10 Things You Need to Know: B2B Becomes the BFD

This year, the leaders are staking their claim and the losers will suffer.
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To glimpse the future of the hot business-to-business sector this year, just rewind the clock to early 1999 and think of the online retailers. The same fate will likely befall B2B stocks: High demand followed by a flood of new issues, followed by a shakeout that separates the strong from the weak.

B2B, of course, is the market where companies deal with suppliers, distributors and buyers over the Net. Until last year, it went by the less catchy name of corporate extranets and was largely ignored by Wall Street. Until last year, most people thought e-commerce meant online retailers such as

Amazon.com

(AMZN) - Get Report

.

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The last few months of 1999 changed all that. The oft-cited forecast from

Forrester Research

that the B2B market would reach $1.3 trillion by 2003, or 10 times the online retailing market, helped set the sector on fire. Online retailers came to be called B2C -- or business-to-consumer -- and most of their stocks languished during the busy holiday season. B2B, not B2C, became the BFD.

Before B2B enthusiasts dismiss the online retailers as worthless, however, they should heed the lessons that e-tailing's decline offers. A year ago, "it didn't matter what you owned" in e-commerce, says a fund manager who is long several B2B stocks. The demand for e-tailers exceeded the supply of shares. But then dozens of new e-commerce companies went public in 1999, ending the imbalance and killing the e-tailing momentum. And as companies missed their earnings forecasts, the success stories began to separate from the also-rans.

The impact has been hardest on second-tier online book and music sellers. A year ago,

Booksamillion

(BAMM)

,

CDnow

(CDNW)

and

Cybershop

(CYSP)

were kings, but their reigns proved short-lived. Cybershop, for instance, rose 400% from October to mid-December 1998; it has since fallen nearly 70%. Booksamillion is down 75% from its peak in late November. But top-tier Amazon has more than doubled.

The IPO flood is expected to be heavy again in 2000 for Internet-related companies, and it probably will include plenty of B2B entries. Last year, a rush of 68 deals were filed in the year's first few months, according to

Thomson Financial Securities Data

. And there are already

100 IPOs in the works for the first few months of 2000, the firm says; 32 are Net-related.

The B2B Shakeout

The B2B rally has lavished big gains on a few stocks.

Commerce One

(CMRC)

,

VerticalNet

(VERT)

and others were up several hundred percent in 1999. While some B2B shares show potential, others look scarily overvalued as second-tier and third-tier stocks have been leap-frogging onto this B2B pile-up.

"There has been a total disregard for risk," says Patrick Manning, a money manager with

Perry Capital

. "People are betting on the who's who in this market, and that's why

Ariba

(ARBA)

and Commerce One are doing so well."

But Manning likes lesser-known B2B play

Descartes Systems Group

(DSGX) - Get Report

, which has shot up to 19 3/4 from 3 in the past six weeks. "I like the fact that it's in the supply chain space, a category that the other big B2B players aren't really in," says Manning, whose firm owns Descartes stock but has no position in Ariba or Commerce One.

Datastream Systems

(DSTM)

is another pick among some observers because it's profitable yet sports a relatively low valuation. "And new CFO Alex Estevez is a top-notch guy," says Joseph Spiegel of

Spinner Asset Management

. Spiegel also likes

En Pointe Technologies

(ENPT)

, a provider of information technology products. Spiegel is long both stocks.

The third-tier names -- the ones that most likely will lose momentum quickest once the B2B hysteria dies down -- are already starting to show themselves, says Spiegel.

Elcom International

(ELCO)

, which rose 78% Dec. 28, is a stock that reminds Spiegel of Booksamillion.

"This is an old, failed PC reseller that has been pushed higher by a feeding frenzy of small investors," says Spiegel, who's short the stock. He has similar things to say about "a third-tier special called

Interactive Buyers

(IBNL)

," which he's also short. (Neither company returned calls seeking comment.)

Until demand is sated, the first companies in the sector "still have a lot of room to grow," says Craig London, a general manager at

Safeguard Scientifics

(SFE) - Get Report

, which acquires, operates and manages B2B companies, and has interests in several private equity funds.

And even with money moving to new issues, the leaders likely will remain strong, says Gary Gratny, a money manager at

Whelan & Gratny Capital Management

. "We haven't seen Amazon or

Yahoo!

(YHOO)

or

America Online

(AOL)

get moved around," he says, referencing the leaders in e-tailing. They may decline from time to time, but "then they recoup." Gratny holds Ariba, Commerce One and VerticalNet.

And as the leaders continue to pull ahead, their highly valued currency will let them scoop up new technologies and companies. "With these valuations, these companies have a lot of buying power," says Jim Feuille, head of investment banking and capital markets at

Prudential Volpe Securities

.

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