Analysts see hard times for e-commerce firms

Until recently, the sector was seen as a can't-lose proposition for Internet start-ups and investors. New companies have poured into the market, which researchers predict will be worth between $2.7 trillion and $7.3 trillion by 2004.

Business-to-business ventures hope to build online marketplaces for industrial and commercial items. Companies selling specialized software and offering online exchanges promise to decrease the cost of doing business, thereby increasing profits and making new, more economically sound ventures possible.

But in the past month, share prices of some of these companies have slumped, in some ways mirroring the slowdown in the consumer e-commerce market. E-commerce software makers Ariba and Commerce One--the poster children for the business-to-business movement--have lost billions in value since the beginning of March. Some analysts see market caps shrinking further, along with a consolidation of smaller companies in the coming months.

Today, Safeguard Scientifics, a Web site investment firm, said it will stop investing in business-to-business e-commerce to concentrate on "infrastructure" companies. The news drove down stocks of many players.

What's caused the about-face? Analysts say overcrowding and a lack of confidence in unproven business models.

"There's no question that a lot of the air has come out of the B2B stock bubble," said Giga Information Group analyst Andrew Bartels. "What is fueling the deflation of the bubble is the realization that its inflation had been driven by erroneous assumptions" and that, for the most part, these companies aren't going to achieve profits in the billions of dollars.

By the 1 p.m. PT close of regular trading, Ariba was down $12.75, or about 12 percent, to $90.75--well below its 52-week high of $183.31. Commerce One shed $20.50, or about 15 percent, to $119.50--also a far cry from its 52-week high of $331. i2 Technologies tumbled $28.88, or about 21 percent, to $108.06. The stock has hit a high of $223.50 in the past 52 weeks.

"Since last summer, B2B has been a strong performing sector, and now we're seeing consolidation and a pullback as investors rethink valuation (on some B2B companies)," said Michael Dubrow, an analyst at New York-based Jacob Asset Management. "I don't think they'll stay out of favor for long, but investors do want to see some traction with the business models."

Analysts warn that a consolidation of exchanges is expected as start-ups overcrowd the market. Recent moves by established firms--such as General Motors, Sears Roebuck and DuPont--to throw their weight into business e-commerce have raised fears that start-ups will be squeezed by well-heeled brick-and-mortar companies.

Donald Goodwin, president of market research firm Technomic, said the smaller companies will ultimately be gobbled up by megasites, such as the one recently proposed by Ford Motor, DaimlerChrysler and GM, aimed at streamlining automakers' supply chains.

Goodwin said that as pressure mounts for business partners to produce profits and grow quickly, they will likely form megasites comprised of subcategories that focus on specific market segments.

To a certain extent, Technomic's conclusion is shared by other industry analysts, but there is disagreement on when a shakeout will occur.

Laurie Orlov, an analyst at Forrester Research, said she doesn't think critical mass has occurred and that a shakeout won't happen soon--unless the money runs out.

"I'd give it a year before we see any shake out. We're in the launch phase right now, and I think that is going to keep going for sometime. If Wall Street money dries out for some reason, then we would see some form of shake out," she added.

Other factors include a corresponding slowdown in consumer e-commerce stocks and fear that government regulation could stifle growth, analysts said.

Once-heralded Internet start-ups Peapod, Drkoop.com and CDNow each acknowledged they are running short of cash. Last week, health site Drkoop said in an Securities and Exchange Commission filing that it has "sustained losses and negative cash flows from operations since its inception," posing a threat to its future as a business.

Online music seller CDNow said its auditor, Arthur Andersen, has expressed "substantial doubt" about whether the company can continue to stay in business, according to an SEC filing. And after losing its chief executive and a planned $120 million investment, online grocer Peapod said it is soliciting takeover offers.

The rapid growth of the business e-commerce market, combined with the merging of online exchanges, has also raised concerns about the potential need for government regulation, an issue that could lead to bitter disputes over control of the multibillion-dollar industry.

While the predictions are not dire, Giga is warning its clients that the opportunity has passed for short-term gains in business-to-business stocks. Prospects for solid profits are still realistic, but the megaprofits once seen in the sector are not likely to materialize.

Despite a cooling down, Giga's Bartels said that most of these companies will continue to turn high valuations and become profitable.

"This does not mean that these (business-to-business stocks) aren't good companies," Bartels said. "It does mean that investors who may have assumed that some of these companies are going to be equivalent of Microsoft and bid up their price on the basis that they were already Microsoft in maturity are going to have to conclude that this prospect is very uncertain and won't materialize for several more years."

Jacob Asset's Dubrow maintains a positive market outlook.

"We do see investors tiptoeing around the sector right now, but at the same time, we don't see corporations pulling back in investing in B2B marketplaces," he added. "We see a continued rush for industry after industry to get connected (to online marketplaces)."

News.com's Sandeep Junnarkar contributed to this report.