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Is 3Com out of step with rivals?

Industry competitors are zeroing in on convergence equipment for voice and data networks within carriers.

As 3Com ekes out another quarter of tepid growth in the aftermath of inventory issues--closing the books on a tumultuous fiscal year and the mammoth purchase of US Robotics--its competitors have started to zero in on providing equipment for the convergence of voice and data networks within carriers.

So where does this leave the second-largest data networking company in the market?

The company's core strength has classically been in networking cards and low-end equipment that allows small and midsized businesses to connect their computers. The addition of USR brought a wealth of remote access technology, from client-side modems to back-end remote access equipment used in service provider settings.

3Com now offers wide area networking technology for the carrier market made up largely of third-party equipment garnered via a partnership with Newbridge Networks and Siemens.

Meanwhile, several shifts are taking place in the networking sector. The recent announcement of the proposed Bay Networks and Northern Telecom merger, along with increased focus on data by Lucent Technologies and on voice by Cisco Systems leaves 3Com in various commodity businesses that are facing declining profit margins.

In the past year, 3Com has been one of several victims of price wars, geographical economic uncertainties, and unpredictable spending patterns. Its stock trades at far below its 52-week high of nearly 60 per share. In addition, the networker also has had to deal with internal inventory issues that have affected its quarterly revenue projections, leaving Wall Street concerned about management's performance.

3com announced earnings that barely beat expectations for its fiscal fourth quarter at the close of the market today.

The industry moves already made do not even take into account the growing interest in data from international telecom equipment providers such as Ericsson, NEC, Fujitsu, and Alcatel Alsthom. All of these behemoths are rumored to be in the market for data-focused companies, especially in the aftermath of the Nortel deal.

"In a lot of ways, 3Com is stuck in a 'me-too' world," noted Ray Keneipp, analyst with market watcher Current Analysis. "I think they've got a tough road ahead of them and it's getting tougher every week."

The company faces many challenges in the carrier market, as well as its obvious target--corporate networks--where they have to duke it out with giant Cisco Systems.

"They aren't in a good position to tackle the carrier space except for their strength in remote access," noted David Passmore, president of industry consultants NetReference, of 3Com. "They can only sell carriers one piece of the puzzle."

A recent Goldman Sachs report compounded the company's awkward positioning: "Providers of wide area data networking equipment are key beneficiaries of technology trends, as the proportion of data traffic in the public networks continues to grow and as telecom equipment suppliers increasingly are pressured to provide solutions addressing both voice and data traffic."

The numbers tell the story of 3Com's current plight. Revenue in the shared hub device and local area switch market dropped from the fourth calendar quarter of 1997 to the first quarter of 1998, according to market researcher the Dell'Oro Group. Meanwhile, revenue in the same market for Cisco grew from nearly $590 million to more than $740 million.

A similar study focused on the local area switch market completed by Dataquest found that while 3Com's share of the market fell from 16.3 percent of the total market to 13.9 percent from the first quarter of 1997 to the same quarter this year, Cisco's percentage of the market expanded from 30 percent to nearly 43 percent. Both companies experienced growth in the sector due to high interest in the technology segment.

"They're going the wrong way," Keneipp said. "They're under attack from all sides and they're only getting weaker."

Moreover, corporate networking is by no means a guaranteed growth engine at the moment.

However, chairman and chief executive officer Eric Benhamou said his firm is uniquely positioned--with unparalleled strength at the client "edge" of the network inward--to take advantage of current trends. "We focus on creating connections," he said.

At the point where a network spews into the public carrier infrastructure, that is where 3Com stops competing and starts to partner, according to the chief executive. In the case of the Siemens deal, Benhamou said the two companies have already completed $250 million worth of mutual business, and he compared the nature of the partnership to the close ties enjoyed by Intel and Microsoft, often referred to as the "Wintel" duopoly.

Benhamou further noted that the size of a combined Bay and Nortel does not worry him and the specter of Cisco in the carrier equipment market will only lead to what he termed "a very violent clash" between the data giant and entrenched telco-oriented competitors such as Lucent.

Some remain hopeful that 3Com can reinvigorate itself in other sectors, including in-home networking and the successful PalmPilot handheld. "They've got other areas they can grow rather than doing what everyone else is trying to do--that is, selling to carriers," Passmore said.