Jeff, here is the best article I've read thus far, concerning 3Com's current ailments. It appears CSCO and ASND's coming price-war in RAS is going to complicate their future (Total Control doesn't stand a chance against the other two bad boys). Also, there is some detail on the modems piling up in the sales channels. Hope this helps if you haven't seen it yet...
Style Pts.
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3Com Corp. Hurt by Cisco and Ascend
The Motley Fool - November 06, 1997 12:12
November 6, 1997/FOOLWIRE/ -- 3COM CORP. (Nasdaq: COMS) lost $2 7/8 to $40 9/16 a day after its main competitor in local area network equipment, CISCO SYSTEMS (Nasdaq: CSCO), reported earnings and its main remote access concentrator competitor, ASCEND COMMUNICATIONS (Nasdaq: ASND), advised of price cuts on its WAN access equipment. Rumors also hold that the company's modems are moving slowly through the channel.
3Com Falls in Worries over Demand and Accounting
November 6, 1997/FOOLWIRE/ -- 3COM (Nasdaq: COMS) came
under heavy fire today, getting slapped with a $2 7/16 loss to close at
$41. Rumors that demand for modems was ebbing and news of major price cuts in remote access concentrators from competitor Ascend were blamed for today's decline. However, questions about accounting irregularities published in the San Francisco Chronicle and the New York Times two to three weeks ago and panic during the currency-driven market turmoil last week have kept the company on the ropes for most of the last month. All of this negative information overhanging the company has put 3Com shares under sustained selling pressure, pushing them down to levels not seen since last May.
According to CNBC, 3Com Chief Executive Eric Benhamou chaired an analyst-only meeting last night that held that the long-term looked
positive, but that short-term the sales channel was chock full o'
modems. This eerily recalls January of this year. Just before 3Com
cracked at the beginning of the year, the first part of a long, jagged
descent was initiated by another analyst-only meeting where Benhamou disclosed that the company would not make its earnings estimates due to price weakness in network interface cards (NICs). While last night's comments might not have been that bad on their own, the fact that they apparently confirm allegations raised in the newspapers that U.S. Robotics modem sales were weak in April and May caused a lot of skittishness.
Two weeks ago, Chronicle writer Herb Greenberg and Times columnist Floyd Norris both wrote about a pretty substantial write-down of U.S. Robotics inventory last quarter. Although the accounting issues are pretty complicated, the gist goes kind of like this. In the company's October 14th 10-Q filing with the SEC under the heading "4. Business Combinations," 3Com disclosed that in the two months ended May 24th U.S. Robotics only sold $15.2 million in product and took a $160.8 million loss. In order to synchronize the 3Com fiscal year with the U.S. Robotics fiscal year under "pooling-of-interest" accounting, 3Com only has to disclose this information in a footnote. Needless to say, both Greenberg and Norris smelled a rat.
The actual nitty-gritty of the accounting gets into a lot of recondite
issues such as revenue recognition that might explain to a large degree the extent of the sales shortfall for the two-month period. It appears that distributor-driven U.S. Robotics may have recognized sales when it shipped to distributors, whereas 3Com and its broader-based sales organization recognizes sales closer to when the product is actually in the hands of a customer. This alone could make millions of dollars in reported sales disappear overnight. Although Norris used the word "cancelled" in his published column, alleging that U.S. Robotics had been stuffing the channel with inventory before it was purchased, the accounting issues are a little more convoluted, to say the least. Regardless, losing about $150 to $200 million in sales is not something most investors like to see.
Additionally, 3Com bean counters probably took the opportunity to load up the period with write-downs, explaining the extent of the loss.
Although this will probably allow the company to report better results
going forward, it only heightens the perception of "cooking the books."
Norris did not pull any punches: "While the accounting appears to be
legal, 3Com could have chosen more conservative accounting that would have made the bad period apparent even to those who do not dissect footnotes in quarterly reports." While technically 3Com could only disclose a change in revenue recognition policy in a footnote, as the normal format for quarterly reports does not have a feature for this,
his words seemed to carry quite a bit of weight.
As if this accounting issue was not enough, 3Com's problems accelerated last week during the October 27th Southeast Asia debacle. Investors dumped shares last week due to concerns that the company's expansion into Singapore and emphasis on modem and network interface card (NIC) sales to the region would give it heavy exposure to any decline in Asian demand. 3Com is in the middle of building a facility in Singapore to pump modems and NICs throughout the region, an investment that was perceived as having a greater risk of returning bupkus if all of the economies over there went belly-up. While much of this was fear mongering by reporters unable to distinguish between a market event and an economic event, 3Com was one of the more exposed companies to that particular corner of the world.
Add to this fuzziness the announcement from remote access concentrator competitor ASCEND COMMUNICATIONS (Nasdaq: ASND) that it would cut prices further in order to meet the upcoming competitive challenge of CISCO SYSTEMS' (Nasdaq: CSCO) AS-5300 universal access server. U.S. Robotics sells its Total Control hubs into the low-end of the remote access concentrator market, a low-end that may not be quite as low any more as Ascend and Cisco slash the price per port on their high-end products. The number one company in remote access concentrators, Ascend has seen its shares wilt from $55 to $25 over the past three months. The change
in Ascend's target operating margins to the mid-20% range from the
mid-30% range as well as the new Chief Financial Officer's affirmation
of $1.10 to $1.20 EPS estimates for 1998 also have had a lot to do with Ascend's descent. That said, price cutting in remote access from the company that commentators are focusing on today could also hurt the other significant part of 3Com's recently acquired U.S. Robotics
business.
While it is too early to draw many conclusions, investors are responding to this sudden plethora of negative information by reducing the valuation of 3Com to account for the perceived risk. Trading at approximately 13.5 times consensus earnings estimates for fiscal year 1998 versus 20.8 times FY98 estimates for Ascend and 26.0 times for Cisco, some might argue that the current discount exceeds the real risk. However, with both of the major businesses of a high-profile acquisition now in apparent jeopardy and the X-factor of Southeast Asia hovering, this discount will likely not disappear until the earnings rubber hits the quarterly report road.
-- By Randy Befumo |
