2HRS2GO: Silver lining lies beneath Xircom cloud

You can build a good amusement park ride based on the latest three month chart of Xircom (Nasdaq: XIRC) stock.

Passengers would ride their cars to a gradual peak about 40 percent of the way through, with a few false drops thrown in before a long, fast slide culminating in a cliff-like plunge at the end. They'll take a few moments to collect their breath, trade a few laughs and then head down a long path past a strategically placed trinkets vendor hoping to pick up some of the visitors' loose coins that didn't fall during the ride.

Have an opinion on this?

Xircom shareholders have lost plenty of change in the last seven weeks. The maker of cards and other network access products mobile devices has lost nearly half its market value since reaching a record closing high of 75 at the end of December, with the plummet accelerating in the last two days. As of early this afternoon, Xircom stock sat 25 percent below Friday's close.

Investors have such fragile psychologies these days. Analysts this week lent credence to the revenue worries dogging this stock for the last couple of months. SG Cowen's Christopher Stix, CS First Boston's Paul J. Weinstein and Advest's Michael Whitney each warned of a slow start to Xircom's fiscal second quarter, which ends Mar. 31.

Stix and Whitney expect Xircom to report sales slightly below their original estimates. Weinstein said Xircom could still meet the $130 million to $133 million range, but he left a bit of wiggle room below that. None of the three analysts expect much deviation from their EPS forecasts, though Whitney did reduce his per-share earnings estimate by a penny.

So analysts tweaked their numbers a bit. They blamed Y2K for weakening demand early in the quarter.

That's all it took to cream this stock.

No wonder Whitney cut his price target to $63 per share from $83. Xircom's long-term fundamentals haven't gotten worse -- they may have even improved -- but clearly the market never strongly backed a high premium for the stock to begin with. In retrospect, that Dec. 31 price of 75 looks more like an anomaly. "I didn't think that kind of multiple premium would be supported by the market anymore," Whitney says.

But that doesn't mean Xircom deserved a 25 percent drop either.

"It's totally overblown, to be honest with you," says the Advest technology analyst, who still has a "strong buy" rating on XIRC. "I think we've seen the worst today. I think it trades sideways until mid-April, but as the company posts the kind of growth we're looking for, the stock will start to rebound."

Once the the first three months of this year are past, Xircom should see year-over-year growth of 20 to 25 percent every quarter, Whitney believes. If that seems slower than in past quarters, remember: Xircom was climbing out out of a hole in 1998. The company solved its problems, but that also means this year presents tougher comparisons.

It's the kind of problem a lot of companies would enjoy having.

CS First Boston's Weinstein notes Xircom is still gaining market share. Cahners In-Stat data indicates Xircom cut into 3Com's lead in combination modem/LAN cards, pulled ahead of 3Com in Ethernet cards, and widened its lead over 3Com in combination Ethernet/modem cards.

There have been some quiet rumblings that as sales of laptops slow, Xircom's growth will slow with it. But Whitney believes Xircom is well-positioned to feed the entire market for mobile Internet access, whether through laptops, notebooks, Web appliances or whatever. Weinstein notes Xircom's non-PC card business should meet the company's target of 25 percent sequential growth. Both Weinstein and Whitney point out Xircom has a line of wireless products on tap.

Everything comes down to this: Xircom's overall picture hasn't worsened from three months ago. There's a strong chance it will look better three months from now. So what's the market's problem?

Other issues:

Gateway

(NYSE: GTW) I'm sure the company can meet its goal of boosting annual sales by 247 percent spread over the next five years, but I'd more impressed if Gateway could promise that kind of growth on the bottom line as well. Boosting sales isn't really all that hard for a determined company, but when your core business lies in a field with falling margins, net income growth becomes the real challenge.

No doubt that's why Gateway says PCs will make up just a small fraction of overall revenue by 2004. But that's not a unique strategy, and as Dell (Nasdaq: DELL), Hewlett-Packard (NYSE: HWP) and others join IBM (NYSE: IBM) and Compaq (NYSE: CPQ) in services and other "non-system" businesses, what do you think will happen to profit margins in those fields? Commoditization doesn't take long these days. 22GO>