From a UBS report focusing on COMS and CSCO.
Although MRVC is not mentioned, note that BAY and COMS are apparently reacting to MRVC's aggressive pricing - and it is apparently impacting their bottom lines (both present and future). Interesting that a #5 or #6 company can dictate pricing -you have to have excellent products to do this! Also note why UBS feels CSCO is not affected. Also, for you MRVCites also owning ASND, note the references to Stratacom!
DATA NETWORKING: INDUSTRY NOTES
SUMMARY
Our note primarily focuses on 3Com (COMS-$33-Hold) and Cisco(CSCO-$67-Buy). On
3Com we believe that the company continues to be impacted by price cuts in key
product areas such as modems, switches, and NICs. We believe that these price
cuts will make it difficult for the company to show strong sequential sales
growth out of the channel for its May quarter. With regard to Cisco we provide
our view on why Cisco is different compared to its struggling competition.
HIGHLIGHTS
* Price reduction in 3 major categories - 10/100 switch pricing, 10 Mb/s PCI
NICs, and modems will make it difficult, in our opinion, for 3Com to show
strong revenue growth in the May quarter.
* It is our opinion that strong sequential revenue growth is probably at least
two quarters away for 3Com.
* Cisco is able to differentiate itself from its struggling counterparts
through a strong position in high-end LAN switching, a strong carrier business,
good indirect sales channels, and a strong, experienced management team.
ANALYSIS
Price Cuts Still Making Life Difficult for 3Com
We believe that 3Com continues to be impacted by price cuts in key product
areas such as modems, switches, and NICs. We believe that these price cuts
will make it difficult for the company to show strong sequential sales growth
out of the channel for its May quarter.
1) LAN Switches
A couple of weeks ago 3Com announced that it was lowering prices for its
24-port Superstack II 3300 stackable 10/100 switch. We believe that 3Com has
dropped its street price for stackable area to near $100 per port (from the
$120 range) for the 24-port version. This $100 per port price gets 3Com closer
to Bay's (BAY-23-Hold) price of $95 per port that it is selling its' competing
350T-HD for. Just to provide a little background, in January, as 3Com and
Cisco were getting ready to introduce new 10/100 stackable switches, Bay
dramatically cut its street price for its new 24-port 10/100 switch, the
350T-HD, to under $100 per port. [and just why did BAY do this, pray tell?] 3Com and Cisco introduced their competing
products in January, both with a street price of near $120 per port. We
believe that 3Com's recent price cut will make it quite competitive to Bay
especially considering that 3Com's Superstack II 3300 appears to have some
features, such as an optional Gigabit Ethernet module, that Bay's 350T-HD does
not.
2) Modems
The approval earlier this year of the new 56k modem standard, v.90, has caused
3Com to drop prices for both its pre-standard 56k x2 modems as well as 33.6
kb/s. For its x2 modems 3Com dropped prices anywhere from $20-$30 per modem
and for 33.6 kb/s modems it cut prices between $10-$20. This is added to the
fact that we believe 3Com's new v.90 modems are priced less than the x2 modems
before prices were cut on x2 modems. While these price cuts are not new news,
we are pointing it out because these price reductions did not take effect until
late February so it is unlikely that 3Com saw much impact in its February
quarter from these price drops. Additionally to clear out inventory for the
pre-standard x2 modems, 3Com may have to cut prices again.
3) NICs
In the NIC area 3Com last week announced that it would be cutting list prices
on 10 Mb/s PCI NICs by 46%. Prior to the price cut the 10 Mb/s PCI NIC was at
a street price of about $100, so we would assume that street prices would come
down to approximately $60. This price cut is not really surprising since we
believe that 3Com's 10/100 NICs are at a street price in the $85 range, lower
than the straight 10 Mb/s. We would very roughly estimate that the 10 Mb/s PCI
NICs are 20% of 3Com's total NIC shipments. For 3Com's overall NIC business,
the 10/100 NICs continue to grow as a percent of total sales and pricing has
been relatively stable. We would expect therefore that any impact to 3Com from
this reduction of price in the 10 Mb/s NICs should be moderate.
In the February quarter 3Com's sales out of the channel were down an estimated
10%, due, in no small part, to price declines in the modem and switch markets.
In our opinion, the price cuts that we mention above will make it challenging
for 3Com to show strong sequential sales growth out of the channel in the May
quarter. We are currently estimating sequential sales growth out of the channel
of 2%-3% for the May quarter. It is our belief that a turnaround in 3Com, and
subsequently in the stock, will be dependent on the company showing good
sequential revenue growth upwards of 5%. Obviously we are not anticipating
good sequential revenue growth in the May quarter and we may not see it in the
August quarter either.
Why Cisco is Different
With three of the 'Big Four' in the networking industry (3Com, Bay Networks,
and Cabletron (CS-14-Hold)) struggling one must consider the possibility that
the other company in the 'Big Four', Cisco, is having problems as well. It is
our view that Cisco has some unique attributes that differentiate it from its
competition. These attribute should enable the company to have another quarter
of sequential earnings growth for its April quarter.
1) Cisco dominates the high-end switch market; minimal exposure to the low-end
The Dell'Oro group estimates that Cisco has over 50% market share in the
modular switch market and has been taking market share from 3Com, Bay, and
Cabletron over the last several quarters. Although there could be some
weakness in the overall LAN business, market share gains in modular switching
can help offset the weakness and we have no reason to believe that Cisco did
not take market share in the first quarter of 1998. Unlike the low-end of the
market where price cuts have really hurt 3Com and Bay, the high-end of the
switch market is not characterized by severe price competition. While Cisco
has been trying to break into the low-end of the switch market it is still a
very portion of overall revenues (5% we estimate). We estimate that the
high-end modular switching makes up about 20% of overall revenues. One other
item to note is that last week Xylan (XYLN-29-NR), a player in the high-end
modular switch segment, reported strong earnings which could indicate that this
high-end market remained robust in the first quarter.
2) Cisco has a strong carrier business
Unlike 3Com, Bay or Cabletron, Cisco is a major player in the carrier market
for routers, remote access concentrators and WAN switching. We estimate that
revenues to carriers currently is about 25% of overall sales. Currently Cisco
basically owns the routing market as nearly all routers in the Internet are
from Cisco. We believe that Cisco continues to do well with its new GSR 12000
router although it is a small part of revenues. In the remote access
concentrator market we believe the company continues to take market share as it
has been quite successful at RBOCs such as Ameritech, US West and Bell
Atlantic. As of the two months ago the StrataCom WAN switching business
appeared to be improving after a rough 1997. That improvement could be
short-lived considering the recent wins by Ascend (ASND-42-Buy) and the
problems with the StrataCom switches in AT&T's Frame Relay network.
3) Strong indirect sales business
In our opinion one of the key trends in the local area networking business is
the importance that indirect sales channels have taken on. More and more sales
of networking equipment is flowing through indirect sales channels, such as
system/network integrators. In the high-end of the networking business no
company has better relationships with the system/network integrators and VARs
than Cisco. In our estimation this has been one of Cabletron's major problems
in that it did not develop relationships with the VARs and system integrators
and instead opted to focus on selling products with its direct sales force.
4) Strong management
One of Cisco's real strengths is its' management team. In an industry as fast
paced as the networking business, experienced and seasoned management is a real
plus. Cisco has the some of the most experienced and definitely the deepest
management in the industry. We have seen at both Cabletron and Bay how
difficult it is for new management that came in from other businesses to
transition to the networking business. Cisco's leadership and experience at
the top have helped the company lengthen its lead in the networking industry. |
