Can 3Com Connect?

The networking company has reconfigured its product line, but its toughest customer is still Wall Street.


3Com Corp. CFO Mike Rescoe has his work cut out for him. He took over as finance chief of the Santa Clara, Calif.-based networking company in May, two months after it announced a massive plan to reorganize and shed underperforming units. The new 3Com will focus on networking for small to midsize companies, home Internet appliances, and broadband. His first order of business was to take the restructuring story to Wall Street, where he told of the company's focus on core competencies and growth opportunities. But some critics claim that this is one they've heard before.

The company once pursued a chunk of the high- end corporate networking market, but lost out to Cisco Systems Inc. It also acquired U.S. Robotics three years ago, and is now shedding it because of the pressures it put on 3Com's profit margins.

In the past, analysts have blamed false starts and slow decision-making for the company's stagnant sales growth. Complicating things further is the question of what 3Com will do without Palm, its crown jewel. It is generally agreed among analysts that the March spin-off of 6% of Palm made sense because Palm had grown into a business model entirely different from 3Com's. Yet they also agree that when the remaining 94% is distributed in July, 3Com will rid itself of the buoy that is keeping its stock price afloat.

Still, 3Com's management is confident that this time, things will change. Rescoe says the restructuring plan brings "dramatic simplification." The company will renew its focus on what Rescoe considers its two main strengths, manufacturing and distribution capability. It has sold its cumbersome analog modem business to Asian companies NatSteel and Accton. In addition to the small and midsize networking market and home Internet connections for consumers, the company plans to launch a line of home Internet appliances. The first device, which lets users check E- mail and their favorite Web sites quickly, is scheduled to be introduced this fall.

Analysts concur with the logic of these changes, but are reserved about predicting the turnaround that the management is heralding. "The restructuring is logical," says Martin Pyykkonen, of the San Francisco office of CIBC Oppenheimer. "But it's not enough in the sense that [the company] is still keeping a revenue base with growth issues-only 15 percent to 20 percent of its revenue comes from high-growth markets," such as DSL modems, LAN telephony, or cable modems. He also expresses only a lukewarm enthusiasm for 3Com's product line, putting it only in the "OK to good" range.

Charles Rutstein, senior analyst at Forrester Research, in Cambridge, Mass., says the company's simplification efforts, though laudable, are insufficient, and that the synergy among the remaining product lines is unclear. He is particularly skeptical of the broadband business's fit. "That should go. It doesn't make any sense," he maintains.

Andy Schopick of Westport, Conn.-based Nutmeg Securities, is also wary of being overly optimistic about the success of the reorganization. "The outcome is uncertain," he says. "With the distribution of Palm, 3Com becomes a company that is searching for market opportunities. [The restructuring] is a process that is going to take an extended period of time before we can measure results in any tangible way." Still, he remains confident in 3Com's fundamentals: "3Com is a company very rich and deep in financial resources, with an outstanding management team."

Indeed, in the effort to sell the new 3Com to investors, Rescoe is leveraging those rich resources, billing the company as a value play. He considers the company's $3 billion in cash, no debt, real estate properties, and dozens of investments in technology start-ups as evidence that the company is a solid investment in today's volatile market. But rich resources notwithstanding, tech companies are rarely seen as value stocks.

Are people buying it? CIBC Oppenheimer's Pyykkonen sees the label as spin- doctoring. "There's a school of thought that says the notion of a value tech stock is a contradiction. In other words, it means there's a problem." Schopick suggests that the company has far to go before it emerges as a real winner in the market: "It is a value play- -now. It has lots of cash, and investors recognize that it's not going to be profitable for a while."

Rescoe insists Wall Street is receiving the pitch warmly and sees 3Com's "large, unrecognized value." Yet 3Com's stock performance paints a different picture. Since the company announced its restructuring plans on March 20, when the stock closed at 68 1/2, it has fallen to the mid-40s to lower-50s range, and remains there today. Apparently, the Street needs convincing. "[3Com has to] keep swinging the ax," says Forrester's Rutstein. "They're not out of the woods yet."


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