Net Sector's Carnage Brings a Real Reckoning

Right now, a lot of Net investors are probably wishing they could toss their stocks back to the dorm-room geeks who did most of the surfing in the first place.

Since peaking at 1333.22 in early March,

TheStreet.com Internet Sector

index has lost more than 35% of its value, leaving it at levels not seen since mid-November.

The spiral in Internet stocks hasn't been kind to many -- even the Internet's "blue-chips," which would presumably include

America Online

(AOL)

,

Cisco

(CSCO) - Get Report

,

Yahoo!

(YHOO)

and

Amazon.com

(AMZN) - Get Report

, are all trading far below their historical highs.

Now, there is precedent for this: Last spring, the index lost nearly half of its value, around the same time technology stocks in general swooned. But Net stocks recovered and were carried to record highs in late 1999 and early 2000 by B2B and other Net plays.

This time, it doesn't feel like a seasonal correction.

Many believe these stocks are now in the midst of a true shakeout. Even if the

Nasdaq Composite Index

re-establishes upward momentum, many believe participation from the Net stocks is going to be limited to the leaders in the various sectors of the Internet economy. Many others in coming months are facing the reality of "merge or die" -- which won't necessarily help their stocks anyway.

"I don't expect tremendous participation

in a rally in the mid- to small-cap Internet stocks that at some point will be fighting for survivability," said Barry Hyman, chief market strategist at

Ehrenkrantz King Nussbaum

.

As investors have begun separating top-tier Net names from the rest, it's become clear that many of these companies' strategies aren't exclusive to the Net. America Online, now that it's merging with

Time Warner

(TWX)

, is fast becoming just a large media company; Amazon.com will someday be seen as just a retailer.

AOL's "Steve Case is a pretty sharp guy, and I think he sent a signal to the Internet sector that we were all overpriced," said Jerry Hegarty, chief analyst at

Cape Market Research

in Osterville, Mass. "He was the blue-chip of the industry, and if he's cashing in and taking the check, it sends a message to investors that these things are way too frothy."

The other companies that seem poised to survive are those providing services unique to the Net, such as Cisco and

Oracle

(ORCL) - Get Report

, or possibly companies such as Yahoo! B2B stocks don't seem quite as innovative now that existing smokestack industries have figured out how to use B2B for their own purposes.

Declining interest in dot-coms has taken the shine out of the "incubator" sector of the Net, companies such as

Internet Capital Group

(ICGE)

and

CMGI

(CMGI)

that look to invest in other Net stocks.

Been Down This Road Before

Analysts liken the revaluing of these stocks to what happened to biotechnology in the early 1990s, and previously to communications, railroads, automotive and any other industry that had wide-ranging economic impact. While the industry itself may have produced great technological and social change, it doesn't mean every company prospered -- or survived.

This isn't something that analysts have failed to acknowledge. Well-known Internet bulls such as Henry Blodget of

Merrill Lynch

expect 75% or more of existing Net companies aren't going to last.

But 1998's and 1999's euphoria yielded many companies that managed to get money through an initial public offering, and now investors are stuck with dogs. So while there are always a few eager investors at the ready to buy Cisco, the same can't be said for stocks such as

drkoop.com

(KOOP)

.

That situation will only get worse in the coming months, as companies that went public during fall's euphoria will foist more shares upon the public when

lockup periods (when insiders cannot sell shares) end.

HomeStore.com

(HOMS)

, for example, went public in August with an offering of 7 million shares and peaked at 122 1/4 in January; it will dump up to 43 million more shares on the market in two weeks. The stock closed today down 7 13/16, or 25%, to 23 1/2.