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3Com pins its profit hopes on new markets

With the upcoming spin-off of its profitable Palm division, 3Com's future success rides on a handful of emerging technologies that so far aren't adding much to its bottom line.

With the planned spin-off of its profitable Palm Computing division, 3Com's future rides on a handful of emerging technologies that so far aren't adding much to its bottom line.

3Com chief executive Eric Benhamou conceded as much yesterday as the networking firm surprised Wall Street with a big first-quarter profit by cutting costs--not by increasing product sales.

Overall revenue dipped slightly and is expected to do so again next quarter as the company continues its transition from traditional products to new technologies. Products like analog modems and networking cards that have experienced slow sales are being set aside for those in the growing wireless networking, Internet telephony, and cable and digital subscriber line (DSL) modem markets.

But with Palm set to become an independent company, 3Com will face pressure to start making money with its new projects. The soon-departing Palm unit now makes up more than 13 percent of 3Com's revenues.

"The half a dozen major, high-growth, emerging areas where we have made a concentration of investments are beginning to show some results, but this is not enough to stimulate the top line," Benhamou said in a conference call with financial analysts yesterday. "The investments we've made need to begin to pay off."

Analysts say 3Com is smart to target these nascent markets, but its prospects rest solely on the company's ability to execute its strategy. 3Com faces stiff competition from other networking firms, such as Cisco Systems, Intel, and Lucent Technologies, which are also gunning for the same new markets.

The next six months will show whether 3Com can capture enough ground to grow its revenue, analysts say.

"Right now, they've done a terrific job of cost cutting, but at the end of the day, their value requires revenue growth," Forrester Research analyst Charles Rutstein said. "They're looking at those potentially profitable markets, but they're currently up for grabs. Cisco and Intel would very much like those markets as well, so there's no guarantee that by simply targeting those markets, they will be successful."

Fishing for profits
3Com predicts that sales from new products will have a significant effect on the company's revenue by the second half of the fiscal year.

3Com executives said revenue for the second quarter will increase less than 10 percent from the first. Sales will decline from year-ago levels, as the company embarks on a major advertising campaign to tout 3Com and Palm products. But the company expects things to pick up in the third and fourth quarters.

Forrester's Rutstein believes that 3Com will do well but won't become a leader in the networking market. "They will succeed with varying levels in the next three years, but they will not dominate any of them, nor will they be dominated," he said.

3Com already sells Internet telephony products to small businesses and DSL and cable modems, and will enter the home and wireless networking markets this fall. 3Com plans to partner with Microsoft to ship home networking kits that allow consumers to connect PCs and other peripherals together to share files and Internet access at home.

Yet analysts questioned 3Com's entry into the market for phone calls over the Internet, or Net telephony. The nascent technology, which combines voice and data on a single network, may not be adopted on a large scale until products and service quality improve.

Steven Frenkel, a financial analyst for Joseph Stevens, said 3Com may suffer by spinning off its lucrative Palm unit and focusing on its networking core.

"They've got bigger and stronger competitors. They're not the first to innovate in those markets nor are they first to the markets," Frenkel said.

Frenkel believes 3Com is shedding its Palm unit so it can focus on the possible sale of its networking business to a telecommunications equipment firm. But Benhamou hinted in yesterday's conference call that no buyout is in the works.

"The announcement we made regarding Palm is not a prelude to anything else," he said.