3Com stock slides on move away from NICs and modems

By Jim Duffy
Network World Fusion, 06/25/99

On the heels of a better than expected fourth quarter, shares of 3Com dropped almost 14% on Wednesday after the company said it would attempt to transition much of its business away from low-margin, price-sensitive network interface cards (NIC) and modems.

During a conference call with Wall Street analysts this week, 3Com said it would begin to cut about 20% of its revenue mix away from NICs and modems in fiscal 2000. NICs and modems have been 3Com strongholds, accounting for 45% of the company fiscal 1999 fourth-quarter revenue of $1.4 billion.

However, 3Com wants to rely less on these products for future growth. The company instead hopes to derive 75% of its revenue from other areas - switches, routers, remote access concentrators and hand held devices such as its PalmPilot - while drawing 25% of sales from NICs and modems.

"As we enter fiscal 2000, rapid growth of emerging new businesses such as handheld computers, IP telephony and broadband access, coupled with success of our systems solutions, are transforming the growth profile of the company," Eric Benhamou, 3Com chairman and CEO, said in a statement.

3Com's fourth-quarter earnings came in 1 cent per share better than analysts expected. The company recorded net income of $88 million, or 24 cents per share, which is 38% better than fourth-quarter 1998 earnings of $63.6 million, or 17 cents per share.

Sales were up only 3%, though, from the fourth quarter of fiscal 1998 - $1.42 billion, compared to $1.38 billion for the year ago period. Analysts say revenue growth will be even tougher in the next four or five quarters as 3Com relies less on sales of NICs and modems.

"My concern is that technology transitions are difficult enough without being forced into it," says David Takata, an analyst at Gruntal & Co. in Beverly Hills, Calif.

"This is really being forced upon them by a changing market - the sub-$1,000 PC, extreme price pressures and slowing growth in some of those business units," Takata says. "The company has a fairly aggressive plan, and I think it's going to be pretty difficult to manage their expense-to-revenue ratios during that period of time."

Gruntal has downgraded its recommendation on 3Com from "strong buy" to "hold."

Similarly, Warburg Dillon Read (WDR) in New York is reiterating its "hold" recommendation on 3Com despite the company's 38% increase in net income from the fourth quarter of a year ago, and a 3% increase in revenue.

"We believe that the company will face several tough quarters ahead as sales in the client access area continue to be a struggle due to the declining revenue outlook in the NIC and modem businesses," WDR said in a research letter. "While the PalmPilot has a been a terrific product for the company we believe that 3Com is in desperate need of some other 'hot' products where growth can be sustained for several quarters that can help offset the expected decline in the client access area."

Some of those 'hot' product areas 3Com is focusing on include voice over IP, broadband access - cable modems, xDSL and wireless - LAN telephony and home networking. However, "we do not have enough confidence that any of the product areas can be substantial and consistent contributors to growth over the next several quarters," WDR says.

For fiscal year 1999, 3Com posted sales of $5.8 billion compared to $5.4 billion in fiscal 1998. Net income was $403.9 million, or $1.09 per share, compared to $30.2 million, or 8 cents per share in fiscal 1998.