Commentary: Fred Hickey makes a rare tech bet
By Mike Tarsala, CBS.MarketWatch.com
Last Update: 12:05 AM ET Aug 20, 2003
SAN FRANCISCO (CBS.MW) - Fred Hickey, the most bearish technology stock-newsletter editor on the planet, came out of hibernation this month, revealing that he recently bought shares of hardware-maker Advanced Micro Devices.
"Has Fred Hickey Gone Bonkers?" Barron's asked, in referencing the editor's shocking AMD (AMD: news) stock purchase in a weekend story that helped send that stock up 18 percent by Tuesday's close.
Barron's asked the right question, given that Hickey, who publishes the High-Tech Strategis newsletter, is so very picky about his tech stocks. He sold the tech sector short for years and continues to call recent stock market gains a "speculative orgy" caused by "wild exuberance." He's bought next to nothing since the late-90s, save for a few short-term trades. See full story.
Yet in writing its feature that sent AMD to the moon, Barron's never mentioned that Hickey also placed a bet on networking-equipment maker 3Com (COMS: news). In some ways, Hickey points out that Santa Clara, Calif.-based 3Com is a less expensive stock than AMD, while possessing the same type of shot at big upside in the coming years.
With help from the joint venture 3Com expects to close in November with China's Huawei Technologies, Hickey says that 3Com may eventually steal industry leader Cisco Systems' thunder -- and more importantly, its market share. See full story.
"If I was to pick one threat against Cisco, this is the one," Hickey said. "And this is the threat that Cisco sees as well. The two companies plan to build a soup-to-nuts product line to compete with Cisco."
Already, 3Com and Huawei are selling one product together -- the 7700 switch -- a mid-range piece of equipment that competes with the 4000 series from Cisco. It's expected that over time, 3Com could start selling higher-end products, including a switch that targets Cisco's core 6500 product.
As the joint venture grows, Hickey says Huawei will be able to sell 3Com's small and midsize business products in China, taking advantage of its U.S. partners' No.2 position in the gigabit Ethernet market, its double-digit market share in voice-over IP technology, and its wireless local-area networking technologies.
There will be future 3Com products to sell as well, since 3Com has 948 patents, and roughly another 850 that are pending.
Hickey is betting that 3Com will eat into Cisco's enterprise business, the way that Compaq did to Digital Equipment in the early '90s, and the way Dell Computer did to Compaq later that same decade.
But there's no overwhelming product design advantage needed: 3Com's biggest leg up will be Chinese labor costs that are a fraction of what Cisco pays in the U.S. As a result, the joint venture can sell competitive equipment under the 3Com brand at a much lower price than Cisco ever could.
The price advantage 3Com and Huawei have over Cisco could last years, since it might take a long time for Cisco to build a cost-competitive work force in China -- provided that Cisco could even overcome likely regulatory hurdles of outsourcing a large portion of both its manufacturing and development.
Huawei probably isn't the kind of company that many U.S. and European corporations feel comfortable patronizing - even if its products are equal or better than Cisco's at a cheaper price. Some technology customers perceive a lack of quality in Chinese products. In addition, there's a backlash against Chinese high-tech goods by some in the U.S. and Europe that are concerned about mounting high-tech job losses.
3Com's brand should help Huawei overcome many of those sales obstacles, due to its brand recognition and its reseller partners. Simply slapping a 3Com label on a product designed and built by Huawei could help the joint venture be the first true threat to Cisco's dominance, he says.
"Chinese engineers are being paid as little as a tenth of what equally qualified people in the U.S. earn," Hickey said. "As an American, you can be against that or for that. Or you can be an investor."
Hardly any of the Wall Street analysts who work for brokerages agree with Hickey's assertion of 3Com's prospects. Many complain that 3Com's company's cost structure remains too high for its declining core revenue. Average selling prices are expected to continue dropping, impacting sales and profit margins. And most importantly, the company is betting the future on the joint venture - and there's no telling if, when, or how much it will benefit sales in future quarters.
Hickey sees others' pessimism as a good sign. Popular stocks are often the losers.
One of the biggest risks to a 3Com investment is ongoing litigation between Cisco (CSCO: news) and Huawei. Cisco sued Huawei in January, claiming that the company used some of its software source code in its routers. In March, Huawei acknowledged in court papers that it used some of Cisco's operating system code, but has since removed it. The company said that it inadvertently took about 30,000 lines of Cisco code - not the 1.5 million lines Cisco claims it did.
There's no denying the legal risks to the stock, Hickey says. The only thing good to say is that the court didn't slap Huawei with a preliminary injunction, prohibiting it from selling its routers and switches.
That, and the price of 3Com's stock, seems to reflect any legal impact. 3Com has a little more than $4 a share in cash, and the company's stock trades at about $5.20 a share -- a little over its book value of $4.67 a share. The stock is trading at slightly more than 1.1 times sales.
"You're not paying a big amount for this speculation," Hickey says.
There's no guarantee that the 3Com-Huawei joint venture will take market share from Cisco. But even if 3Com's management continues to keep a tight rein on cash, the way it has the past two years, and maintains its current position in key markets, the company should be able to keep its stock price near current levels.
And if Hickey is right, and the joint venture leads to higher 3Com sales and additional margin expansion, then he and his newsletter subscribers could have their biggest gainer since AMD.
Mike Tarsala is a San Francisco-based reporter for CBS.MarketWatch.com.
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