B2B Stocks Take a Hit, but Rebound Says Investors Still Believe

Business-to-business stocks slid sharply Friday on the heels of a downgrade of three highfliers. Still, their rebound off early lows suggests the stocks' many supporters continue to believe.

Ariba (ARBA Quote), Commerce One (CMRC Quote) and i2 Technologies (ITWO Quote) plunged 15% early Friday after Prudential Securities analyst Douglas Crook downgraded the trio to accumulate from strong buy on concerns about future revenue streams. At midafternoon the stocks had recovered somewhat, with Commerce One off 16 3/4, or 9.7%, at 156 9/16, Ariba off 10 5/8, or 4.8%, at 209 3/8, and i2 off 8, or 6.2%, at 121. The Nasdaq was up 100, or 2.3%.

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With these stocks having run up so sharply in the last six months, supporters say it's natural that a negative report takes the wind out of the sector, for a day at least. But make no mistake: Industry insiders have been discussing the issues the report raises, and with these young companies valued well into the billions of dollars, the questions aren't going to go away.

Pricing and Resources

Crook raised two main issues in his report. First, he questioned whether, in light of increased competition, the companies will continue to get a piece of the potentially lucrative transaction fees from market exchanges that their technologies help power. He pointed to Oracle (ORCL Quote), which has been aggressively casting itself as a B2B heavyweight, as a company that has said it will set up exchanges without charging transaction fees. He also noted Microsoft (MSFT Quote) as a potential competitor in the B2B exchange market.

Second, Crook noted that the three have all signed major deals to which they must now dedicate significant resources. Commerce One, for example, emerged this week as a technology provider for the $400 billion aerospace industry's market exchange, and it's already dedicating resources for an exchange in the auto industry. Ariba has signed deals with giants like Chevron (CHV Quote) and Cargill, and i2 counts Toyota (TM Quote) and Compaq (CPQ Quote) among its customers.

"We assume each of these customers will demand levels of service from their technology partners that assumes no other customers exist," Crook wrote. "As a result, we believe focus will increasingly become a key fundamental risk among these three vendors." He did not return a call seeking comment on his report.

The Transactions Business

Crook's report came at a time when industry insiders and analysts have been talking about these very issues.

Alex Osadzinski, vice president of marketing at Vitria Technologies (VITR Quote), an enabling software-maker in Sunnyvale, Calif., says his company has consciously been staying away from a transaction-based business model.

"I can't speak for the industry as a whole, but we certainly have been talking about it here," Osadzinski says. "We've avoided the transaction-pricing model for a number of reasons, one of the biggest being that our customers are resistant to it." For its part, Vitria was off 3 1/8, or 2.7%, at 110 Friday afternoon.

Referring to Crook's comments about focus among the B2B companies, Patrick Mason, an analyst with E*Offering, concurs: "That's the one point that I think is valid," says Mason, who rates Commerce One as a strong buy and whose firm has done no underwriting for the company. "The biggest factor for all these guys is putting enough manpower behind the sales that they've closed, and executing from the standpoint of deploying these exchanges."

Tech-Stock Volatility

Also possibly contributing to the sharp pullback: Technology stocks have been extremely volatile lately.

"The group's been very hot, and the stocks got bid up to some excessive valuation," says Eric Efron, co-manager of the (USAUX Quote)USAA Aggressive Growth fund, which counts Commerce One, FreeMarkets (FMKT Quote) and PurchasePro.com (PPRO Quote) among its holdings.

"Now, we've got a nervous market and people are starting to look for things that could go wrong," Efron adds. "Today, they seem to have centered their aim on the B2B area." FreeMarkets was off 9, or 6.7%, at 126, while PurchasePro was off 11, or 12%, at 78 1/2.

Buying the Dips

The sector's defenders remain steadfast.

"We've seen no evidence of this price erosion or revenue-sharing erosion that's been discussed today, and we would be very strong buyers of these stocks at these levels," says William Epifanio, an analyst at J.P. Morgan who has a buy rating on both Ariba and Commerce One and whose firm hasn't done underwriting for the companies.

And on balance, many analysts point to the fact that with earnings season approaching, and that fact that B2B has been surging with activity throughout the first quarter, Friday's selloff may just be the perfect entry point before quarterly report-driven gains. If you believe the market is sound, that is.

"Everyone's kind of itchy at this point and afraid of bad news," says Michael R. Micciche, a Donaldson Lufkin & Jenrette analyst who rates i2 a market performer. "The feedback I've been getting is that business is good, so I don't think the fundamentals have changed. Of course, don't ask where the market is going, because I don't know."

But that, of course, is the $50 trillion question.