Glen & All, News From Barron's : The Future is 3Com
This beleaguered firm has an ace up its sleeve:
mind-blowing Internet capabilities
By BILL ALPERT
When I bought my house, I installed a cable TV jack near
my personal computer. I was ready for one of the new
cable modems that would allow me to surf the Internet
hundreds of times faster than the clunker modem that's
attached to my phone line. I couldn't wait for waves of
full-motion video to come crashing over me. What a relief
it would be after years of watching Internet images appear
piecemeal on my computer screen, like photos from some
deep-space probe.
"What's a cable modem?" asked my cable-service rep,
irritably. That was almost two years ago. I'm still waiting.
So are lots of other folks, including investors in 3Com
Corp., the Santa Clara, California-based networking
company that became a leader in the modem business in
February by agreeing to acquire US Robotics.
Sales of modems that
permit 'Net surfing via
cable TV lines may surge
before long, but for now,
3Com and its rivals are
dependent mainly on sales
of traditional modems, meaning the ones that get
computer users onto the 'Net via phone lines. And sales of
phone modems are sagging. Recent disclosures show, for
example, that sales at 3Com's US Robotics operation
dropped to an anemic $15 million in April and May of this
year, down from $690 million in the previous three
months.
With unsold phone modems stacking up in retail stores,
Wall Street has started to worry that 3Com's earnings will
suffer. For the quarter ended November 30, analysts have
reduced their earnings expectations to $160 million, or 44
cents a share, down from $190 million, or 53 cents. The
lowered expectations are quite a comedown from the
quarter ended August 30, when 3Com earned $172
million, or 48 cents a share, excluding merger charges, on
revenues of $1.6 billion.
The earnings shortfall certainly seems to indicate that
3Com overpaid when it bought US Robotics for $8
billion. Indeed, for the current fiscal year, ending next
May, 3Com will be lucky to earn $750 million, or $2 a
share, on revenues of perhaps $7 billion. Little wonder
that 3Com's shares in the past six weeks have been
pounded down from the mid-50s to a recent 36.
But what's been obscured in all the hand-wringing is the
tremendous potential of the modems that 3Com will soon
sell to allow folks to get on the Internet through their
cable-TV lines. By the year 2003, cable-TV modems alone
could make 3Com more than $2 billion in annual revenues.
Such optimistic predictions are based in part on the
phenomenal performance of these modems. They will
allow personal computers to take in data from the Internet
100 times faster than do today's 28.8-kilobit-per-second
modems. This is the breakthrough I've been waiting for,
the one that will allow personal computers to take in video
and audio feeds that are clear, crisp and lifelike.
Right now only about 50,000 people are tapping into the
Internet via their cable-TV lines. But the rollout of such
service should accelerate in the next year or so, particularly
after cable modems start appearing on the shelves of
computer retailers in the second half of 1998. The new
modems will be made by 3Com as well as by rivals such as
Motorola, Samsung, Sony and Matsushita's Panasonic unit.
The spread of cable modems will also prod cable-TV
operators to buy more networking gear, and those
purchases should benefit 3Com, Bay Networks and Cisco
Systems, among others.
What should make the market for cable-TV modems
explosive is the fact that manufacturers have already agreed
to a common standard. By contrast, sales of phone
modems have been lame because there is no common
standard for high-speed modems, making it difficult for
PCs to rapidly communicate with one another and with
online services.
To understand 3Com's potential in this area, you first have
to understand the current situation in the Internet access
field. Most homes in North America nowadays have two
wires running into them: a phone line and a cable TV line.
Until this year, many folks predicted that the first
high-speed Internet service available to homeowners would
be a technology called Digital Subscriber Line, from the
telephone companies. Although "DSL" service is available
in a few locales from such telephone companies as U S
West Communications and SBC Communications,
squabbles on standards and tariffs have delayed industry
plans for widespread deployment into 1999 and beyond.
Even where it is available today, DSL service ain't cheap,
with U S West charging $145 per month for 704
kilobit-per-second Internet service, which is about 25 times
faster than today's typical modem links.
Cable-TV wires are fatter, so it has been quicker and
cheaper to hammer out that industry's high-speed data
technology. Through cable's big pipe, goodies can flow
downstream from the Internet to the subscriber's home at
rates that average a few thousand kilobits per second-100
times the speed of most phone modems.
Pushed by three large providers, Internet access via cable
TV started a slow rollout in the last year. The biggest
promoter is the At Home Corp., a Redwood City,
California, firm whose shares popped from $10.50 to $25
on the day of its Nasdaq debut this past July. That put a
momentary valuation of $3 billion on the firm, whose
cumulative revenues were under $3 million. At Home has
a lock on providing Internet service to the nearly 50
million customers of Tele-Communications Inc., Comcast
Corp., Cox Communications and Cablevision, among
others, and those cable firms remain At Home's controlling
shareholders.
Next in size is the Road Runner Group, a Stamford,
Connecticut, joint venture of Time Warner Cable and
Time Inc. that has first dibs on Time Warner's 13 million
cable homes. Third-largest in cable modem service, with a
market of five million homes, is MediaOne, now part of
US West Media Group.
For Internet geeks like
me, the price of
accessing the Internet
via cable TV represents a
great value. Most
operators charge $40 a
month, modem
included. My
old-fashioned Internet
service seems thrifty, at
$20, but I'm paying
telephone charges in
addition to my Internet
service payment, and
most heavy users pay for
a second phone line, too.
