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Technology Stocks : 3Com Corporation (COMS) -- Ignore unavailable to you. Want to Upgrade?

To: craig crawford who wrote (12569)	12/19/1997 7:22:00 PM
From: Valentino	Respond to of 45548

To All: Motley Fool 12/19 Networkers Hit Hard Times 3Com (Nasdaq:COMS - news) shareholders caught a breather late today when shares only closed down $1/2 to $32 5/8 after being down as much $2 1/16 this morning. A downpour of earnings estimate revisions followed by the company's somewhat somber guidance in last night's post-earnings conference call dragged on the shares. 3Com's plight has tracked almost exactly that of the industry, as company after company has been laid low by a lumpy demand, executive error, and management hubris. The Computer-Local Networks Industry currently ranks 146 out of 197 industries in Investor's Business Daily after sitting at number 16 only three months ago. Many investors find it hard to remember a time when companies involved in the fast-growing networking industry were not doing well, with the exception of last April. Now it is hard to find a company in the industry that is doing well. Where small networking companies were once viewed as an engine of innovation and growth, many of these companies now have been left behind for dead as the Cisco-led "end-to-end" systems solutions have come to dominate the industry. The conventional wisdom holds that if you are not among the top five players, forget about it. As much as a Fool would like to dispute this conclusion, for the most part except for companies with expertise in a single product line the big guys are not involved in, it usually holds true. While the small companies have been getting smaller, the big have not been doing all that well either. With the single exception of Cisco Systems (Nasdaq:CSCO - news) , each of the big five has either warned, made discouraging comments, or issued questionable and confusing statements to analysts that some interpreted as negative. In the past month, 3Com has cleaned out its inventory channel, Cabletron (NYSE:CS - news) has laid off 600 workers, Bay Networks (NYSE:BAY - news) issued statements at an analyst meeting interpreted by some attending as negative, and Ascend Communications (Nasdaq:ASND - news) has only poked its head up when pretty outlandish rumors of a Lucent (NYSE:LU - news) buy-out circulated for the umpteenth time. The problem that many investors have with these companies is that based on deteriorating financial results, they are not getting cheaper. The valuations are declining just enough to keep up with the earnings shortfalls and revenue shortcomings. Take 3Com for instance. In the quarter it just completed, sales dropped 14% year-over-year and 24% sequentially to $1.22 billion. The lion's share of this drop came from the client access business (modems and NICs), which saw revenues tumble 24% year-over-year and 32% sequentially. However, even the systems business dropped 2% year-over-year and 13% sequentially to $621.5 million. The company reported that it still had inventory to clear in the systems business next quarter, and that for half a dozen reasons gross margins might fall further -- indicating that financial results may not recover substantially until fiscal 1999. With $621.5 in systems sales, consisting of switches, routers, hubs, and remote access, 3Com is the second-largest company in the networking business. In fact, the company may not even be the number two company for the current quarter. Number three Bay Networks did $601 million in revenues last quarter and sees sales going up sequentially, although there are significant questions about whether or not the company's router business (22% of sales last quarter) will further erode. A sequential sales gain of more than 3% will put the company on par with 3Com for the first time since the Wellfleet-Synoptics merger that created the company, an interesting turn of events indeed. Although both companies have their individual issues, things get even worse further down the networking food chain. Two weeks ago number four in the industry, Cabletron, said it would do $330 to $340 million in sales in its upcoming quarter, not counting the $70 to $80 million in revenues from the Digital Equipment Networking business it recently bought. Put another way, sales could drop more than 9% for Cabletron's core business without clearing out an inventory channel that some analysts believe is equally as bloated as 3Com's. The fact that the company has laid off 600 workers in an attempt to realign its cost structure is even more troubling that anything 3Com or Bay can offer up, as it suggests that the problems Cabletron has encountered may still be here next year. Number five Ascend is even more of a wild card, with sales already down by more than 12% last quarter and potentially slipping even more as pricing in remote access is destroyed by Cisco. Despite this sustained downtrend in the industry, all of these companies still are valued at more than two times trailing sales -- even though profit margins at all but Cisco have gone below 15% -- with most seeing profits below 10%. While certainly networking is not going to become a thing of the past, as the industry continues to consolidate and demand gets lumpier, these companies will command less generous valuations. Even if 3Com, Bay Networks, Cabletron, or Ascend manage to right their businesses, what new valuation paradigm will exist remains unknown. With industry growth for the next two years estimated to be well below that seen in the first part of the decade, investors involved in any of these stocks should be careful that they do not just use historical multiples as their guide but instead focus on what the underlying profitability of these companies will be and what sort of value companies with similar profitability get. The bloom may not be off the rose, but the halo has certainly been removed from quite a few corporate heads.