A Loss of Focus May Be Cause of 3Com’s Problems

As 3Com Corp. stock takes a pounding in the wake of a disappointing earnings forecast, some analysts are expressing doubts about the networking gear company’s strategy and long-term prospects for remaining independent.

Its popular Palm line of hand-held computers has done well in the consumer market, but its other ventures--modems for personal computers and high-end networking equipment for businesses--have faced severe pricing pressure and increased competition.

Santa Clara, Calif.-based 3Com says its sales volume appears to be holding, but the prices of some of its key products are dropping, particularly modems and network cards for personal computers, which are quickly becoming cheap commodities.

The central problem, said Joel Achramowicz, a senior analyst with Preferred Capital Markets, is that 3Com seems to have lost its focus, spreading itself among a variety of consumer products with low margins and high-end networking gear that must compete against the networking powerhouse Cisco Systems Inc.

“At this point in time, I’m just puzzled by what 3Com is trying to do,” Achramowicz said. “Do they want to be a consumer company or a networking company? They have to make a decision.”

Since January, shares of 3Com have fallen more than 50%--from $51.13 to its closing price Friday on Nasdaq of $24.63. Its latest drop was prompted by warnings from the company that its earnings per share for the fiscal third quarter will probably be about 23 cents--a far cry from the consensus 36 cents per share that analysts had expected.

Before 3Com issued its profit warning, company insiders sold as much as $178 million worth of 3Com stock in the fiscal third quarter.

Chairman and Chief Executive Eric A. Benhamou, Chief Financial Officer Christopher Paisley and other executives sold at prices near a 52-week high of $51.13 reached on Dec. 23, according to Washington Service, which tracks insider buying and selling.

3Com Senior Vice President and General Counsel Mark Michael said all 3Com employees have a limited time after a quarterly earnings report to exercise their stock options. He declined to comment on any of the individual sales.

3Com plans to release its final third-quarter earnings report on March 23.

Farrokh Billimoria, an analyst with the San Francisco-based investment banking firm of Hambrecht & Quist, said that at its current price, “it’s clearly an acquisition target.”

Patrick Houghton, an analyst with the investment firm Sutro & Co., said that 3Com--the No. 2 maker of networking equipment--is a tempting morsel because of its strong position in the quickly growing networking realm.

“At the right price, it would be an easy way to get a big share of the networking market,” he said.

On Thursday, the New York Times reported that Siemens, the giant telecommunications equipment maker of Germany, was in preliminary discussions to buy 3Com’s telecommunications networking unit for $1.2 billion.

Neither company would comment on the report, although Siemens has scheduled a news conference Monday to discuss a shift in its networking strategy. A source within 3Com said the company will not participate in the news conference.

Achramowicz said a 3Com deal would be a boon for Siemens, but made no sense at all for 3Com, which would be selling one of its best units with high growth potential.

“I’m kind of laughing at this deal,” he said. “If 3Com wants to sell, what is the strategy? If they’re not going to compete against Lucent, Alcatel and Nortel, then they might as well sell the company.”

Benhamou said the company has recognized its problems and begun a strategic shift away from stagnated products, such as modems and network cards for personal computers, to higher-growth ventures, such as hand-held computers, high-speed cable modems, Internet telephony equipment and home networking.

3Com has traditionally suffered a seasonal drop in the third quarter, but Benhamou conceded that this quarter went beyond the usual.

Billimoria said 3Com has been facing increasing pressure from Cisco--the No. 1 producer of networking equipment--in the market for small and mid-sized companies.

Benhamou said the company wants to focus on the “edge” of networking--the point of connection between personal computers and large network carriers.

But Achramowicz said it was defeatist strategy, conceding a lucrative chunk of networking to its archrivals. “3Com just hasn’t made the moves you’d expect from a major player,” he said.

3Com has ended up a powerful player in stagnated markets. Nearly half of its business is in modems and network cards, yet there is little revenue growth possibilities in those areas.

Even though the Palm Computing unit, which has become almost a required accessory for the up-and-coming professional, has done well, it is in the end a minor part of 3Com’s business. “Even if the Palm Pilot did well, would it have made a difference?” asked Billimoria. “No.”

Houghton said that for all its problems, 3Com is still a strong company with a well-known brand name that will serve it well as the cable modem, Internet telephony and hand-held computer markets mature.

“3Com has had a tough time, but at least it makes money,” Houghton said.

Bloomberg News was used in compiling this report.