NEEDHAM ANALYST INTERVIEW ON COMS COMS TO DOUBLE
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StockHouse.com News Maker Interview - Apr. 22, 1999
Needham Analyst Peter Lieu Says 3Com Shares Could Double;
Re-iterates Strong Buy Rating on 3Com
• • •
Peter Lieu covers technology issues for Needham & Co. (Boston). Mr. Lieu recently upgraded 3Com
[NASDAQ - COMS] shares from Buy to Strong Buy. On Wednesday, he reiterated the Strong Buy
rating on 3Com. He has closely followed 3Com for a number of years and has successfully called
the bottom, three times, in 3Com shares.
StockHouse:You reiterated your strong buy on 3Com Corp. on Wednesday?
Peter Lieu: What happened was, on Monday, we upgraded the opinion from buy to strong
buy. The stock was around 20-1/2 we got a lot of questions about the assets that underlie the
company. In other words, the recommendation on Monday was based on a better earnings
outlook than we had previously held. We were too conservative, we discovered. We were
looking for only 2% revenue gain and I think they can reasonably do 7% revenue gain. The
stock had come off from $27 to under $21. At the same time, we felt that the earnings picture
would be better so we upgraded the stock on Monday. We got a lot of questions about what
the different businesses were worth so we did a little calculation. That's what we put out today
[Wednesday]. What we tried to do was: We put multiples on the sale of the different divisions
and we came up with a number that was about $11 billion - rounding it out. But again, what we
said was, if the company started to develop some momentum, the value could be 30% higher.
StockHouse: If you established momentum?
Peter Lieu: Yes. Right now, there's no momentum because the revenues are sort of flatish,
growing at a couple of percentage points sequentially.
StockHouse: Are you calling for a price target of $26 a share?
Peter Lieu: No. That price target will double within a year
StockHouse: Double within a year?
Peter Lieu: YES!
StockHouse:How do you feel about Michael Murphy's
(California Technology Stock letter) prediction that 3Com will be
taken over by Ericsson, Siemens, Alcatel, Lucent or Nokia this
year?
Peter Lieu: Well, you know, there's tremendous value. I tell
people the analogy I draw is that if you have a pretty girl go to a
dance and she's all alone and you try to make your bet on who's
going to take her home, chances are there will be a lot of interest.
But you can't really pick who she's going to go home with. I'm
looking at a company with $6 billion of sales, and if you take the
cash away from the market value - it's selling at 1X sales? It's a
bargain. It's an extraordinary bargain. This is not a crappy
company. This is a company that earns gross margins of 47 percent. And, people say, "Gee,
you know they're in NIC cards and modems. That's the commodity business. Well, commodity
business, by my definition, earns between 15 and 20 percent - not 47 percent. Now whether
you accept that or not is up to you. They also have incredible cash flow generation. They're
going to generate this year $750 million of net-free cash. How many companies do you know
that can generate that much net-free cash? This is not cash flow including depreciation. This is
the cash balance increasing from the beginning of the year to the end of the year. People don't
focus on balance sheets anymore. People don't focus on cash flow. They focus on momentum.
So you have little stocks like Rhythms, which last year had revenues of one-half million and now
has a market value of between $4 and $6 billion, depending on the day you look at it. I mean it's
absolutely nuts.
StockHouse: Hasn't 3Com been left behind this market, especially technologically?
Peter Lieu: You know, this esoteric technology, whatever it is, this is not what the company is
about. What the company is about is brand name, distribution, and market credibility - that's
what it's about. Everybody that has a hot technology - no matter how hot the technology is -
they want it to be broadly distributed. They want customer base to show this to and this is why
they want 3Com. I mean, if you look at the cable-modem companies, they want 3Com to
distribute and make their cable-modems. Why? Because they have huge - thousands and
thousands of - distributors in place. Cable modems, DSL, all the hot companies like Copper
Mountain? They have an incredible amount of market potential, but they can't get there without
3Com distribution. That's what this company is all about. I'm not going to focus on some small
thing that might be terrific but could represent 1 or 2% of revenues at a year out. Now, if you
add it all together, it counts. Because if you look at Palm Pilot, three years ago, Palm Pilot's
revenues were about $3 million a year. This year, they will be $500 million. It gets to be pretty
meaningful.
StockHouse: But 3Com peaked in December and has been drifting lower nearly every week,
with the occasional shakeout to the downside.
Peter Lieu: If you look at the first half of the year, it's like a guy who is 25 points ahead after
the first three quarters and then he has a disastrous fourth quarter. In the case of 3Com, they
blew the numbers out Q1. They blew the numbers out again Q2. What they achieved was about
20% ahead of my estimates. Then, they really dropped the ball in Q3. The market is so
momentum-driven, that this disappointment was very hard to overcome. That's what really
turned things around. But I ask you to take a look at the 5-year chart on this company and just
look at this thing. In the last 3 years, if you had been fortunate enough to pick the stock up at its
trough - there were three occasions where the stock moved almost 100%. The first two times it
moved 100% and the last time it moved 95%. So here I am, I'm making it a 4th try. I called the
first three and I blew it on the 3rd quarter because I didn't sell. I didn't see this 3rd quarter
coming and here I am. So at the bottom, when nobody has any faith in Eric Benhamou (CEO of
3Com) - this is the time to buy. That's why I put it on the Buy.
StockHouse: You see this as the bottom for 3Com?
Peter Lieu: It is a rumor that we heard from somebody who should know what's going on. I
think 3Com has talked to a lot of people over the last 6 or 7 months. Part of those talks, I think,
were in sort of alliance discussions to see what happened. But Ericsson, I believe, is visiting
them in the Valley and talking with them.
StockHouse: Do you think the company is an attractive partner for Ericsson or Siemens or
Alcatel or Nokia?
Peter Lieu: It depends on the market these guys want to address. What 3Com is very, very
good at is playing at the edge of the network. And, they're very good at pursuing consumer
markets and they're very good at pursuing small business and medium-size business. If that's the
business you want to be in, 3Com is a wonderful partner. So you have to ask these guys, "What
business do they want to be in?" I think each one of these guys is different, but they're all very
big and they know 3Com by reputation. They know that Eric Benhamou is very smart. Now if
you look at Eric Benhamou, everybody is down on Eric Benhamou.
StockHouse: There have been predictions of resignation, an ousting, and the whole works. It
sounds like some investors want this man tarred and feathered.
Peter Lieu: When this guy became President of 3Com, the revenues were $400,000. Through
1997, the company grew from $400,000 to $2.9 billion. How many executives do you know
over a ten-year period can do that to a company? And he had a lot less to work with, when he
started this company at $400,000 than when John Chambers took over as CEO at Cisco,
because he had some pretty good stuff to work with. Then the Internet really helped Cisco and
routers. This company used to be a local area network operating system company and
adapt-a-card company. He turned it into a systems company, so that's pretty extraordinary.
You could argue that he made a very bad mistake and overpaid for US Robotics and I'm not
going to disagree with you. But at these prices we are evaluating the US Robotics total control
business at $2 billion. They paid $8.6 billion for the company. I'm just making up a number, but
if you could buy it for an 80% discount, is that a good value? I'd say probably. You know
you're buying 3Com - the stock that everybody loved at 6 times revenue. In 1999, you're
buying it at 1 times revenues. That's the way I look at 3Com. They're partners with some of the
best companies. They're partners with Microsoft, Newbridge and Dell. You know, these are
pretty smart people. Why would all these wonderful companies partner with 3Com is they're a
bunch of dodos? They must have some interesting technology.
StockHouse: Thank you very much Mr. Lieu.
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