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3Com: It's a Palm, Palm world

The networking technology provider is charting a course that largely depends on the success of its Palm Computing division to drive sales of its other higher-margin products.

    SAN FRANCISCO--Struggling 3Com may have either latched its future to the next big thing in computing or doomed its fortunes faster than a future wireless version of its PalmPilot will connect to the Net.

    The networking technology provider is charting a course that largely depends on the success of its Palm Computing division to drive sales of its other higher-margin products, such as its networking devices for small and medium-sized businesses and remote access hardware.

    "Palm has a very central place in the future because not only does it illustrate what we stand for very nicely, but also it's a very successful business," said Eric Benhamou, 3Com's chairman and chief executive, in an interview with News.com.

    But unlike a company such as Microsoft, 3Com can ill-afford to make strategic blunders and fight battles on multiple fronts. Redmond can fiddle with various side businesses like Internet content, knowing that sales of its core operating system will continue to drive profits. 3Com, however, doesn't have that luxury.

    Benhamou said 3Com currently has too much revenue coming from mature businesses.

    The firm derives 45 percent of its sales from older niches, like networking cards, and another 45 percent from existing growth businesses, like network switching. Yet only 10 percent of the company's revenue comes from emerging opportunities, the chief executive said. Looking ahead, Benhamou said he wanted 3Com's so-called mature products to account for only 25 percent of revenues.

    At stake here is the future of 3Com, which was once thought to be a toe-to-toe competitor to industry titans like Cisco Systems, the Bay Networks arm of Nortel Networks, and Cabletron Systems. As Cisco got bigger and Bay got bought, 3Com just tread water, seemingly unsure of which direction to go.

    While 3Com's rivals jump into the telecommunications equipment fray, the company is focusing on the consumer market as it attempts to shed its mature businesses in favor of emerging opportunities.

    The result will likely be a far different 3Com. The company plans to utilize its lead in handheld computing devices to emphasize other technology, similar, Benhamou said, to the way Sun Microsystems used its Java programming language to drive sales of its back-end systems. The company has even struck aggregation deals with Net content providers and plans to gain revenue from Web advertising in a bid to attract a wider audience to its PalmPilot technology.

    "We're the only one that has really connected users. This is really what the soul of the company is about," the chief executive said. "And you're going to see this more and more in how we choose to position the company and how we choose to orient the future of our business."

    At one point during the executive's News.com visit, Benhamou even pointed to one part of the PalmPilot interface and said: "This is worth $25 million" to advertisers. To illustrate his point further, the executive went to a white board and drew a chart of possible rates for various types of ads, pointing to them as 1-cent, 25-cent, and $1 revenue opportunities--a striking pose for a veteran networking player.

    Wall street fallout
    3Com has been on a roller coaster ride since early 1997 when the firm's stock plunged during a price war with Intel over adapter and network interface cards. The troubles also coincided with company's purchase of US Robotics, the genesis of the company's Palm-oriented evolution.

    3Com stock chart The stock has fluctuated following a series of inventory problems and sales concerns, yet jumped early this year amid speculation that numerous players might be interested in the company, including Lucent Technologies and Siemens.

    The chief executive, however, refused to comment on the acquisition rumors concerning 3Com. He also dismissed the notion that 3Com would spin off its Palm division.

    As a measure of the company's plight, 3Com has a market capitalization of more than $9 billion after 20 years in the networking business. Yet Net newbies like Yahoo and Amazon both have valuations of more than $25 billion.

    To remedy recent woes, 3Com has said it would reduce its investment in mature businesses, such as client access, analog modems, and mobile networking card groups, and focus on emerging growth opportunities in home networking, broadband access, and Internet-based voice technology.

    A great day for baseball at Palm Park?
    3Com's strategy was once thought to be similar to that of Cisco and the former Bay Networks, focusing primarily on technology for the development of large firms' internal networks.

    Cisco has since extended its focus to include telecommunications equipment, while Bay Networks was bought by Canadian phone equipment giant Nortel.

    But Benhamou says the public network, where huge switches route voice and data transmissions across vast distances, is where 3Com's business abruptly halts.

    "We have never really focused on the core carrier infrastructure," Benhamou said. "All of the consolidation that has taken place over the past couple of years--and there's been some pretty big ones--have focused on the core carrier infrastructure. I understand why they are taking place: Because there are big bucks there.

    "When people say, 'Oh yeah, but you can't compete against Nortel and Lucent and so on.' Well, it's the wrong question to ask," Benhamou noted. "There's presumption that we want to compete against these people and we do not."

    In the Palm of 3Com's hand
    Though 3Com's Palm focus may throw off some of its traditional advocates, some view the business--and its associated perks--as another example of the rapid change the Internet has wrought.

    Because PalmPilots have dominated the handheld market, analysts believe 3Com stands a good chance at succeeding. A recent study by Research firm Computer Economics said 3Com's market share will grow from 54 percent in 1999 to 60 percent in 2003, while the Microsoft Windows CE platform will grow from 8 percent to 18 percent during the same period.

    Analyst Esmeralda Silva, an analyst with market researcher International Data Corporation, believes Palm-related revenue, which currently accounts for 10 percent of 3Com's more than $6 billion in annual sales, can increase to 30 percent. But 3Com executives believe the Palm strategy won't impact overall revenue for at least a year or two.

    The question is whether that's soon enough for Wall Street.

    Gruntal & Co analyst David Takata thinks investors will show patience, as long as 3Com's revenue continues to grow during the transition, he said.

    "As long as they can show growth, the Street will show interest. Why is Amazon.com or Yahoo trading at ungodly multiples? Because people are saying at these growth rates, earnings will be there in a few years," he said. "Investors are smart enough that if the Palm becomes ubiquitous and captures the platform sales, then there's upgrade cycles and all that over time."

    But analyst Scott Heritage of Warburg Dillon Read doesn't foresee good revenue growth in the short term. Until Palm sales and 3Com's other new efforts in IP telephony, broadband access, and home networking products become a bigger chunk of 3Com's overall revenue, the company will have a tough time financially, he said.

    "Palm's a big part of 3Com's future, but the company will have a rough time for the next six months to a year," Heritage said. "Revenue growth is not going to look stellar."

    For the Palm strategy to succeed, Takata said 3Com has to be more aggressive in licensing Palm to clonemakers, such as Ericsson and Nokia, to make it more ubiquitous. So far, 3Com has licensed Palm technology to a handful of vendors, including IBM and Qualcomm, which is building a smart phone with Palm capabilities.

    The executive says 3Com will need time to extricate itself out of its current plight and align a strategy that makes sense to the industry and Wall Street. "It will probably take us more than a year and less than two to have the right mix of businesses between high-growth businesses, existing growth businesses, and mature businesses," Benhamou said.

    "If we just let Darwinism take its course, it will probably take us two to three years," the chief executive said. "The faster we do this, the quicker we'll get back up.

    "Two years ago, when we first got in the Palm business, you could ask, "Well, what is it doing here?" Today there is no question. Palm is a networking play."