What's The Deal: B2B, or Not 2B

It's not clear whether Tuesday's market drubbing is the start of something bigger for Net stocks. Few would argue that Internet stocks will avoid a large correction in 2000, but when the market is roaring upward, it's hard to give that idea more than lip service. Hot markets such as we've seen since October can obscure the obvious. Getting clear about what's obvious is the first step to being prepared for it.

A close look at 1999 reveals that valuations of Internet stocks may seem irrational, but beneath the surface one can see patterns that are as regular as tides.

Past Prologue

A year ago, the marriage of major media and Internet portals was said to be critical to the fortunes of both. And consumer e-commerce was viewed as the premier engine of profit. Today, Disney's mating with Infoseek and the NBCi union of myriad dot-coms are viewed by investors as genetic engineering gone awry.

Meanwhile, investors discovered that retailing is at least as tough on the Net as it is on terra firma. Now, clicks 'n bricks mating of consumer Netcos with major retailers is seen as imperative to the fortunes of both. And B2B commerce is viewed as the premier engine of profit.

Driving these mutable trends are immutable forces. As the Internet changes everything, the Internet is changed by everything. "The fundamental things apply as time goes by," sang Sam to Rick and Ilsa in Casablanca. In business, as in romance, basic principles are as inexorable as gravity.

In 1998 online retail stocks soared on ecstatic projections of holiday shopping. In 1999, despite even grander projections, they were dogged by a deathwatch of endless articles about problems of customer service and shipping.

The irony is that the big Net retailing winners are the major media - not via their Web efforts but from avalanche of desperate dot-com advertising dollars.

In both 1998 and 1999 the overall stock market, including the Net sector, experienced sharp declines that ended in October and were followed by equally dramatic recoveries into January. In the 1998 recovery, the stocks of Net retailers scored big gains. In 1999 they badly lagged the pack that was led by B2B.

A year ago, the magic of the Net retailing business model was "no inventory," and revenue growth was all that mattered. On Wednesday, Amazon drove another stake into those cherished notions. The company announced that fourth-quarter sales were up 150 percent over last year, to $650 million. But it said that wouldn't translate to a narrowing of losses, and that there would also be unexpectedly large charges related to the write-down of unsold inventory - something that a year ago was thought to afflict only brick-and-mortar stores.

Amazon's stock tanked 15 percent.

Future Tense

History says that in 2000, an intrusion of reality on imagination will hit the business-to-business sector. No matter how compelling a new technology may be, deeply rooted business structures of mega-billion dollar industries don't change quickly. When they do change, the process is the epitome of incremental, often shaping the technology as much as the other way around.

Business took more than a decade to gain significant productivity from the use of PCs. The promise of B2B requires far more profound changes to business processes. The growth curve won't look like a hockey stick.

Just as investors became disabused of simplistic business-model buzz about Net retailing, business-to-business stocks won't continue to ride crazy trains like "vertical market procurement."

For decades, phones and faxes have given companies the ability to "disintermediate middlemen." Yet distributors thrived because they organize and serve markets in a highly hands-on fashion. Business-to-business eBay-types have a role. But they won't change everything. Just as fundamental things like customer service and fulfillment became big issues for e-retailing, basics ignored by today's business-to-business fantasists will soon come front and center.

The investment opportunity doesn't evaporate just because we acknowledge that Net business is complex and challenging. It actually creates a more stable foundation for it. But the transition can be awkward.

Selling Sense

The Y2K problem for business-to-business stocks is that we know a significant correction is up ahead, we just don't know when. That's never been a reason to avoid buying stocks. At the same time, the greatest attention should be paid to planning how to sell. After buying, that's the next question every investor has. Few think about it in advance. Cheerleading price increases doesn't give an answer. It's just a set-up for panic during the inevitable decline.

The traditional selling gauge of valuation doesn't apply to Internet stocks - at least, it doesn't apply yet. That leaves money management. Professional gamblers will tell you it's the most important thing. With Internet stocks, the same rule applies.

It boils down to not getting caught up in greed. Taking money off the table with disciplined calculation, and setting rigorous downside limits. Developing a plan for selling is the hardest work any investor can do. But it's the only way to hang onto the gains that can be made from manias. Entering the market with an easy-money mindset is the simplest way to wind up losing.

David Simons is managing director of Digital Video Investments, an institutional research firm. Write to him at mailto: simonsd@digvid.com.

At the time of publication, neither DVI nor any of its employees had securities positions in any of the companies mentioned herein. This column is solely for informational purposes. Under no circumstances is it to be construed as a recommendation to buy or sell securities. Neither DVI nor the author can provide investment advice to individuals.

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