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Bottom line for Cabletron's reworked Compaq deal uncertain

The giant PC manufacturer says it will make an equity investment in Cabletron's Spectrum software unit, but the struggling networking equipment maker agrees to cancel a reselling agreement.

Cabletron received both good and bad news from sometime partner Compaq Computer today.

The giant PC manufacturer announced it will make an equity investment in Cabletron's Spectrum software unit, but at the same time, the struggling networking equipment maker agreed to cancel a reselling agreement and may lose at least some portion of a revenue windfall. Compaq was on the hook to buy $300 million worth of Cabletron networking equipment a year, according to a deal signed earlier this summer.

The PC maker was planning to resell Cabletron products under its own name, but asked to get out of the agreement after deciding to move away from the networking business, Cabletron executives said.

Analysts had considered the deal vital to Cabletron's health because it would have represented more than 20 percent of the firm's $1.4 billion in annual sales. But Cabletron executives say they're not afraid of losing the guaranteed revenue and believe the revamped agreement allows the company to recoup the money--and possibly make more.

In exchange for dropping the guaranteed contract, Cabletron will receive a multimillion-dollar investment in its Spectrum network management software unit, according to one source close to the company.

Meanwhile, Compaq's professional services unit will continue to sell Cabletron's networking equipment, this time as a "preferred partner," Cabletron executives said. For the first time, Compaq will begin selling Spectrum software.

Cabletron made $50 million to $60 million this past quarter through the resale agreement with Compaq, and expects to do so again in the next two quarters.

"The money will still come in," said Romulus Pereira, Cabletron's chief operating officer. "We see flatish results for a couple of quarters, but we see 'upside' opportunities."

Some analysts weren't so sure about making up for the loss in guaranteed revenue. Compaq has been increasingly disinterested in selling networking equipment, said Craig Johnson of the Pita Group, and follows IBM as the second big systems vendor to recently back out of the market.

In this climate, Cabletron will have to find new ways to sell its networking products, Johnson said.

Cabletron chief financial officer David Kirkpatrick said the company is gung ho about the revised deal because, as a preferred partner, Compaq will now refer customers to Cabletron's equipment. That positions Cabletron to better compete against Cisco, also a Compaq preferred partner, he said.

Cabletron further gains improved access to a special niche of Compaq customers--buyers of Digital Equipment networking equipment--Pereira said. In late 1997, Cabletron bought Digital's networking equipment division with the requirement that Digital would sell more than $1 billion worth of Cabletron equipment over three years. Compaq inherited the deal last year when it purchased the remainder of Digital.

Now, Cabletron can sell directly to the former Digital's base of customers, which it couldn't previously do. Historically, customers spent $500 million to $600 million a year on Digital's networking equipment, Pereira said.

The revised deal comes on the heels of Cabletron's successful second-quarter earnings announcement, in which the company beat Wall Street estimates by one cent. Cabletron earned $12.5 million profit, or 7 cents per share, on revenue of $356.6 million.

Also today, the company said it is considering spinning off its growing digital subscriber line networking equipment business, which has leapt from $4 million in revenue in 1999 to $20 million in the first six months of fiscal year 2000. The company previously announced plans to spin off its Spectrum unit, which makes software that allows businesses and service providers to monitor the health of networks.

Cabletron executives suggested the decision will be influenced by how the DSL unit performs in the next quarter or two. Fitzpatrick cited the large market-capitalization figures of its DSL competitors, such as start-ups Copper Mountain and Redback Networks, as proof it could work.

"We've been one of the leading providers in the DSL marketplace," Fitzpatrick said. "And it's an untapped value for Cabletron."

Analysts say the two announcements are part of Cabletron's efforts to rebuild itself into the powerhouse networking firm it once was before Cisco, Nortel Networks, and others stole market share.