At Robbie Tech Conference, Net Investors Smell Smoke

Internet stocks are on fire, and not in the basketball sense.
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SAN FRANCISCO -- The sirens started ringing about 45 minutes after Wall Street's closing bell, as some 400 mutual fund managers crowded into a conference room of just 192 seats.

In conservative suits and prim haircuts, they lined the walls and crowded the doorways in this basement room of the

San Francisco Ritz-Carlton Hotel

to hear

BancBoston Robertson Stephens

analyst Keith Benjamin discuss Internet stocks. As the fire alarm rang, hotel functionaries rushed to the door, trying to evacuate the room -- but no one would budge.

Someone had

already

yelled fire in this crowded theater -- Internet stocks were going down in flames.

TheStreet.com Internet Sector

index tumbled to 499.7 Wednesday morning, off 27.5% since its recent high on July 6. It's down 10.1% this week alone, a harsher fall than the 2.5% decline in the

Nasdaq Composite

. The Internet pain is being felt throughout Robbie Stephens'

Investing in Innovations

conference, where more than 200 companies and some 1,500 fund managers have gathered.

Even as the fire alarm proved to be false, the burning sensation wouldn't dissipate. The Internet industry is especially

sensitive to tumbling stocks: With so little capital and so much promise, Internet start-ups look to stock options as the glue to seal contracts with landlords, business partners and, above all, employees.

"Uggghhhhh," groaned

Ask Jeeves

(ASKJ)

CEO Robert Wrubel, after looking at his stock's chart while stopping by the press room. Shares in the Berkeley, Calif.-based search service dropped 6 7/16, or 15.7%, to 34 9/16. Little wonder he's hurting: According to documents with the

Securities and Exchange Commission

, Wrubel has options to buy 1.25 million shares.

Wrubel doesn't think lower valuations will impede his ability to retain employees or make acquisitions. "If the whole sector goes down, then everyone's currency goes down," says Wrubel. "People just buy things at less outrageous prices." Then again, Ask Jeeves was lucky (or smart) enough to go public on July 1, nearly three weeks before the Internet sector began to tank.

"If there was an extended correction there might be a problem with taking the company public," says Scott Walker, who works in corporate development for

Freemac.com

, a privately held company that made a minor splash at the conference. And he has a lot riding on the line. Like a number of executives of early-stage Internet start-ups, Walker says his compensation is all stock options -- no salary. Still, he says he's unconcerned.

Walker, a former stock broker, voiced the refrain of die-hard optimism that surely was running through the mind of most Internet executives this week. "I look at things longer term," he says. As an emblem of his long-term outlook, Walker even got a tattoo of a bull when the

Dow Jones Industrial Average

hit 1900. And Dow 10,000? "My wife wouldn't let me do it again," Walker laughs.

Most others here are salving their anxieties with such long-term confidence when they're not scratching their heads at the reason for declining Net stocks. "It's a self-fulfilling prophesy. Everybody says, you don't wanna own Net stocks in August," says Jeffrey Diecidue, a New York-based hedge fund manager. "Then everybody stops buying Net stocks in August and tries to figure out what happened. We expected this -- still, we never expected the severity of this drop."

Still, even those who take the long view admit that such dramatic moves can have lasting ripples. Bryan M. Kennedy, a general partner with

Platinum Venture Partners

, says a sustained downturn forces his firm to think harder about when to sell the stock of companies it's funded that have since gone public.

"You are trying to time and manage your exit as well as you can," says Kennedy. "The venture guys do a fairly lousy job with the public stuff. We're looking more at the wave that's coming and the markets are looking at the wave that's arriving."

Worse for executives, Net downdrafts can also influence the pricing of stock options and valuations of potential Platinum investments. The valuation of a start-up is often the most

contentious part of an investment negotiation. "You can bet that if

eBay

(EBAY) - Get Report

tanks on the day we have a pricing negotiation it'll get brought up," says Kennedy, who estimates that market swings can change the valuation of an Internet start-up anywhere from 10% to 20%. "It's shockingly influential."

Meanwhile, a number of investors see this as an opportunity to dumpster-dive. "Some of the other institutional guys -- the nonmomentum institutions -- are sniffing around for bargains," says Tom Sheedy, who sees most everything from his post as the head of institutional sales at Robertson Stephens. "They look for hot deals they couldn't get in initially, or the companies delivering revenues way better than expected."

Others are waiting for more contrary indicators before getting back in. "We're not there yet," says Jerry Apodaca, of the

Apodaca Investment Group

hedge fund. "When everybody is short, everybody is negative, everybody is in cash and everybody has done their selling, that's the time to buy."

Which explains the singular piece of joy Diecidue saw. "The happiest guy I saw here is between jobs and launching a new fund," he says. "He doesn't own anything!"

We should all be so lucky.

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