Why 3COM has potential:
The following is a post from Motley fool's board:
I have been waiting for the court news on the JV to play out in COMS' favor. In my book, that happened last night. So, at the open, I placed a large percentage of my portfolio into COMS.
I interviewed with COMS in the late 1980's and have been unimpressed with the company since then -- until the JV was announced. As a information technology (IT) consultant, and a former IT corporate executive, I know and understand the IT buying cycle and the buying parameters. When the JV is in place, COMS has a real opportunity on its hands. The following quotes some from this COMS press release:
3com.com
Over the next three quarters we are targeting a reduction in our channel inventory levels by one to two weeks from the current level of slightly under six weeks. This would position us at the lower end of our targeted range of four to six weeks. We believe our supply chain capabilities will allow us to operate effectively at the lower end of our targeted range without significant stock out situations.
This is just good business. Inventory costs money. It also puts COMS in the position of having little or no inventory to blow out (or write off) when the JV product starts to role in.
In the near term expect gross margins in the low to mid thirties as we take action to restore the competitiveness of our 10/100 switching products from both a cost and price standpoint. As we launch the joint venture, expand and enhance the mix of our product portfolio, and improve our capacity utilization, we plan to restore gross margins into the forties. As we get closer to launching the joint venture, we plan to provide more insight into our longer term financial assumptions and projections.
If margins were in the 40's today, COMS results last quarter would have been boosted by $12 to $17 million. That would not have produced a profit but it would have helped slow the cash burn. Once sales start to increase, that margin will help COMS move quickly to a profit.
Regarding legal issues, we are pleased with the ruling by the federal district court on Cisco's motion for a preliminary injunction. If you recall, Cisco has asserted that Huawei has broadly misused Cisco IP throughout their products and based on that assertion, sought a worldwide preliminary injunction preventing, among other things, Huawei from any shipments of its Virtual Routing Protocol (VRP) network operating system. This was denied. Instead, on the issue of source code, the court narrowly issued a restriction limited to the EIGRP module, a non-essential feature constituting less than one percent of the VRP source code. Huawei had already voluntarily removed this module from its product.
This source code is what is at the heart of the court case. It is my understanding that what happened yesterday was that COMS can now get pre-trial releases for products that are not covered by the VRP source code -- which, if the press release is correct, is 100% of the JV product. So, one injunction at a time, COMS can get products released for sale. That's a big step forward -- and why I waited. It should take very little time (weeks) before all products are released.
To that end, on June 18 we announced our new Switch 7700, a full-featured, modular switch, initially sourced from Huawei. It will begin shipping in volume at the end of July. This product is the first of several modular switches and a full line of routers that will be sourced from the joint venture over the next several months. It's targeted at the mid-level, modular switching market for an enterprise's core networking needs. Compared to the Cisco Catalyst 4500 series, it will offer competitive features and performance at a better value to customers. Further, we will provide our channel partners with the opportunity to make higher margins selling our products than when selling comparable Cisco products.
This time table looks like it is right on track.
What is significant is that COMS is going head-to-head with Cisco in a high margin business. There is a lot of revenue available. In fact, I think the good news is that the JV's sales will be constrained by manufacturing output. Cisco is gigantic and it will take time for the JV to build capacity to meet demand.
Note, too, even with the 40's margins that COMS is planning to play this game based on price. That is smart for two reasons. IT budgets have been held back by the recession and slow business recovery. If one thing sells today, it is price. It also shows that COMS understood that it will take more than beating Cisco on features to win customers.
There are plenty of risks and this is a good place to name a few. Cisco has a great reputation based on customer service. They keep their products working. So, the COMS JV must have two things that have yet to be established. First, they must have a high quality product (with failure rates that fall in line with those of Cisco). Second, they must service the product like Cisco. If they fail in either, the trade press will kill them with bad publicity.
As an IT executive, I always hated to add new vendors. Besides the obvious training issues, there were also integration and stability issues. No person outside IT remembers the price of anything you purchased, but they certainly remember the last time the equipment failed. It is easy for a CIO to pay higher prices if they can reasonably prove that it will produce high up-time results. Do not expect COMS' first sales to be to big accounts. They will let the price sensitive people prove the JV has great product. But, once that has been proven, expect price to be very important.
Also, expect a price war from Cisco. They have a lot to protect. Do not expect that price war to erupt in the next 12 months. Cisco may lower some prices to show "good intent" in keeping large customers, but that will be done to keep the industry watchdog Gartner saying that Cisco is responding. But, after the JV has had a chance to make Cisco notice, expect Cisco to respond strongly.
We also require Chinese government approval. Feedback from various government ministries has been favorable and we fully expect approvals, but the timing of approvals may be a factor. However, as our announcement of the Switch 7700 shows, we are moving quickly to get the benefits of our relationship with Huawei by getting products announced and in the market quickly.
The words "Chinese government" are the biggest negative. This should not be overlooked as people investigate the COMS JV. It sounds like no big deal. It is. I also heard a John Chambers' speech many years ago about his first trip to China. All the negative things he had heard about slow government response, etc., did not apply to him and Cisco. The Chinese, at the highest level, were interested in Cisco.
Cisco has a good foothold in China and Asia. The JV's ties to China will help it in Asia. Here is a snip that shows the JV is already being anticipated in China:
For example, our business in China, Hong Kong and Singapore was adversely impacted by SARS, and in China there was also some channel disruption stemming from the announcement of the planned joint venture with Huawei.
The need to get government approval will be a long-term concern. With the stroke of a pen, the government could change the venture's potential. I think this is one reason why, as tech stocks have rallied, COMS has held back.
Marketing and pricing will be very important Day 1 for the JV. In my mind, COMS has their plan on the right path:
Going forward we are changing our pricing approach, moving more to a lower list price while also reducing the use of one-time promotions. We are redirecting our marketing budgets more to end user "pull" demand as opposed to channel "push" programs.
Price is something everybody can measure. To promise futures (e.g., free future software upgrades) or offer free software (which ignores that fact that no software is free when you consider training and integration costs) just complicates sales. The COMS approach is KISS at its best. Expect it to last 12 months. LOL.
The results in Q4 point out the importance of expanding our product line to include more Layer 3 plus products, a full line of modular switches and routers, and a higher-end Voice over IP offering-gaps we have already begun to address and expect to fill over this fiscal year. This will lead to a broad product portfolio, allowing us to deliver converged voice and data networking solutions not only to our traditional customer base, but to larger and multi-site enterprises.
What this says to me is that COMS will be selling the state-of-the-art at great prices and great margins. Sales volume increases are just around the corner. Enough said -- at least for now.
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