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Three strikes for 3Com?

Even as the networking firm moves to refocus its business model, the company's financial woes may reinvigorate rumors that it's ripe for a takeover.

4 min read
It seemed like a good idea at the time: Put the 3Com name on a high-profile ballpark to bolster the company's position in the often esoteric networking market.

San Francisco's 3Com Park, however, is emblematic of deeper woes at the company, representing a consumer-focused albatross that has weighed heavily on 3Com's fortunes.

The company announced yesterday that earnings for its current quarter would fall well below expectations, prompting executives to shift the company's strategy away from its classical strengths in networking cards and modems.

3Com's woes should reinvigorate rumors that the company is ripe for a takeover. One potential suitor--French telecommunications equipment giant Alcatel--would appear to have little need for 3Com as it continues with its own ambitious acquisition binge.

But Siemens, another European firm with close ties to 3Com, still remains at the top of the potential suitor list--underscoring the changing dynamics in the networking industry. These dynamic shifts could also alter 3Com's future plans for its potentially lucrative businesses.

Most analysts estimate that about half of 3Com's business comes from consumer-oriented products, such as networking cards for PCs, modems for Internet connections, and the company's PalmPilot line, which 3Com inherited when it acquired U.S. Robotics two years ago.

The other half is derived from 3Com's strength in networking equipment for small and medium-sized businesses, remote access devices, and emerging opportunities.

Most of the money and margins in networking is found in high-end products for phone carriers and service providers--a market where 3Com lags behind rivals such as Cisco Systems, Nortel Networks, and Lucent Technologies.

3Com has attempted to tackle these firms head-on with its Siemens' partnership, as well as with its focus on the so-called edge of the network--connecting PCs and systems that feed into large carrier networks. 3Com has said it will leave the high-end of the networking market for others to take on--a rapidly expanding opportunity company chief Eric Benhamou has predicted will result in "a very violent clash."

But this game plan has left 3Com more susceptible to consumer whims.

"It's been obvious to me for a long time that 3Com doesn't have a very good strategy," said Joel Achramowicz, financial analyst with Preferred Capital Markets. "They want to dominate the edge of the network? That doesn't make any sense."

"It's a company that's mired in these low-margin businesses," he added. "They really need to establish a position in a market and dominate it. They did that with networking cards, but that's a dead business."

PalmPilot plans
One consumer asset most analysts are bullish on remains the company's Palm technology, a niche that 3Com dominates despite encroachment from a variety of players, including Microsoft and its hardware partners.

3Com could choose to break out the Palm business into a separate company, thereby allowing the parent firm to re-focus its efforts on the high-end markets. But analysts said such a scenario is unlikely given the success of 3Com's Palm division.

"It's not hurting them, they have 40 percent of the handheld market," said Steven Frankel, vice president at investment banking firm Joseph Stevens & Company. "It's a plus, a source of potential tremendous growth for them."

In other low-end areas, 3Com may be feeling the pinch that has already hit PC makers, amid rapid price drops in the computer market, according to some. Since 3Com's technology often plays an integral part in the sale of a PC, it could be affected by the sways of that market, unlike competitors such as Lucent or Cisco.

To counter 3Com's low-end vulnerabilities, Frankel floated the idea of a more direct sales model, akin to successful PC player Dell Computer. "[3Com] can become the Dell of networking. That's how you have to fight this thing," he said. "You customize, turn over inventory quickly, respond to customer needs more quickly and engineer their needs into solutions quickly."

But market realities remain. "You've got a fundamentally price-sensitive, decreased margin business," said Martin Pyykkonen, a financial analyst with CIBC Oppenheimer. "The problem for 3Com is that half of the company is in commodity businesses and the other half is in systems."

This was not part of an altered strategy discussed yesterday by the company, however. In the aftermath of the sales shortfall, 3Com executives articulated a slightly new focus targeted at six businesses: handheld computers, telephony products, broadband access devices, home networking systems, wireless hardware, and storage area networks.

Those niches, 3Com executives said, will complement the company's current thrust into corporate networking--a come-from-behind play that could reap rewards for the firm going forward. But for some, 3Com's confusing array of technologies could hamper its overall focus.

"3Com is in a tough position, its business is rapidly changing," said Greg McClenon, an analyst with Moors & Cabot. Data communications devices have become a "commodity" with very low profit margins, he noted.

Meanwhile, high-end telecom equipment like that produced by Cisco and Lucent continues to post high margins, but this market is outside 3Com's traditional strength, he added.

3Com's claim that an industry slowdown could be in the works may also hold some weight. Networking specialist Fore Systems quietly announced last week that its sales could also lag forecasts for its current quarter. But that hypothesis has not been reflected in current estimates from high-end players like Cisco and Lucent.

Furthermore, some analysts say they have heard that excuse from 3Com before when the company has missed estimates.

In conjunction with the expected earnings shortfall, 3Com announced that Doug Spreng, senior vice president of the company's client access business unit, will leave his position in June. Jeff Graham, currently vice president and general manager of 3Com's mobile communications division, will replace Spreng. Spreng will be retained to work on various company strategies.

News.com's Wylie Wong and John Borland contributed to this story.