Credit Swiss Report January 21, 1999 - 8:47am
Suisse? Spare me the French unless one writes Suisse cheese!
10 days in the topsy-turvy life of 3Com
CREDIT SUISSE FIRST BOSTON CORPORATION
Equity Research Americas
U.S./Technolgy/Data Networking
STRONG BUY
LARGE CAP
3Com Corporation (COMS)
Analyst Meeting Highlights Growth opportunities for 1999
Summary
Analyst meeting as expected - no change in guidance, business
so far this quarter sounds on plan, and contrary to
questioning, there is no company wide hiring freeze
Meeting focused on strategy and opportunities for
accelerating revenue growth and expanding profitability
New COO clearly focused on raising operational competencies
to best in class, strengthening the case for rising operating
margins going forward
Price Target Mkt.Value 52-Week
1/20/991 (12mo.) Div. Yield (MM) Price Range
USD 48 $55+ $0 None $17,198.4 $51-23
Annual Prev. Abs. Rel. EV/ EBITDA/
EPS EPS P/E P/E EBITDA Share
5/00E $2.30 20.9X 71% NA NA
5/99E 1.40 34.3 107% NA NA
5/98A 0.68 70.6 223% NA NA
Aug. Nov. Feb. May FY End
2000E $0.51 $0.55 $0.56 $0.64 May
1999E 0.24 0.36 0.35 0.45
1998A 0.47 0.01 0.02 0.18
ROIC (11/98) NA
Total Debt (11/98) $24
Book Value/Share (11/98) $8.02
WACC (11/98) NA
Debt/Total Capital (11/98) 0.8%
Common Shares 358.3
EP Trend2 NA
Est. 5-Yr. EPS Growth 25%
Est. 5-Yr. Div. Growth NM
1On 1/20/99 DJIA closed at 9335.9 and S&P 500 at 1256.62.
2Economic profit trend.
3Com is a leading provider of a broad range of networking
equipment including ac-cess devices (adapters, modems),
systems products (hubs, LAN switches and re-mote access
concentrators) and handheld devices (Palm Pilot). 3Com is the
number 2 supplier after Cisco and has strong manufacturing.
and distribution strengths.
Investment Summary
3Com's senior management reviewed the operating strategy for
each of the business units and highlighted the significant
milestones/objectives that it hoped to achieve in 1999. 3Com
believes that converged voice and data networks are the path
to pervasive networking. 3Com sees a time when billion of
network connections are required, versus the 200 mm or so
today, and the means of getting there is to connect new
devices - handhelds, internet appliances, IP phones, home
appliances, storage peripherals, etc. - to the network.
Tone of Business is Healthy
Overall, the meeting was upbeat and, as expected, there was
no change in estimates. 3Com remains leveraged to powerful
networking trends - voice/data convergence, the Internet/
Intranet as tool for commerce, circuit to packet transitions
and growing home/consumer opportunities - all of which should
allow 3Com to reach its goal of exceeding the industry growth
rate over the intermediate term. The most exciting
opportunities where 3Com could have a differential advantage
or leverage a core competency are in LAN telephony (voice
over existing LAN infrastructure), wireless and handheld computing.
Offline conversations with management suggest that the
overall tone of demand is probably running slightly stronger
than expected in the systems business and in-line with
expectations in the client access business. The strength in
the systems business is due to LAN switching, gigabit
Ethernet and WAN access and is particularly important for the
February quarter given the seasonal weakness generally
experienced in the client access business.
3Com's new COO presented to investors for the first time and
highlighted the aggressive goals 3Com has for improving
operating results - greater use of e-commerce, supply chain
management, cutting the cash conversion cycle in half and
increasing inventory turns nearly four fold over the long term
. Without disclosing specifics, 3Com expects cost savings
will be in the hundreds of millions of dollars over time as
it implements stronger internal operating and control
procedures. It's clear that as networking technologies
permeates more high volume segments, operational excellence
will become increasingly imperative and 3Com appears to
understand this better than most networking companies.
As we discussed earlier this week, fears of a pricing debacle
appear unfounded. 3Com is looking for 15-20% average price
erosion across all its major product families this year.
More importantly 3Com believes pricing will end up being more
predictable than in the past given the consolidation among
suppliers that has taken place.
