For Faded Star 3Com, A Bold Act II
By Peter Keating

(MONEY Magazine) – Perhaps you recall 3Com (COMS) from the Internet gold rush, when it dominated the market for the interface cards that connect computers to networks. 3Com also sold the Palm Pilot, the iPod of its day. At the point of maximum hubris, the company slapped its moniker on Candlestick Park. Then came bad acquisitions, collapsing card prices and huge losses. A much humbled 3Com is still digging out.

What the bulls say

• 3Com used to focus on network cards. Now it thinks about the whole network: The company sells switches, Internet telephony service and security products to corporate customers. It bought TippingPoint Technologies, which makes intrusion-prevention hardware, in January.

3Com has cut costs by closing factories and outsourcing the manufacture of its hardware. It has also invested $160 million in a joint venture with China's Huawei Technologies to build and sell routers and switches. That partnership is not only drastically cutting engineering and manufacturing expenses, it is opening up Asian markets to 3Com.

Yes, the company continues to lose money. Forecasts are for a loss of $140 million on revenue of $735 million this year. But it has plenty of cash on hand--nearly $900 million at the end of the last quarter. That amounts to about $2.30 a share for a stock that recently traded at just $3.45.

That safety net, and better prospects, means 3Com is cheap, says John Buckingham, president of Al Frank Asset Management. "Based on what we know today, we think it's worth $7."

• What the bears say

Once upon a time, circa 2000, 3Com was indeed poised to compete in the network equipment business. But as its losses began piling up, it left that playing field to Cisco Systems, and now 3Com could be steering itself into a buzz saw of competition against more established rivals. "There are already a number of other companies doing what 3Com is doing, such as Extreme Networks and Juniper Networks," says Eric Buck, an analyst with Janco Partners. "It's going to be a tough road for them."

Even if 3Com does generate substantial new revenue from products for big companies, it still faces the challenge of converting those sales into earnings. At 45.5% of revenue, 3Com's selling and administrative costs remain stubbornly high, as the company invests in new sales channels. The comparable figure for rival Juniper, for instance, is just 26.5%.

Similarly, 3Com's push to launch products has driven up research-and-development costs to 14% of revenue. "Just look at the net income, or the lack thereof," says Buck, and he has a point: 3Com hasn't turned a profit since 2000.

bottom line

• CEO Bruce Claflin has a tough road ahead of him. But his sell-more, manufacture-less strategy is already showing signs of promise: 3Com's revenue is growing again, and gross margins are improving. It may take time, not to mention actual earnings, for investors to feel new love for a stock that's down 80%-plus from its all-time high. But as companies begin spending more heavily on technology and telecom, 3Com could benefit mightily. And its new status as a player in Asia should pay dividends. In the meantime, 3Com's cash on hand means that the company has the wherewithal to see Claflin's plan through. That kind of downside protection is hard to find in a speculative investment, and it's even harder to beat.