THE WALL STREET JOURNAL
Heard in New England: New Routers May Help Cabletron Become a Contender -- and a Target
By Andrew Caffrey 05/26/1999
Cabletron feels like a live wire again.
Shares of the struggling Rochester, N.H., network-switching company have enjoyed a resurgence recently, as investors see promise in Cabletron's new products and sales strategy. After being as far down as $7 just a month ago, the shares are now hovering around $15, and analysts believe they could climb as high as $25 if Cabletron continues strong sales of its superfast routers.
Some chary investors say that Cabletron may have too much ground to make up after years of getting hammered by industry titan Cisco Systems, and that management still has a lot to prove.
But more optimistic analysts say that if Cabletron can capitalize on the sales growth from its new routers, investors might be in for an even bigger payoff: that a once-stubborn Cabletron will finally allow itself to be bought and folded into a large telecommunications-equipment company -- at a rich premium.
Indeed, even bulls concede that Cisco is too much Goliath for this David. They note that other networking companies have given in to pricey buyout offers from Lucent Technologies, Nortel Networks and others looking to own their technologies.
"It's inevitable at some time Cabletron will be bought," says John Armstrong, an analyst at Dataquest in San Jose, Calif. "You've got to have a sugar daddy out there in the telecom business."
Cabletron CEO Craig Benson won't comment specifically on the prospect of a sale. "I'm not ruling out or ruling in any possibilities," he says.
But in an important psychological shift for Cabletron, Mr. Benson recently signaled that management is exploring ways to "increase shareholder value." At a technology conference in San Francisco in early May, he and other company officials suggested Cabletron might spin off its successful Spectrum software line.
That's not the same as hanging out the for-sale sign. But it does reflect a greater openness to thinking about shareholder concerns. If Mr. Benson gets an offer and "thinks accepting it is the best way to enhance shareholder value, he'll do it," predicts William Becklean, a Boston analyst for SunTrust Equitable Securities.
On the day Mr. Benson made his remarks, Cabletron shares leapt $2, to above $11. They rode up a little higher in mid-May after a fund managed by George Soros disclosed that it had accumulated 4.8 million shares of Cabletron. The Soros fund declined to comment on its stake.
For much of the 1990s, Cabletron was a powerful player in the then-burgeoning business of network "hubs," powerful terminals that hook together computers and peripherals into one local network.
But by 1998, hubs were fast becoming obsolete, replaced by routers and switches that transmitted data faster and more efficiently across and between networks. While companies like Cisco grew into giants, Cabletron -- and its stock -- reeled.
So Cabletron began a tumultuous transition away from its hub business into more advanced routers. A management shakeup in early 1998 brought Mr. Benson in as CEO of the company he co-founded. The sales channel was revamped to focus more on working with resellers.
Manufacturing was outsourced. And the company embarked on a buying spree that would prove fortuitous later on.
Meantime, other competitors got swallowed up: Ascend Communications into Lucent in a proposed $20 billion deal; Bay Networks by Nortel for $7.68 billion; and most recently, Fore Systems, Warrendale, Pa., agreed to be acquired by Britain's General Electric Co. PLC for $4.5 billion. All the prices were much higher than Cabletron trades at today, based on the ratio of price to per-share revenue.
Fans think Cabletron's time will come, too. Meanwhile, they say, genuine improvements are taking place at Cabletron that should make it attractive in any form.
"We believe the company has been successful in correcting its problems and we forecast a significant breakout in sales and earnings this year," SunTrust's Mr. Becklean wrote in a research report last week.
One of the improvements bulls point to was the 1998 acquisition of closely held Yago Systems, which designs advanced routing devices. Cabletron is now selling Yago's "layer 3" switches, faster and less expensive devices that work especially well over Internet systems.
One rival maker of layer 3 switches, start-up Extreme Networks of Santa Clara, Calif., trades at a far higher multiple -- 22 times per-share revenue, based on yesterday's trading prices, compared with Cabletron's 1.7 -- even though Cabletron has roughly double the market share and revenue in layer 3 switches. Analysts say that on this comparison alone, Cabletron's stock should be accorded a higher valuation -- at least $20 a share.
"We believe the stock is undervalued at current levels both as an ongoing business and based on the value of its component businesses," Mr. Becklean wrote.
The fundamentals of the business are looking better, too, analysts say. Sales of the layer 3 switches are doubling the previous quarter's levels, and last week network industry watcher Dell'Oro Group reported that Cabletron captured 31% share in one segment of the layer 3 switch market in the first quarter, ahead of Cisco and Nortel.
After slipping 2% in fiscal 1998, Cabletron's revenue is turning up again, and is projected to grow 11% from fiscal year 2000 to 2001.
Another significant development: Cabletron has a new sales agreement with Compaq Computer to use Cabletron networking devices in the systems Compaq sells. The pact upgrades an earlier alliance to involve more of Cabletron's product line.
To be sure, not all analysts are convinced that Cabletron's moves will make it a better competitor or takeover target. Brendan Hannigan, an analyst with Forrester Research in Cambridge, Mass., says Cisco and Nortel will prove to be too much competition for Cabletron. What's more, he says, Cabletron is still too new to some of its markets to bring much value to potential suitors. "Cabletron doesn't help them a lot," he says.
But Mr. Benson, the CEO, says that being smaller makes Cabletron nimbler and potentially more innovative. He also notes the company has other successful product lines, including its network software, that will help it compete on many fronts.
"Cisco's a good competitor," he says, but the market is big enough that "Cisco can be successful and we can be successful without that being mutually exclusive."
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