growth of e-commerce. And there is the
enormous overlap among companies that do business in various
categories.
Experts divide the business-to-business Internet world differently, but
many settle on several key categories, beginning with so-called
infrastructure and architecture companies that make the gear and
software that store, retrieve, organize and send bits back and forth
across the World Wide Web. These services are meant to support the
back end of a corporation's e-commerce system -- Oracle's database
software and EMC's data storage systems are but two examples.
Next comes the software that the companies use within their
business-to-business systems to serve their customers -- software that is
more closely aligned with, say, the sales process or customer relations
than a corporation's internal information technology department. B-to-b
e-commerce software can help companies buy goods from suppliers or
pitch their customers' products on the Internet.
Companies that advise and guide other concerns through the maze of
introducing their e-commerce business plans are another
business-to-business sector. Call them e-guidance companies if you like.
Then there are the b-to-b marketplaces, roughly the business equivalents
of eBay, through which companies exchange goods that are at the core
of their business processes. The sector also includes those companies
that make software needed to run the exchanges.
Architecture
For investors, the appeal of Internet architecture and infrastructure
companies is clear. "If you're in a war, you don't want to take sides --
you just want to sell the guns," said Bob Turner, chief investment officer
of Turner Investment Partners of Berwyn, Pa. "That's what these guys
do."
The heavy artillery includes the hardware, routers, software and
technologies that move huge amounts of data as quickly as possible
through an Internet connection and are usually the kind of gear made by
Cisco and Sun. But many money managers are also bullish on the EMC
Corporation, a pre-Internet company that has flourished in the data-rich
environment of the Web by selling data storage systems that stockpile a
wealth of information, along with software, networks and services to
manage that data. Its products are the runaway favorites among
corporations.
"To distill it, EMC is the best at what they do, bar none," said Bill Lewis,
an analyst at Chase H&Q. "They're absolutely the dominant supplier of
enterprise storage systems, and the competition is behind," he added,
referring to I.B.M., Compaq, Sun and Hewlett-Packard.
All blue-chip companies have a lot of sales that are not
business-to-business. So in approaching a company like EMC as a
b-to-b play, analysts said to focus on its revenue streams from its push
into e-commerce. The company says that while just 12 percent of its
sales are Internet related, growth in that area will be the major driver of
revenue this year and will account for the majority of sales in the next 2 to
5 years.
Mr. Lewis is forecasting earnings growth of 30 percent a year over the
next two to three years.
The stock has weathered the Nasdaq storm well, closing on Friday at
$138, just below its 52-week high of $144 on March 7. Last week,
EMC announced a 2-for-1 stock split payable June 2.
That said, the number and strength of its rivals are cause for worry down
the road, Mr. Lewis said: "Each of those companies has increased their
efforts in storage because they're losing money to EMC. The question is:
Does the competition catch up, and when? But so far, we've been
expecting more than we've gotten."
Regardless of the pace of corporate e-commerce, Mr. Lewis said the
demand for data storage would grow.
Mr. Lewis rates EMC a buy, but has no price target.
One infrastructure stock that has retained favor among money managers
-- despite the steep fall in its share price -- is Exodus Communications,
which builds and hosts Internet systems on its vast "server farms" for
corporations. "With the acceleration of e-commerce, a lot of companies
have realized they lack the internal resources to manage their Web
operations" with their own information technology departments, said
Andrea Grosz, an analyst at First Union Securities.
"We think 20 percent of companies outsource some piece of I.T. today,
and 50 percent will by 2002," Ms. Grosz continued. "Exodus will be one
of the major beneficiaries of that."
The company has roughly 30 percent of the overall market now, she
said. More important, that figure includes 50 percent of the most visited
Web sites, including Yahoo, Lycos and eBay.
Data hosting, Ms. Grosz said, represents 40 percent of Exodus revenues
and, again, the stock's risk lies in the fact that rivals are trying to muscle in
on its business. "Large telcos like Qwest and Level3," she said, are
among those pushing, "and that could create a commoditization, and
price pressure along with it, particularly in the data hosting piece."
Exodus shares suffered mightily in the technology sell-off. On Friday,
they closed at $85.75, about half their high of $173.3125 in March. Still,
Ms. Grosz has a 12-month price target of $130 on the stock.
Software
Business-to-business software products seem to metamorphose monthly
amid a roiling mass of shifting corporate alliances.
Among the melange of products: procurement software, to manage the
buying and selling of products; content management and database
management software, to analyze and present content on company Web
sites; personalization software, to tailor the content to different users, like
human resource employees; and customer relationship management
software, which allows salespeople to work more effectively.
The best tactic for investors, money managers said, is to focus on the
market leader in each category. Companies with a reputation for having
the best product are likely to flourish. Among others, money managers
cited Broadvision, which makes personalization software; Interwoven
which sells content-management software; and Vignette, which makes
specialized software used for everything from running site content to
automating some customer-service functions.
"This a very niche-oriented software market now, but it will be
consolidated, because sites will want to get it done with two or three
different vendors," said Mr. Wrona of PBHG. "That just reinforces why
you want to have the best-of-breed."
Instead of trying to figure out the best software products themselves,
investors can look at the products that the leading companies are buying.
"It's a very, very good indicator of quality," said Storm Boswick, a
portfolio manager for J&W Seligman. "It shows the market understands
the product, that these are the companies that G.E. and others are willing
to go into battle with."
