11/20 FOP USRX: LONG LINES & FAST MODEM SPEEDS; COMDEX `96
OBSERVATIONS & SYMBOLS: USRX S/COM S/CUS S/CNA I/TELECM I/DATAPR I/COMPUT ANALYSIS...P1
Part 1 of 2
Oppenheimer & Co., Inc. November 20, 1996
U.S. ROBOTICS CORPORATION
Long Lines And Fast Modem Speeds; Comdex '96 Observations And
Analysis
Steven D. Levy (212) 667-7062
Sender Z. Cohen (212) 667-4744
Rating: BUY
USRX-OTC (11/19/96): $66 1/8 Dividend: Nil
52-week Range: $105 1/2-$32 1/2 Yield: Nil
Shares Outstanding: 96 Million Fiscal Year Ends: September
Market Capitalization: $6.3 Billion Debt-to-Capital: 12.7%
Earnings per Share: P/E Ratio:
FY 1994 $0.52 FY 1994 127.2X
FY 1995 $1.05 FY 1995 63.0X
FY 1996 $2.36 FY 1996 28.0X
FY 1997E $3.50 FY 1997E 18.9X
Oppenheimer & Co., Inc., or one of its affiliated companies, makes a market in the securities of this company.
Oppenheimer & Co., Inc., or one of its affiliated companies,
managed or co-managed a public offering of securities for this company within the last three years.
Quarter ending December 31 EPS estimated at $0.72 vs. $0.45.
Company Description: U.S. Robotics is the leading designer,
manufacturer and marketer of dial-up connectivity products, systems, and software,used for remote access to information networks.
INVESTMENT CONCLUSION: For the past two days we, and more than
200,000 others, attended the annual Fall Comdex PC technology trade show in Las
Vegas. Our main intent was to further investigate the potential 56,000 bit per second (56 kbps) product offerings and what they mean for USRobotics. After having spent almost as much time waiting in line for either a taxi or to register for the exhibit hall entrance card--which was free--as we did visiting company booths, our conclusions about the impact of the upcoming 56 kbps upgrade cycle were reinforced. Essentially we have maintained a two part view of this increasingly important technology introduction: (1) 56 kbps is good for the entire remote access industry and particularly good for USRobotics
as the market leader, and (2) USRobotics' time-to-market advantage of at least three months gives it an even greater edge on competitors in both segments of its business, modems and systems.
More Modem Vendors Poised To Rollout x2. In addition to witnessing a live demo of USRobotics x2 products--they really are real--we had the opportunity to discuss the 56 kbps product cycle with about 10 other modem vendors and the leading provider of fixed
function modem chip sets, Rockwell (ROK-NYSE $62 3/8, rated Buy). Based on these discussions we believe that USRobotics and its semiconductor partners Texas Instruments (TXN-NYSE $54 3/8) and Cirrus (CRUS-OTC $20 ) are likely to win quite a few new accounts with the x2 56 kbps technology. Additionally, as we described in our report dated November 15, Cardinal Technology became the first non-USRobotics modem vendor to jump on the x2 bandwagon. Although it is hard to forecast the magnitude of the change, its direction is clear; toward x2. The importance of this trend for USRobotics goes well beyond the potential license fees it might generate. Dramatically increasing the number of modems using x2 at the client end of a remote access connection increases the utility and therefore the need for x2 ports at the Internet Service Providers points-of-presence (ISP POPs). This is the company's fastest growing business and the one with the largest incremental impact on the bottom line.
A Reality Check For x2; USRobotics Still Appears To Have A
Meaningful Time-To-Market Advantage The only company at Comdex with a real demonstration of 56 kbps products, in our view, was USRobotics. The company was conducting regular 56 kbps calls to a live ISP site over the regular phone network at its main booth and was also showing off its x2 products in a private room that allowed closer inspection.
The x2 technology is now scheduled to go into final quality and
assurance control during the next week and then ship out to a few large initial ISPs for trials a week later. Final product development seem to be on schedule for x2 rollout for Sportster products in January with the remaining x2-enabled modems and remote access systems available in February. Given the time it takes to roll out the upgrades to USRobotics' ISP customers, a period likely
to be measured in days, we believe that the company's time-to-market
advantage for a complete end-to-end 56 kbps solution is at least three months.
USRobotics Expands Its Free x2 Upgrade Program To The Sportster
Brand Although it does not appear to have been widely disseminated, we
have found out, and confirmed, that the company told its resellers that any Sportster 28.8/33.6 modem bought between October 1 and December 31 will be upgraded at no cost to the consumer. This is significant in our opinion, because it removes yet another potential concern regarding USRobotics' short-term results--i.e. purchase delays in the December quarter. Since most Sportsters will require an EPROM chip swap-out, at a cost to USRobotics of $6 to $8 each, this program does not appear to be sacrificing too much of the
company's profits in the way of upgrade costs. In fact, this facet of the 56 kbps race could actually accelerate USRobotics' market share gains and allow it to consolidate even more of the modem market in advance of the formal x2 product deliveries.
