CREDIT SUISSE FIRST BOSTON CORPORATION: 3Com update 12/2
Equity Research-Americas
Industry: Data Networking
Data Networking Update
Summary
Three of the largest and most influential vendors in the networking
space - Cisco Systems (Strong Buy), 3Com Corp. (Strong Buy) and Broadcom
Corp. (Buy) - presented at the CSFB conference on Tuesday. In all cases
we believe that management's level of conviction in the underlying demand
drivers for networking equipment in 1999 is increasing. We sense that
near term business remains strong and would expect the bias on estimate
revisions throughout next year will be to the upside. The key message of
each of these companies was:
Cisco - the Internet enabled economy changes the rules of competition,
allowing fast acting companies to dominate slow ones, irrespective of
size or geography.
3Com - moving beyond recovery mode and will exploit several incremental
market opportunities in 1999 which should drive multiple expansion, thus
our 12 month price objective is $50 per share vs. 40+ previously.
Broadcom - while BRCM's end markets continue to accelerate, new
networking, cable and set top box products have yet to kick in leaving
lots of upside during 1999.
3Com Corp. - Strong Buy
With a growing conviction on our part that 3Com is well on the road
to recovery and now has before it the chance to exploit 6 or 7
incremental market opportunities (see First Call note dated
November 13) we are raising our 12 month price objective to $50+
per share. This reflects an increase in our assumed PE multiple to
25-30x forward earnings from a previous assumption of 20-25x.
While the long term growth rate is likely to be 25%, we believe
this higher multiple is appropriate give than the near term EPS
growth rate should be well over 100% for the next four quarters.
Management presentation was very upbeat with 3Com clearly more
confident about its prospects given the healthy market conditions,
new product rollouts and internal efficiencies. Pricing has
returned to more normalized levels (although we are mindful that
CQ1:99 will see systems and adapter price reductions) and end user
PC demand has been strong, helping modem and adapter cards sales.
We expect 3Com will meet or beat our FQ2 EPS estimate $0.32 on
$1.55 billion in sales.
We believe management confidence in the sustainability of the
momentum is on the upswing, incrementally higher than the positive
tone exhibited just a few weeks ago. Likewise, investor reception
was very positive, with 3Com's presentation and breakout sessions
packed with investors. The increased confidence is reflected in
3Com's comment that it may be able to achieve its operating margin
target faster than is generally expected. However, we believe this
would require sacrificing lower margin revenue (Palm, modems, etc.)
which is not likely given 3Com's desire to increase its market
share. We remain comfortable that operating margins can climb to
14%+ by the end of FY (May) 1999 from the current 8%, and be within
the 16-20% targeted range by FY 2000.
As has been the case recently, 3Com management focused on the
incremental opportunities available in 1999 above it already strong
businesses in switching and client access. In order of importance
to 3Com's top line we believe Voice over IP (half billion plus
opportunity next year), handheld computing (press conference at
1:30 PM EST) and cable modems (deployments underway now) will be
important in the first half of 1999. The second half of 1999 and
beyond will see revenue from LAN telephony (replacing PBXs),
wireless, storage area networks and home networking. None of these
opportunities existed last year, but could contribute 10-15% of
revenue by the end of 1999 in our estimation.
3Com alluded to several upcoming announcements that could be made
within the next few weeks including: a new version of wireless
enabled Palm Pilots with Internet connectivity; supply agreement
with major PC OEM (we believe its Dell) for cable modem and DSL
connectivity; and two DSL wins that would signify early momentum of
this technology. |
