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Will 3Com's new networking strategy hold up?

Free from its Palm handheld computing unit, the once formidable network equipment maker is recasting itself as a niche provider of gear and software for specific markets.

    3Com has officially hit the restart button.

    Free from its Palm handheld computing unit, as well as from Palm's associated valuation, the once formidable network equipment maker is recasting itself as a niche provider of gear and software for specific markets. But the question remains: Does the new strategy merit optimism?

    On top of spinning off Palm, the company has dumped its high-end business-networking operation and slow-growing analog modem business and is concentrating on three markets: consumers, small and medium-sized businesses, and carriers.

    Focus areas include wireless and home networking products, Internet telephony, cable and DSL modems, and new, forthcoming handheld devices like Web pads and Internet-based radios.

    As a result, the veteran company will have to prove itself once again, according to analysts.

    "They are a shadow of their former self. They very much stood in one place while the market has moved ahead," said Forrester Research analyst Charles Rutstein. "But they have a loyal client base, so in the markets they've chosen to continue playing, they'll probably do just fine. But those markets don't have the same growth rates and revenue opportunities as the larger networking market."

    The struggling networking company's market value tumbled by nearly $18 billion recently, after the official Palm break.

    3Com's share price fell from $65 to about $13, reflecting 3Com's worth after its separation from Palm. In the past week, the company's shares inched up to about $18.75, raising the company's market value from $4.6 billion to its current $6.6 billion.

    As proof of the changes at 3Com, Standard & Poor's recently dropped the company from its influential S&P 500 stock index and replaced it with Palm, whose shares are worth twice as much.

    3Com, however, aspires to play in a variety of emerging markets to boost its flagging stock and get the price back up to $37 to $54--the level company executives believe the stock is worth.

    After suffering from disappointing earnings and a year of flip-flopping strategies, 3Com reorganized recently in hopes of reviving itself.

    While 3Com is banking on see Q&A: 3Com president predicts company revival emerging businesses, analysts say the company is not in three of the hottest networking markets that rivals such as Cisco Systems, Nortel Networks, Lucent Technologies and others are fighting for: the "core" of the telecommunications carrier network, through which most Net traffic travels; metropolitan networks, or the building of fiber-optic networks within big cities; and Web switches, networking equipment that speeds Internet content to Web surfers.

    For example, start-up Web switch makers ArrowPoint Communications and Alteon WebSystems were recently snatched up by Cisco and Nortel for $5.7 billion and $7.8 billion, respectively--purchase prices nearly equal to or more than 3Com's current market value.

    Though 3Com has not entered the metropolitan networking market, it has invested in a metropolitan networking start-up called Atrica, giving 3Com a potential presence in what Rutstein believes is the industry's hottest area.

    Analysts, however, say 3Com finally has a focused business strategy--and still has a chance to succeed in the networking industry. But the company has to prove to investors that it can execute on its newest approach. It also remains a second-tier player--no longer the rival it once was to networking giant Cisco, analysts say.

    "The company still has very good brand recognition and a good sales channel," Rutstein said. "But they have retrenched from being an all-things-to-all-people networking vendor and are rapidly moving toward (becoming) a niche player."

    Analysts praise 3Com chief executive Eric Benhamou's mantra of "radical simplicity," giving the company's customers easy-to-use technology with all the See related newsmaker: Eric Benhamou features they need. But they have a wait-and-see attitude for the company, giving the stock lukewarm ratings of "accumulate" and "neutral."

    Analyst Tere' Bracco, of market watcher Current Analysis, said the company must prove itself in the next three to six months with new products and strategy announcements.

    "The company is far from dead, but it depends on whether they can make the case that 'radical simplicity' is not the dumbing down of vital devices, but actually a technology that does all the work a user or network manager needs," Bracco said. "If they do, then there's a lot of life left in the company."

    3Com spokesman Brian Johnson admits investors and analysts have a "show me" attitude, adding that 3Com executives intend to articulate a vision of a company on the right track.

    With two handheld devices coming out this fall, 3Com executives believe the company's consumer business should have the same valuation as Palm, which is currently worth around the $40 per share range.

    The rest of the company--which plays in many of the same markets as rival Cabletron Systems, such as business networking and the carrier market--should be on par with its competitor, Johnson said. In fact, to help pump up the stock price, 3Com is spending $1 billion of its $3 billion in cash to buy back its stock, he said.

    "We think we have taken the steps to focus the company and get back on track and for people to take a good hard look and reevaluate us," Johnson said.

    The company, which expects its next profitable quarter to be a year away, expects its carrier business to grow more than 30 percent and its consumer- and business-networking units to grow more than 20 percent in the next year.

    Analyst Chris Stix of Morgan Stanley Dean Witter believes the company will report better-than-expected revenue next quarter but values 3Com's stock at $25.

    "We're maintaining a neutral stance because the company's execution has been inconsistent," Stix said.