Will someone with more technical knowledge that I comment on whether 3Com operations in the cable will compliment or compete with CUBE. Below is a story form barrons 12/1/97 edition
at interactive.wsj.com
The Future is 3Com
This beleaguered firm has an ace up its sleeve: mind-blowing Internet capabilities
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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.
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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.
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3Com has lost billions in market value since its US Robotics merger in February. Can its new modems repair the damage?
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.
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