Networking stocks may be returning to the high life.
Donaldson Lufkin & Jenrette today raised its rating on 3Com (COMS) to "buy" from "market perform." Last week, Bay Networks (BAY) was picked up by Deutsche Morgan Grenfell with a "buy" rating, and Oppenheimer & Company initiated coverage on Ascend (ASND) with a "buy" rating.
DLJ analyst Steve Koffler said the upgrade of 3Com does not necessarily signal that the sector as a whole has improved. But a handful of networking companies have seen their stocks pull up off December and January lows.
Analysts say the establishment of a modem standard, combined with bright future business prospects, are boosting investor confidence in the networking sector. The companies also benefit from a favorable swing for tech stocks in general, as the Nasdaq market has gained 11 percent since the New Year.
Ascend, which has a 52-week high of 60, was down as low as 22 in December. Today it closed at 34-5/8. 3Com, which had a year high of 59-11/16, fell to 29-7/8 in January. Today it closed at 37-11/16. Bay, with a 52-week high of 41-7/8, fell to 24-1/8 in December before rebounding today to a close of 30-3/8.
Koffler explained that 3Com is at the tail end of its downside, and noted that the uncertainty surrounding the company "is more or less removed." 3Com had reported an 87-percent drop in second-quarter profits, which it attributed to excess inventory from its modem business and its shift to a new product line.
Other problems included lower earnings from the economic troubles in Asia and a shareholder lawsuit that alleged certain executives misled investors about demand for 3Com products acquired through the company's merger with US Robotics.
Koffler said the new product line that once was a drag on earnings should be a catalyst for the company going forward.
That product news is company-specific to 3Com and does not mark a trend for industry growth overall, he said, noting that while some networking stocks have shown improvement, there has not been a fundamental change in the activity of other companies in the sector, like Cisco Systems (CSCO) and Bay.
Michael Graham, an analyst at Raymond James & Associates, agreed that the latest upticks do not indicate a sweeping improvement in all networking companies, but rather a selective advance. A large amount of uncertainty continues to linger for these companies, he said.
Asia is still a concern, and people are wondering about the next evolution of the network, he explained. Today most information transmitted over networks is voice and data, but in the future, it will be multimedia. Consumers will need to have multimedia-enabled lines that can handle this dense information in a speedy manner, he said, which provides a growth opportunity for some companies.
Indeed some in the networking field are trying to nudge their way into the growing data networking market by partnering with smaller companies focused on the latest technology--companies that aren't being held back by existing customers.
"One thing helping these stocks is speculation on how they will get in on this new business," Graham said.
In February, Bay Networks finalized its $37.6 million equity investment in NetSpeak (NSPK), a maker of IP (Internet protocol) telephony technology. The companies will team to build new networking systems for handling voice and fax services based on IP.
"Bay appears to have successfully brought to market a full line of switching products, in both the low and high end, to sustain its recovery," said a recent Bear Stearns report. "In our view, with expanded product offerings through acquisitions and internal development...Bay has made significant progress in gaining customer acceptance as a potential source of networking solutions."
ATM LAN switch, ATM WAN switch, and LAN switch segments were predicted by Merrill Lynch to be the fastest-growing data networking markets in 1998. The brokerage firm estimated also that those three segments account for 33 percent of Cisco's revenue, 84 percent of Fore Systems' revenues, and 34 percent of Bay's revenues.
"These companies are well-positioned to continue to benefit from growth in these markets," Merrill Lynch's recent report said.
Other companies are likely to benefit from the 56-kbps modem standard, Graham said.
Bay Networks, for example, said about a week ago that it has completed testing of the new standard for high-speed 56-kbps modems and will begin offering remote access supporting the standard next quarter. In mid-February, 3Com became the first vendor to ship a modem based on the standard.
One exception to the favorable stock movement is Cabletron Systems (CS). The company said this week that its quarterly revenue will drop below year-ago levels due to a shortfall in sales for some parts of its business.
Cabletron's stock, which has a 52-week high of 46-1/2, is trading near its year low at around 14 a share.