2HRS2GO: Cabletron benefits from resurgence

Cabletron Systems (NYSE: CS) picked up about 5 percent this morning following the network equipment vendor's decision to sell its DSL router unit, but beyond that immediate news perhaps the stock boost marks renewed investor belief in Cabletron's future.

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The market has been slowly returning to the stock: earlier this month Cabletron shares broke the $20 barrier; several weeks prior, they pierced the $15 line that had served as a ceiling since late 1997. Yet most analysts remain cautious about Cabletron; going into today, 13 of 19 analysts maintained the equivalent of a "hold" rating on CS shares, and one firm has a "strong sell" advisory on the stock.

Few network hardware companies have been held in such disregard as Cabletron. Consider: every time the company reported earnings this year, the stock fell, even though each of those three quarterly reports came in ahead of Wall Street estimates.

"Given the attractive valuation and the key growth products for the company, you could argue that it's not reflected in the fundamentals of the stock," says Erik Suppinger, analyst for Hambrecht & Quist, which has had a "buy" rating on Cabletron for the last few months, and a "Focus Buy" on the stock for the past six weeks.

Suppinger and the four other analysts who have some kind of "buy" recommendation on CS were joined this morning by Tim Luke of Lehman Bros. Luke upgraded Cabletron to "buy" from a "neutral" rating and raised his earnings estimates to 35 cents per share from 33 cents for fiscal 2000, and 73 cents from 66 cents in 2001.

"We believe increased momentum in the company's growth segments are improving while older legacy shared media products have declined to a minimal 4 percent of sales," write Luke and associate Mark H. Sue.

Software, services and DSL products should add even more to the top and bottom lines. Lehman's analysts predict Cabletron to top the First Call consensus estimates for net income and revunue in the fiscal third quarter. Luke and Sue also expect Cabletron's orders booked to exceed orders billed, meaning stronger growth in the future.

Driving Cabletron's growth are its SmartSwitches, the market share leader (measured in units shipped) in the field for "Layer 3" communications switches, Suppinger says. Cabletron routers based on that SmartSwitch technology more than tripled revenue year-over-year in the latest quarter reported. And selling FlowPoint for $861 million in stock of Efficient Networks lets Cabletron focus on its own core businesses while maintaining a stake in the DSL field.

A year ago Cabletron was in the midst of a steep decline as the company struggled to move into the new world of networking. The turnaround seems to be far along, but investors haven't been completely convinced yet -- today's initial burst for CS deflated rapidly, with the increase for the session falling from more than 5 percent in the morning to about 3.5 percent by early afternoon.

Valuation might be catching up to Cabletron, with the stock now trading at more than 35 times estimated 2001 earnings. Not much of a bargain -- except compared to other network equipment vendors.

It's in the game, and the game is spreading

Today's stock price surge for Electronic Arts (Nasdaq: ERTS) didn't happen because of its sponsorship of last night's WCW Mayhem pro wrestling show (well-done main event, incidentally, assuming you're into characters nicknamed "The Hitman" and "The Canadian Crippler"), but you could say that investors are happy about EA's growing ubiquity.

Already the biggest vendor of game software, Electronic Arts announced a deal that makes it the ruler of the America Online (NYSE: AOL) gaming universe. EA also unveiled plans to sell tracking shares for an online division.

Leaving aside the rip-off potential of tracking stocks -- basically a way to get investors' money while offering few or no ownership rights -- EA's moves appear smart on the surface. The company has some online gaming experience with the Ultima Online franchise, and plenty of other popular brand names to leverage into Internet games. Online entertainment provides a steady revenue stream, since it typically involves toward monthly subscription fees. And AOL remains the leading distribution platform on the Internet.

But online gaming is a tricky thing; much of Ultima Online's success came because it had almost no competition when the game debuted two years ago. Now the Internet field is becoming crowded not only for massive, time-devouring enterprises such as role-playing games, but also for shorter wargames, puzzles and action shoot-'em-ups. Many of them can be played for free on places such as Battle.net and MSN Zone, which is one reason why AOL's gaming efforts have produced mixed results so far; why pay a monthly fee to shoot people on AOL's proprietary service when you can pop a copy of StarCraft or Quake III into your CD-ROM drive and find an opponent on the Internet?

Online gaming could also be a lower margin business than the traditional software field, because Internet games require constant network maintenance and customer support. Companies in the field so far haven't released earnings figures for online projects, because none of these efforts have produced any profit worth mentioning.

Don't overlook the not-inconsequential question of quality. I had an Ultima Online account for more than a year-and-a-half; it was a great game for its time, but also maddeningly flawed and buggy, even by software industry standards. EA could get away with that two years ago, but the competition has gotten much better. That's why I don't have an UO subscription anymore. 22GO>