from briefing.com - comments on 3com & others incl. nn. comment made regarding if weakness with 3com/siemens, nn could be a takeover target:
june 12/98
Panelists
Scott Heritage, Vice President, Equity Research at UBS Securities.
Patrick Houghton, Senior Vice President, Equity Research at Wheat First Union.
Matthew Barzowskas, Vice President, Networking Analyst at First Albany Corp.
Q&A
Briefing: What factors have contributed to 3Com's poor stock performance?
Can 3Com position itself to compete in the high-margin growth area of the
telecom equipment market?
Scott Heritage: 3Com has been plagued by several things in the last year. Two of the most
significant are related to the purchase of US Robotics in June 1997. The first important issue was
excess inventory in the channel - that is product was being shipped to distributors even though
end-users weren't taking the products. We are just now beginning to see this turn around. The
second big issue has been weakness in the modem business. The was much hype surrounding 56K
modems which did not materialize largely because there was no industry standard. There were
standards in the lower speed modems, but not at the higher speed modems, so many ISPs and
consumers alike did not upgrade because of the compatibility issue. There now is a 56K modem
standard but the modem market has remained weak. We see it improving in the second half of this
year.
3Com would like to participate more in the service provider market and to a certain extent is
making steps in that direction. We think that partnerships alone will not allow them to become a
force in this market, but rather it may be necessary for them to make a major acquisition to become
a significant player. The flip side of course is that one of the telecom companies will acquire them,
but we don't think that they are the most attractive candidate, although we wouldn't totally dismiss
the possibility.
Patrick Houghton US Robotics accounts for a majority of 3Com's poor stock performance
because of overhang from the new 56K standard and weakness in consumer modem sales. Most
new PCs are shipped with imbedded modems and Lucent has a dominant share of that market,
followed by 3Com and Rockwell. 3Com is fighting to gain market share in imbedded modems
because there is less demand for stand alone modems which are sold through the consumer channel.
where 3Com currently has a dominant market share. 3Com also dominates the market in Network
Interface Cards (NIC). In its system business, which represents about 40% of 3Com's revenues, its
big challenger is Cisco. Most PCs are still sold to enterprises and virtually all these PCs sold into the
enterprise get NICs installed. Where the two companies are meeting is in the workgroup hubs
space and in the wiring closets, a market that is now being challenged by Cisco, which is moving out
of the network and into the wiring closets. This is clearly making the systems business much more
competitive for 3Com.
3Com has entered into a partnership with Siemens and Newbridge Networks with the Carrier Scale
Internetworking (CSI) initiative . The important factor with CSI is that it scales MPOA (Multi
Protocol Over ATM) from the LAN to the WAN for the telecom market. It is not clear at this time
how much 3Com will benefit from this partnership and the success of the triumvirate will depend on
their execution.
Matthew Barzowskas: First and foremost, investors have been turned off by 3Com's
disappointing revenue and earnings growth. Among the contributing factors for the disappointment
have been tough pricing pressure at the low end of the market, slower modem sales, and difficulty
integrating U.S. Robotics' portfolio of products at a time when both companies had excessive
inventory in the channel, and modem sales slowed. 3Com is currently in the last quarter of its
inventory restructuring plan, but given tough industry conditions, is still hoping to reduce inventory
levels even lower than its stated objective.
To maintain its position as a leading networking provider, 3Com will have to cater to the telco
market. At the moment, 3Com lacks the full product suite that is necessary to compete effectively in
this area, yet its acquisition of U.S. Robotics has given it a channel to the telco environment as it has
provided 3Com with a total control remote access hub. Currently, 3Com does not have ATM or
frame relay products, but it is working with Newbridge Networks to provide these offerings.
Briefing: Is the Tellabs/Ciena merger a setback to Cisco given its focus on
becoming a total solutions provider in the telecom equipment market? How do
you expect Cisco to respond?
Scott Heritage: Tellabs/Ciena merger is certainly not a setback for Cisco because their business is
a not a direct threat to Cisco's. In fact, this merger might even be a positive for Cisco as their
businesses are complimentary.
Patrick Houghton Ciena is a very good fit with Tellabs and it is important to understand the
benefits of this merger. Layer 1 of the OSI model is the transport layer which is the strength of both
Ciena and Tellabs. Tellabs owns 65-70% of the core of the Telco data network with its 3/1 digital
cross connects. Tellabs brings three important strengths to the merger - long and trusted
relationships with the RBOCs, a huge sales and support organization, and expertise in managing
bandwidth, all of which Ciena needs. In the near-term, Ciena brings new products for the Tellabs
sales force, but in the long-term, Ciena brings Tellabs the ability to manage bandwidth optically
rather than electronically. Cisco operates at layer 3 where it dominates Internet Protocol (IP) with
its large core routers and is building its share of layer 2 with its ATM switches.