For instance, the fact that Merrill Lynch chose to buy its customer
personalization software from Vignette is evidence that it is a leader in
that category, analysts said.
According to Stephen Sigmon, an analyst with Dain Rauscher Wessels,
Vignette is on track to achieve "one-stop shop" status, the ability to
furnish most software needs to customers, through its V/5 series, which is
being rolled out slowly, and the array of applications that the company
has either developed on its own or added through acquisitions. "All the
key metrics -- market share, customer acquisition growth, revenue
growth -- are going in the right direction," he said. The stock closed on
Friday at $56.3125; Mr. Sigmon has a 12-month price target of $100.
E-Guidance
Armies of consultants stand ready to coax Internet-shy executives into
the e-commerce revolution -- and collect hefty fees in the process.
The problem, both institutional investors and analysts said, is that
companies that provide Internet business development strategies --
Scient, Viant, AppNet -- are seen as "body shops." In other words,
they are regarded as businesses whose futures hinge on the quality and
number of consultants they can muster.
But not all service companies should be avoided, and the technology
stock sell-off may have provided relatively attractive valuations, money
managers said. "The best bets here are companies that have a different
approach in the marketplace, and large companies," said Alan Harris,
senior portfolio manager at Munder Capital Management in Birmingham,
Mich. In particular, he cited Diamond Technology Partners, whose
consultants advise the highest levels of corporate management.
Among other things, said Richard Leggett, an analyst with Friedman,
Billings, Ramsey, a small investment bank based in Arlington, Va.,
Diamond consultants generate the most revenue per person of any
publicly traded company, at $360,000 to $400,000, compared with the
industry average of $250,000. And the company's clients renew their
contracts with Diamond 81 percent of the time, versus an industry
average of 60 to 70 percent, he said.
Still, the dependence on human capital is likely to be a hindrance over all.
"The company can only scale so much," he said. "And this market is
growing at 60 percent a year."
Diamond shares fell 50 percent from their high of $100 on March 9 to
$49.0625 on April 14. They have since rebounded to $83.625.
Exchanges
No category has done more to push business-to-business e-commerce
to the front of investors' minds in recent months than the debut of online
marketplaces, often referred to as exchanges. These are one-stop shops
for various industries that give commercial buyers and sellers a place to
display their goods, sell them at auction, put out requests for proposals
and perform other business functions that used to be the domain of the
telephone and fax machine.
The sector has two parts. First are those companies that build or run the
exchanges, like VerticalNet, Ventro and the Internet Capital Group.
Second are the companies that want to sell software to the exchanges,
like FreeMarkets, Oracle, Ariba and Commerce One.
The smart way to assess the viability of a particular marketplace is to
look at its industry relationships. "The key thing to look at with these
exchanges is who's got the big fish in every industry," said Mr. Harris, of
Munder Capital. "Once they sign him up, the big fish goes to the
suppliers, and says, 'You need to standardize on this platform if you want
to continue doing business with me.' "
That means the exchange category is particularly vulnerable to
old-economy giants. G.E. Medical Systems and Johnson & Johnson,
for instance, recently announced the formation of an online marketplace
to serve the medical industry. That is bad news for Neoforma.com, a
business-to-business exchange focusing on the same category.
The exchanges best able to defend themselves against old-economy
competition are those that address more fragmented markets, where the
power is not consolidated among a few hands. That leads Steven
Frankel, managing director of Adams Harkness & Hill, to recommend
eMerge Interactive, an exchange that serves the cattle industry.
EMerge "doesn't have to fear the big guys," he said. "The beauty of it is
there aren't any industry giants here." EMerge shares closed on Friday at
$21.8125, 67 percent off their March high of $66.875. Mr. Frankel said
he had no price target on the stock, but that he continued to "pound the
table on this one."
To spread one's bets, some analysts and money managers have
gravitated toward the Internet Capital Group, a b-to-b incubator that
invests in dozens of exchanges and has helped take them public. It closed
on Friday at $38.625, down 81 percent from its closing high of $200 on
Jan. 3.
"We're still with I.C.G.," Mr. Turner said.
"If b-to-b is to survive, I.C.G. will have to be there."
Mr. McCabe, of Merrill Lynch, said he, too, remains bullish on Internet
Capital. But in the short term, he said, the company is "very dependent
on the market sentiment regarding business-to-business, and the I.P.O.
market." He has no price target for the stock but rates it buy-accumulate.
Stocks of companies that sell software to the exchanges were also
battered in the spring sell-off.
Ariba shares fell from a high of $165.50 on March 8 to $54.4375 on
April 17; they closed on Friday at $76.
In part, the exchange software companies followed the decline in the
exchanges themselves because they often get a small share of every
transaction completed on exchange sites that use their software. When
G.M. and Ford indicated that they might not accept such a
revenue-sharing model for their proposed exchange, investors feared that
the exchange software companies would end up like, well, ordinary
software companies, searching for reliable, recurring revenue streams.
However, Scott Phillips, an analyst with CIBC World Markets, said he
expected Ariba to get a share of exchange revenues regardless -- if not
from a per-transaction fee then from a share of flat fees that exchange
participants will likely pay in the future. Such recurring revenue, Mr.
Phillips said, gives the company "a compelling business model." He has a
12-month price target of $150 on Ariba. |