Management strongly denied questions from participants about
a hiring freeze at 3Com. We believe the company is
controlling costs in slower growth areas but this in no way
is indicative of a hiring freeze.
Although we have yet to see the fruits of the partnership
with Microsoft, 3Com was very bullish about the leverage 3Com
would gain by tightly integrating its products with Windows
2000. Several indicators are positive (over 100 joint
projects, MSFT endorsing 3Com as standard for client access,
new 3Com R&D facility close to MSFT) but we are not convinced
that 3Com has an distinct advantage yet. The message from
3Com is stay tuned, there is more to come with MSFT in the next few months.
Below is a brief review of the strategic thrust of 3Com's
major operating units:
Systems Business
Business is continuing its strong momentum of last quarter,
lead by the flagship CoreBuilder 9000 switching platform.
This product, which comes in both ATM and Gigabit
configurations, has been instrumental in securing new
customer wins, as well as dragging along incremental sales of
stackable hubs and switches. 3Com continues to enjoy a very
strong new product pipeline and indicates that it believes it
is now a strong second to Cisco in many large enterprise deals
. We believe this is reflective of 3Com's strategic thrust
to transition to more of a systems/solutions supplier, and
away from simply a point product company.
3Com is focused on proliferating converged networks
throughout large enterprises but more importantly, is
focusing resources on the less penetrated small and medium
enterprise (SME) segment where 3Com has a huge base of 65,000
resellers. This focus is wise as 3Com has brand, market and
mind share leadership in SME but also because SME's will
likely be the first to buy into converged solutions (i.e. IP PBX,
LAN telephony, etc.).
In the WAN segment, 3Com is well positioned to benefit from a
significant upgrade cycle (5 mm port installed base) as it
will soon raise modem density in its remote access devices by
a factor of at least 3x (as will the industry). Additionally
, 3Com should experience favorable pricing dynamics in the
remote access space as two new applications - VoIP and
wireless data - are both commanding substantial price
premiums to commodity remote access platforms. In time,
3Com's platform could evolve to a class 4 switch replacement
but this will take external partnerships.
CREDIT SUISSE FIRST BOSTON CORPORATION
Equity Research Americas
U.S./Technolgy/Data Networking
STRONG BUY
LARGE CAP
3Com Corporation (COMS)
As it moves to a systems supplier, 3Com has made it easier
for customers to do business by consolidating the number of
platforms that it sells. The products from the numerous
acquisitions have finally been integrated to a point where
each product category now only has one flagship platform.
Client Access
The tone of business in client access sounded healthy,
running at but not really above or below plan. This is
typically a quarter that gets off to a slow start, but then
accelerates as the quarter progresses. This year is no
exception and business in the channels is now picking up.
3Com is spending considerable resources on both cable and
xDSL technologies. As with most networking vendors 3Com
believes cable will be a more significant contributor in 1999
than xDSL. 3Com has signed deals with 10 MSO's in the last 6 months.
The strategy in both adapters and modems is to add value
through software and segment the market, which will enable
3Com to garner both a premium over competitors while
extending its volume leadership.
Remote wake up, modem manager, bundled voice support,
integrated boot agents, packet acceleration and security are
just some of the features that 3Com is adding to adapters and
modems that help mitigate price declines. As a result, 3Com
is not expecting price erosion much above the 20% level, and
in some cases even less.
3Com will continue to drive for volume in these markets as
volume will lower costs. This year, 3Com added a new
dimension to its volume strategy, specifically citing that it
would develop more fabless semiconductor capabilities. This
involves controlling more of the silicon intellectual property
, specifically gaining broader tools and libraries. We are
still determining which of 3Com's suppliers this could impact.
Consumer/Home/Palm
3Com's home networking strategy is still being rounded out,
with partnerships and acquisitions an integral part of
delivering products in 1999. 3Com has formed a separate home
networking division and has alluded to further partnerships
with MSFT in this arena.
3Com cites Asia as the region where Palm could have the most
significant growth as the penetration rate is significantly
less than Europe and North America.
In 1999, 3Com will focus on developing awareness of Palm
computing as a platform with a much broader licensing campaign
. Additionally, 3Com will segment the market across price
and features, as well as user categories believing it can
enable new market opportunities for Palm with new
applications (especially wireless and Web clipping features
). Palm.net, a wireless service is one such application that
3Com will use to extend brand awareness.
|
