Microsoft Investor. Can Cabletron turn it around? [No ASND reference]
investor.msn.com
The networker has tumbled into Wall
Street's dumpster, but its prospects are
improving. A key acquisition -- or takeover
-- could reverse its fortunes.
By Howard Isenstein
Computer-networking companies enjoy
stratospheric valuations on Wall Street
because growth and profits in their
industry continue to explode. But woe to
the company that disappoints. Just ask
Cabletron Systems, Inc. (CS), whose
stock price has plummeted to less than a
third of its 52-week high and is trading at
1.6 times revenues -- a fifth of its peers'
valuation.
It's appropriate now to wonder whether
investors and analysts have overreacted.
Sure, Cabletron needs to overcome a
number of major problems, but it has
recently put a strategic plan in place to
address them and it has a solid brand
image and customer base -- as well as
leading-edge products coming out of the
pipeline.
Charts
Cabletron vs. the
Networking Industry, 1-year
"The Street thinks the company is a piece
of junk," said William Becklean, an
analyst at Tucker Anthony, a regional
brokerage in Boston. "One of the bets I'm
willing to make is that there's a lot of
value there, although it does have
problems."
The Rochester, N.H.-based company
makes local-area and wide-area network
switches, routers, software, and other
products that allow computers to talk to
each other -- and unlike a lot of
investment darlings today, has racked up
years of growing profits. In its fiscal year
ending February 1997, for instance, the
company earned $222.1 million, nearly
double its 1994 earnings of $119.2 million.
But Cabletron then spilled barrels of red
ink in its final quarter of fiscal 1998 --
racking up a loss of $263.4 million due to
lower sales, reduced gross margins and
inventory-related charges.
Details
Company Facts
1-yr Chart
*Highlights
* Earnings Estimates
* Advisor FYI
The sagging fortunes of the company
were evident a year ago as the company's
strength of hard-driving execution became
hindered by blunders of strategic
planning, including a disorganized sales
force and holes in its product line that
pushed customers into the arms of its
competitors. To remedy the situation,
Cabletron last August hired Donald B.
Reed as chief executive to create a plan
that called for, among other items,
instituting stronger management controls
and bolstering international sales and
distribution.
Reed also arranged the acquisition of
Yago Systems, which developed a
state-of-the art router that could power the
company's comeback. Analysts say that
Reed, a former Nynex Corp. executive,
succeeded in his task. But on March 30,
the company announced that Reed had
quit and would be replaced by chairman
Craig Benson. The company declined to
make Benson or other executives
available for comment.
Customers and technology
Benson has at least three things going for
him in his quest to turn the company
around, Becklean said. For starters, there
is the company's strong base of
customers, including Chase Manhattan
Bank, which used the company's
products to integrate its merger with
Chemical Bank computers.
Details
Company Facts
1-yr Chart
*Highlights
Details
Company Facts
1-yr Chart
*Highlights
Next is the company's technology. The
Yago acquisition fills a key product hole
at the high end of the market with its
SmartSwitch router, Becklean said. While
the router is limited to Internet protocol
(IP) -- compared with competitors' routers
that accept IP and other protocols -- IP is
becoming the standard that most
companies and makers are moving
toward.
"Cabletron has a completely new
opportunity to leapfrog Bay Networks
(BAY) and Cisco Systems, Inc. (CSCO)
with the SmartSwitch router" if a few big
customers talk the product up and
convince others to give it a try, said Glenn
Gabriel Ben-Josef of Clear Thinking
Research, a network consulting firm in
Cambridge, Mass. SmartSwitch is
already being shipped and may add $50
million in revenue this year, Becklean
said. Just last week, the company
announced next-generation additions to
the SmartSwitch product line that were
well received in the trade press.
The company is filling other holes in its
product line. On My 6, Cabletron
announced its SmartVoice Technology --
which allows computer networks to merge
voice and data traffic onto a single
network, reducing long-distance charges
in the process. And on April 6 Cabletron
released a family of asynchronous
transfer mode (ATM) switches, which the
company says are 50 times faster and far
cheaper than the competition's products.
As for software, the company's Spectrum
Enterprise Management product is "very
strong," Becklean said. The software
allows network managers to control
networks comprised of any type of
hardware, so Cabletron still has an in with
potential customers using competitors'
hardware products. Indeed, nearly 40% of
the hardware being used with Spectrum
software is non-Cabletron.
Getting things under control
In terms of management, Cabletron is well
on the way to implementing a new sales,
marketing, and returns forecasting
system that should give the company
much better financial and business
control, Becklean said. And by reducing
staff and consolidating facilities, Cabletron
has already cut expenses by an
annualized $40 million and believes that it
can increase this annual savings by an
additional $20 million.
Details
Company Facts
1-yr Chart
*Highlights
On the sales and distribution front, the
company's Feb. 7 acquisition of Digital
Equipment Corp.'s (DEC)
network-products business instantly gave
the company a presence in the
telecommunications and
Internet-service-provider markets as well
as international sales muscle, a key goal
of Reed's. It also put the company directly
on the radar of Compaq Computer Corp.
(CPQ), which bought Digital last year and
could well purchase Cabletron to beef up
its networking business.
Becklean acknowledged that the
company faced very strong competitors
that have more powerful brand equity --
but he doesn't buy the argument that
customers want a solution from a single
company.
"I think customers today, especially as
backbones move toward IP, are much
more willing to buy best-of-breed
products," Becklean said. The
SmartSwitch "has the potential to be best
of breed."
Opportunity to buy?
Becklean, however, is among the few
analysts who are bullish on the company,
which is one reason its stock price is so
depressed and why there is an
opportunity to get into what would
otherwise be a very pricey stock.
Analysts Peter Lieu of Adams Harkness
and Matthew Barzowskas of First Albany
Corp. think that the company is going
through a major transition and has been
slow to make adjustments while market
leader Cisco remains a highly focused
and formidable competitor.
Details
Cabletron
Analyst Info
* Earnings Estimates
* Recommendations
*Earnings Surprise
*Consensus EPS Trend
*Earnings Growth Rates
Cabletron does not need to overtake
Cisco as the market leader in order for its
stock price to start recovering. It just
needs to show that it is capable of
delivering strong products and making
customers happy. When will that happen?
No one knows for sure, but Becklean
predicts that once the company's sales
numbers start to show improvement, as
the SmartSwitch ships in significant
quantities, the company's stock price will
come back -- most likely in the fall.
"It may not get back to where its peers
are (on a price-earnings basis), but it
certainly will be higher than it is now,"
Becklean said.
At least one other analyst agrees. Keith
R. Bossey of Robert M. Cohen & Co.
initiated coverage of Cabletron on April 9
with a "speculative buy" recommendation
and set a 12-month target price of $28 per
share, up almost 100% from about $14.25
today.
"While recent financial performance and
management uncertainty raises concerns,
Cabletron does provide us with what we
feel to be an unprecedented opportunity to
invest in a firmly entrenched networking
sales-and-marketing force at less than
half industry valuation multiples," said
Bossey in a prepared release.
The point of maximum pessimism about a
company is usually the best time for value
investors to make their move. For those
who have shunned high-tech stocks due
to their high valuations, Cabletron may
just be the ticket for getting into the
sector on the cheap.
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