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Network firms running scared

Investors in leading networking firms balk after Intel advances into the low end of the market.

Intel (INTC) has managed to spook investors in leading networking companies.

Networking stocks took a heavy hit in early trading, a day after Intel announced plans to make a stackable hub for less than $100 and a single-chip Fast Ethernet component for motherboards. While Intel has been making inroads into the low-end networking market for several months, yesterday's pair of announcements highlighted the microprocessor giant's threat to companies that have long been a staple of many a high-tech portfolio.

Networking stocks dropped by as much as four points in trading this morning, though the big players had largely recovered by the afternoon. The volatility, however, indicates that investors are concerned that Intel's aggressive moves into this market will touch off a price war and erode profits of networking powerhouses like 3Com (COMS), Bay Networks (BAY), Cisco Systems (CSCO), and Cascade Communications (CSCC). Firms that specialize in the low-end market like 3Com and Bay are particularly at risk.

"People are concerned about the commoditization of the low-end [networking] market," said David Takata, an analyst with Gruntal in Los Angeles.

The companies themselves are also aware of the new threat that Intel poses.

Intel announced a stackable and manageable hub that can run at 10 or 100 mbps for less than $100 per port, whereas competitors like Bay have a 100-mbps hub that sells for roughly $198 a port. Intel also said it has developed a single-chip network connection device that could be installed directly on a motherboard. That would eliminate the need for local network adapter cards that contribute greatly to the bottom line of several networking companies.

3Com announced immediately that it will cut its prices for competing products, putting the reductions into place a little earlier than planned. The company declined to specify the size of the reductions and said the timing of the announcement was a coincidence.

But the networking vendors are clearly aware of and responding to Intel's networking strategy. Competing with the chip giant is one factor behind the recent wave of networking mergers, including the marriage of Cascade Systems and Ascend as well as the deal between 3Com and U.S. Robotics. All of these companies want to offer "one-stop shopping" for networking gear so they can provide package deals to customers who otherwise might be tempted to go with Intel.

Takata speculated that Intel's presence may force 3Com and Bay to target a more high-end market now dominated by Cisco and Cascade.

On the other hand, 3Com argues that even while it is responding to Intel's new pricing, its unit sales are growing quickly, in fact faster than before Intel entered the arena.

"Just dropping prices is not going to ensure that Intel is going to get market share," said Doug Spring, executive vice president of interface products.

And some analysts agreed that Wall Street initially overreacted to Intel's announcement, an assessment borne out by the stocks' subsequent recovery. "We thought the reaction was totally overblown," said Eric Blachno, an analyst with Bear Stearns. "Although Intel is a formidable competitor, these other companies aren't lightweights, either."

Intel is an investor in CNET: The Computer Network.

Reuters contributed to this report.