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More Potholes in the E-Business Highway

Bill Loomis

It has been a wild ride for investors in technology this year, but for e-business solutions investors, it has been even bumpier than usual.

While traditional IT stocks have been generally weak since early 1999, the
e-business companies enjoyed strong gains last year and early this year. After the group fell with the broader Internet stock correction this spring, the group's several rally attempts were stalled by pullbacks in the broader technology stocks.

This time is different, however. The latest drop in the e-business stocks has occurred because of problems at various companies in the space and increasingly cautious comments from the companies ? or no comments at all.

The drop began after many e-business solutions companies appeared somewhat more cautious in their second-half earnings outlooks following the report of very strong second-quarter 2000 results. The reason was logical, in our opinion. Because these companies have been looked at primarily by their sequential improvements in revenue and earnings ? in other words, from the quarter before instead of year-over-year ? the third quarter of 2000 could show slow growth due to vacations and fewer billable hours.

Last year, this was less of an issue for the industry because the companies were much smaller and able to hire a lot of people relative to their small size. Also, the market is shifting to larger clients and larger projects, increasing sales cycles. These company comments and the recent concern about dot-com credit risk prompted investors to sell the group.

Cysive Inc., an e-business solutions developer focused on complex technologies, shocked investors when it cancelled a project with its largest client, which represented 15 percent of revenue, after a dispute resulting in CorPay's refusal to pay outstanding invoices. Because Cysive often was cited as the company that tackled the tough projects that others failed on ? 70 percent to 80 percent of its business was "redo's" from either the customer's or another vendor's attempt to develop the original project ? this shook investor confidence in even the premier players in e-business solutions.

This event, coupled with senior management turnovers at Razorfish Inc. and Modem Media Inc., and a negative earnings pre-announcement from Viant Corp., has resulted in many of these stocks' hitting 52-week lows. The traditional IT companies can't laugh quite yet at the e-business solutions companies' plight though, because it looks as if third-quarter 2000 results at traditional companies will continue to be soft, as they were in the second quarter. Federal IT companies are facing a moderate growth quarter as well.

So is this the end of IT services as we know it?

Hardly. While the easy dot-com money has been made by the integrators, with venture capitalists and other investors willing to let their dot-com investments spend quickly and pay high rates in an effort to get to market quickly, the much longer-term, larger-dollar market is just beginning.

Among the stronger e-business companies, we are seeing the transition to larger projects and larger clients. Such a client base typically means longer sales cycles and more price sensitivity. Of course, it also means more emphasis on back-end integration with existing client-server and ? gasp! ? mainframe systems. This aspect should make traditional IT companies more competitive in this next leg of e-business systems development.

New technologies such as wireless, broadband, artificial intelligence, natural language and others should ensure that the leading-edge e-business solutions companies can continue to maintain their above-average profit margins and bill rates. Now, if we can only get past this next quarter....

Bill Loomis is managing director of the Technology Research Group at Legg Mason Wood Walker Inc., Baltimore. He can be reached at wrloomis@leggmason.com. Legg Mason makes a market in the securities of Cysive Inc. and Viant Corp. Within the last three years, Legg Mason has managed or co-managed a public offering of Cysive. Loomis has a long position in the securities of Cysive. This information is based on sources believed to be reliable but is not guaranteed as to completeness or accuracy, and is not intended to be an offer to buy or sell any security. Opinions expressed are subject to change. Additional information available on request.

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