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Let's now place the entire article in perspective:
Monday, December 1, 1997
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.
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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Copyright c 1997 Dow Jones & Company, Inc. All Rights Reserved.
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