It is clear that Cisco is focused on the Telecom equipment market and needs to increase its
products and market presence with the Telcos. A bold strategic move would be to acquire the
Tellabs/Ciena combination. Cisco has a $9 billion revenue run rate. If they are to continue to grow
at 30-50%, the enterprise market isn't large enough to sustain that level of growth so it has to come
from the $200 billion telecom market. Even at the low-end of that growth range, in two years, Cisco
will be the size of Nortel and in four years, the size of Lucent. Cisco has an $80 billion market cap.
Tellabs/Ciena combined have an $18 billion market cap. If Cisco bought Tellabs, it would be about
the same proportionally as the Cisco/Stratacom acquisition two years ago. For Cisco, it is important
to have the market access that Tellabs provides and we believe that the Tellabs acquisition of Ciena
makes Tellabs an even more attractive takeover candidate for Cisco. Moreover, the acquisition
could be neutral to slightly accretive to Cisco's earnings.
Matthew Barzowskas: Voice switch players such as Lucent, Northern Telecom, and Ericsson,
are looking to be more aggressive in the data environment, and for that to happen, they have to buy
the necessary equipment. As a result, acquisition activity is picking up. With respect to the
Tellabs-Ciena merger, it is a sign of things to come as point-product players will have to combine
product offerings to compete on a more level playing field with larger companies such as Lucent and
Cisco. Overall, we don't see this particular deal as a setback to Cisco since its size alone has
already provided them with a channel into the telco space. Thus, the most likely response from
Cisco will be to continue its strategy of buying smaller, point-product players, and taking advantage
of its massive distribution channel.
Briefing: Which networkers are likely takeover candidates as telecom
equipment makers race to provide telecom companies with a single network
that can carry voice, data, and video?
Scott Heritage: The three networkers and telecom equipment companies that we think are
probably most ripe for takeover are Bay Networks (BAY), Ascend Communications (ASND), and
Advanced Fibre Communications (AFCI).
Patrick Houghton Ascend (ASND) is a likely candidate because of Cascade's strong frame relay
and ATM products and the fact that they have no strong alliances with any large partners. If
Newbridge Networks (NN) shows any weakness in its alliance with Siemens and 3Com, they
could be a good candidate. FORE Systems (FORE) is another potential takeover as they have just
come out with what looks like a very good ATM switch. I think that the LAN game is over, Cisco
won and consequently, Bay Networks (BAY ) and Cabletron (CS) are not very attractive
candidates.
Matthew Barzowskas: Bay Networks, Ascend, and Fore Systems are the most likely takeover
candidates, yet each would complement an acquirer in a different way. Bay Networks would be the
most logical choice for telecom equipment providers wanting to get more aggressive in the enterpise
space as it offers a lot in the way of product portfolio, customer base, and distribution channels. If
looking to be telco-specific by providing infrastructure for the service providers, then Ascend would
be a better fit since it has the broadest end-to-end solutions. Finally, if looking for ATM technology,
FORE Systems would be the likely target since it is a leader in the enterprise space and possesses
the technology necessary to channel into the telco space.
Briefing: Which stocks are you recommending and/or avoiding?
Scott Heritage: In the networking sector specifically, we have a BUY recommendation on
Ascend Communications (ASND), Cisco Systems (CSCO), and Xylan Corporation (XYLN).
Patrick Houghton I have BUYS on the following: Cisco (CSCO), Tellabs (TLAB), and
Newbridge Networks (NN). I have a LT BUY on 3Com (COMS), and I have OUTPERFORM
on Northern Telcom(NT).
Matthew Barzowskas: We have BUY ratings on 3Com (COMS) and Cisco (CSCO). Ascend
(ASND), because we think it is fairly valued, is rated NEUTRAL. Similarly, Bay Networks
(BAY) and Fore Systems (FORE) are also rated NEUTRAL since we feel any impending
acquisition has already been built into the stock price. As a derivative of networking growth, we
think there is an opportunity in the network management and security space, and have BUY ratings
on Concord Communications (CCRD) and CheckPoint Software (CHKPF).
[ |