And that doesn't factor
in the
blow-your-hair-back
experience of fast access.
According to the
December issue of
Windows Magazine,
downloading a 10
megabyte file with today's best 56-kilobit telephone
modem took 30 minutes, under ideal circumstances. With
ISDN service, which is a faster and much more expensive
telephone service, the download took just over 10 minutes.
On a T-1 phone line, which costs $500-$1,000 a month,
the download took 52 seconds. And on a $40-a-month
cable modem service, the file download was less than 27
seconds.
"Very few people give up the service once they have it,"
says Steve Hill, a former broadband data services executive
at MediaOne. In the year since the introduction of
MediaOne's two-way data service, there have been almost
no subscriber defections, Hill says.
Cable-TV Internet systems weren't born with all the
advantages. Cable television was invented as a one-way
medium, so upstream transmission from the home to the
Internet is just rotten over a traditional cable system. An
inexpensive stopgap approach uses an old-fashioned
telephone modem to carry signals back upstream, but such
schemes give up some speed. They also do away with one
of the most appealing features of Internet service via cable,
the "always on" capability.
As users know all too well, it can take five minutes to dial
up a conventional online service to get E-mail. With
cableTV modems, subscribers get their E-mail instantly.
The same goes for stock prices, traffic reports or basketball
scores. To deliver "always on" service, cable operators have
to upgrade their cable systems for two-way traffic, laying
down a network that's a hybrid of fiber optics and cable.
These system upgrades cost plenty, averaging as much as
$1,400 per subscriber, so any cable modem deployment
has to leap some economic hurdles.
After putting in a two-way pipe, the remaining pieces of a
cable data network are two: the companies' "head end"
boxes and the homeowners' cable modems. At the head
end, the hardware is quite similar to that of a traditional
online-service provider, with racks of modems, routers and
computer servers. A head-end setup that can handle a few
thousand subscribers costs $500,000-$1 million.
A much bigger expenditure will loom at the other end of
the pipe as the number of subscribers climbs. To date,
cable Internet services have followed the tradition they
established with set-top boxes and rented subscribers their
cable modems. At $400$500 a modem, this cost would
weigh heavily on cable firms' balance sheets, far exceeding
the hardware at their headends. That's why cable
companies want to encourage consumers to buy their
modems at retail stores.
Any major bout of capital spending might have seemed
impossible for the cash-strapped cable-TV industry to
handle before Microsoft invested $1 billion in Comcast
this past June. The infusion was intended to finance
Comcast's upgrade to allow Internet access, among other
things. Microsoft's investment has also had a
multibillion-dollar multiplier effect by making cable-TV
stocks rise, by 50% in some cases. A rich stock price, of
course, makes it easier to finance upgrades.
Through September, cable firms linked by At Home had
upgraded cable operations serving 2.7 million homes, says
At Home Chief Financial Officer Ken Goldman, with the
total expected to approach five million by year-end. That's
10% of those systems' homes. Next year Goldman expects
upgrades in systems serving an additional six million
homes.
Time Warner's Road Runner will be nearing two million
homes by year-end. The Time Warner system hopes to be
entirely spruced up for two-way service by the year 2000.
Meanwhile, a million homes in MediaOne's franchises are
passed by upgraded cable networks.
As noted, only about 50,000 North American homes had
actually signed up with the major cable modem services
through September: 26,000 with At Home; 20,000 with
Road Runner; and 10,000 with MediaOne. That's a small
start, but most systems have only recently turned on. In
the four markets that Road Runner has had in operation
for at least six months, penetration averages 2.5%, with
Portland, Maine, already at 4.2%.
Roger Keating, who runs Comcast's online operation, says
that the Comcast-At Home venture will become a financial
success when it signs up roughly 5% of Comcast's cable
TV homes. At Home Network should start showing net
profits in 1999, at somewhere between 5% and 10%
penetration of its cable affiliates.
Cable modems will sell through computer and electronics
stores, and eventually cost less than $200. Mail-order
personal computers will come with the modems
pre-installed. 3Com and other manufacturers aim to
provide modems to both retailers and computer makers.
Although the cable guy will continue to show up at homes
to install the gear, eventually there will be plug-and-play
modems that subscribers can install themselves.
"Retail distribution for modems is going to be a huge
boost," says Henry T. Nicholas, chief executive of
Broadcom Corp., an Irvine, California, firm that makes
microchips for cable modems.
With its dominant share of telephone modem sales to retail
outlets, 3Com predicts that its US Robotics brand will also
become the No. 1-selling cable modem in 1998. "This is
our home turf," declares 3Com Senior Vice President Rick
Edson.
Edson hopes that by 2003, 3Com will be selling cable
modems at the same rate it sells phone modems today, that
is, a million units a month, making for potential annual
revenue of more than $2 billion. It's true that the other
two-thirds of 3Com's business, meaning network cards and
local-area-network systems, are encountering some price
competition. But the company is gaining market share in
these areas, and its customers must continually upgrade
their networks, says UBS Securities analyst Scott Heritage.
Let's face it, the coming surge in cable-modem sales at
3Com may not come quickly enough to gracefully pick up
where phone-modem sales are leaving off. But the
cable-modem market will surely be a huge one. And that
fact isn't fully reflected in 3Com's current stock price. |
