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Network sector weathering storm

While most networking companies are grappling with Asian economic woes and inventory issues, analysts see signs that the sector can get through the turbulence.

While most major networking companies are grappling with Asian economic woes and inventory issues that have caused investors to view their stocks warily, analysts see signs that the sector can weather the turbulence.

3Com (COMS), Bay Networks (BAY), and Cabletron (CS) will announce their quarterly earnings in the coming weeks and are expected to report varying degrees of profitability. Cisco Systems (CSCO) is scheduled to report in February.

Analyst Noel Lindsay of Deutsche Morgan Grenfell says that he is bullish on the networking sector as a whole, despite its exposure to the Asian currency crisis and the weaknesses of individual companies.

"The industry is poised to grow," Lindsay said. "The only issues that I think will mitigate growth is that we are seeing such aggressive price competition."

Lindsay added that price cuts could reduce the benefits the networking sector may see from an increase in unit sales.

According to First Call's consensus of analysts' estimates, Cisco is expected to announce second-quarter earnings of 63 cents per share, compared with earnings of 49 cents per share last year. Cisco's stock has gotten hammered on Wall Street during the past few days as a result of the company's announcement that it had greater-than-expected inventory levels.

While increased inventory usually is an indication to investors that a company's sales are slowing, in Cisco's case, some analysts believe Wall Street has misread the signals.

"If one takes a bit of a closer look, one realizes that Cisco has been ramping up sales," said Lindsay, who pointed out that larger inventories are necessary in the small-business market that Cisco is attempting to enter. "The fact that the inventory has gone up so substantially is primarily representative of the fact that they've been successful."

Paine Webber's Paul Weinstein emphatically agreed that investors have misread Cisco's current financial standing.

"Anyone who thinks that inventories were higher than expected was not listening. It's just silly. Inventories are much more of a real issue for 3Com," said Weinstein.

In 3Com's case, however, the company's bloated inventory is not the result of a changing business model, but rather the result of extra inventory it inherited when it acquired US Robotics earlier this year.

According to Lindsay, US Robotics' channel inventory was "much more than had been expected in the investor community."

3Com has pre-announced that they expect to miss analysts' earnings expectations for the quarter when they report this Thursday. According to First Call, the company now is expected to post a profit of 4 cents per share for the current quarter, compared with earnings of 57 cents a share during the same quarter last year.

Cabletron also has announced that it probably will miss expectations this quarter, and said that it expects to report earnings between 8 cents and 12 cents per share. The company announced on December 2 that revenues would fall between $330 million and $340 million, down from $361 million for the same period last year.

At the time, Cabletron was at a loss to explain its poor quarterly performance, but the company recently attributed some of the loss to weakness in the domestic market.

Bay Networks, for its part, is expected to report profits of 26 cents for the quarter, compared with a loss of 90 cents a year ago, according to First Call.

Although all of the individual networking companies are going through a transition resulting from the fact that this year's growth in the networking sector has been 20 percent, as opposed to last year's 40 percent, according to Weinstein, analysts nevertheless remain optimistic about the coming year.

"I think the opportunity for '98 is a lot better than it was for '97," Weinstein said.