The free upgrade program also leads us to believe that USRobotics
is planning an even more aggressive initial pricing of 56 kbps modems than previously thought. While we have consistently maintained that the company would charge a meaningful premium of $50 to $75 for x2 on top of the cost of today's modems plus an unspecified upgrade cost, we had been thinking that the starting price point would be in excess of $200. It now appears that USRobotics is positioning x2 modems at prices as low as $150. The rationale supporting this conclusion is that with some Sportster models selling for less than $100, and
the upgrade to x2 now known to be free, USRobotics can still create
a tiered pricing structure that differentiates its highest speed modems and be quite aggressive with the new x2 modems. In other words, the new 56 kbps modems are likely to be even more attractively priced than in our original model.
Rockwell Is Not Far Behind But...
In its September 10 press release announcing 56 kbps technology
Rockwell said that it expected to "demonstrate 56 Kbps transmission capabilities at the November 1996 Comdex show". At Comdex Rockwell started aggressively marketing its K56Plus brand of technology and its presence was evident in many booths. We are still convinced, however, that the original schedule of sample chip set delivery in the first calendar quarter of 1997 and initial chip production in the second quarter is about as early as modem vendors can expect
their 56 kbps chipset. After receiving the chips we also believe it is
appropriate to expect at least a one to two month lag before end-user or ISP products begin to hit the market. Thus, we do not believe that a Rockwell-based end-to-end 56 kbps solution is likely to become available until mid second quarter, or approximately three months after x2.
We stopped by the Rockwell booth and saw a "simulated" demo but it
was not one that could dial out of the booth. We were also not allowed to see the prototype modems, which only increases our skepticism about the near-term deliverability of the chips. Another factor that is making this product cycle different from previous speeds is the need for follow-on software upgrades to the final international standard. Rockwell did indicate to us that its new K56Plus chip set would be flash memory upgradeable, confirming our view.
Finally, in marketing its K56Plus chips, Rockwell is attempting to
paint a picture that, in our view, is somewhat misleading. Therefore, we feel compelled to help investors better understand what we believe are the accurate "facts" and whether they are important or not. For example the paragraph below is excerpted from a brochure that Rockwell was distributing at Comdex.
"Rockwell engines drive 75% of the world's modems (over 100 million
at last count--the world's largest installed base). In fact, Rockwell-based modems account for 70% of all connections to the Internet, and Rockwell's central site partners have the most digital connections to the phone network. So chances are good you'll be able to connect if you use a Rockwell-based 56 kbps modem."
Our comments about this are as follows: Rockwell's installed base of modems only matters if they are easily and cost effectively upgradeable. We do not believe that the installed base
of Rockwell-based modems are either. Assuming Rockwell's K56Plus modem chip sets support previous international standards such as V.34 and V.32, almost any modem in the world should "be able to connect" to the new modems, although it will not happen at 56 kbps. We do not agree with Rockwell's assertion that 70% of ISP ports are based on
its modem technology and again, the value of this installed base is
significantly diminished because of its upgrade path. We think that
Rockwell's central site systems customers might be selling to 70%
of the ISPs but we believe the market share of modem ports is much closer to 50%, at the most.
We believe that USRobotics' current market share of approximately
35% of new modems shipping is actually much more valuable because, with the exception of the PC card (Megahertz) product line, all of the company's 28.8 kbps/33.6 kbps modems are easily upgradeable to x2 56 kbps speeds.
Lucent Announces Interoperability With Rockwell Lucent Technologies (LU-NYSE $51 3/8) recently announced intention
to make its proprietary V.flex 56 kbps modem chip sets interoperable with Rockwell's K56Plus is a clear plus for Rockwell and a matter of practical urgency for Lucent, in our opinion. While Lucent has a meaningful position on the client side of the modem business its share of chip sets used for central site modems is small. Thus it seems to be a good move for Lucent to ensure that its modem manufacturers are able to connect with ISPs at 56 kbps. We would not be surprised to see Motorola, another contender in the 56 kbps modem technology race, follow a similar path in order to protect its small modem
chipset market share as well.
Our quarterly EPS estimates are shown below.
1 Qtr. 2 Qtr. 3 Qtr. 4 Qtr. Year
FY 1994 Actual $0.13 $0.17 $0.14 $0.07 $0.52
FY 1995 Actual $0.17 $0.21 $0.30 $0.37 $1.05
FY 1996 Actual $0.45 $0.55 $0.66 $0.71 $2.36
FY 1997E Prior $0.72E $0.82E $0.93E $1.03E $3.50E
FY 1997E Current $0.72E $0.82E $0.93E $1.03E $3.50E
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