Big Changes Brewing for 3Com

SANTA CLARA, CALIF. (03/10/2000) - Having recently spun off part of its Palm operations, 3Com Corp. may have other, more significant restructuring plans in the works.

Sources say 3Com may also spin off pieces of its Network Systems business unit and significantly restructure other parts of the company. The Network Systems business unit oversees development and marketing of the company's large enterprise LAN switches and remote access platforms for service providers.

Edgar Masri, senior vice president and general manager of the unit, has been meeting with consultants to discuss restructuring and reorganization options in an attempt to keep the shareholder value momentum going after the Palm IPO spinoff, the sources say.

3Com took 5% of Palm public last week to return a dividend to shareholders and focus on its core network business, which includes network interface cards (NIC) and modems in addition to LAN switches and remote access gear.

For the second quarter, ended Nov. 26, 1999, 3Com's sales of $1.475 billion was a 4% drop from the same period one year earlier. Earnings, though, were up about 33% from a year ago.

Sales of NICs and analog, cable and digital subscriber line (DSL) modems increased 15% between the first and second quarters, while sales of Network Systems products - switches, hubs, remote access concentrators, routers and network management software - decreased 12% from the first quarter to the second quarter.

3Com stock hovered at or below $30 between September and November 1999. But then the stock took off in anticipation of the Palm initial public offering, reaching a high of about $120 last week.

Thursday, it closed just above $68. Observers believe it will decline even more after Palm is completely spun off in six months because 3Com will be left with mostly low-growth, low-margin, pricesensitive businesses.

3Com declined to comment on reports of Masri's meetings with consultants and declined an interview with Network World on the company's next moves. A company spokesman says 3Com is in a "quiet period" before it announces third-quarter earnings March 20.

The earnings announcement may be accompanied by another restructuring, observers speculate. Some believe 3Com could follow the lead of Cabletron and Lucent and divest itself of some slow-growth enterprise operations.

"3Com should consider emulating Lucent and Cabletron by spinning off its enterprise network business units in order to focus more on software applications in booming segments such as e-commerce and wireless," states CurrentAnalysis analyst Tere Bracco in a recent report on Lucent's enterprise business divestiture.

Unlike Cabletron and Lucent, 3Com should maintain its brand recognition in the enterprise, Bracco says. So she believes 3Com will give its service provider business a new identity.

"I think 3Com will spin off its enterprise division, but if it spins it off and gives it a new name, launches it as a different entity, I don't think it will be making the best choice," she says. "I think 3Com has the best chance to succeed in the enterprise business. It can own the evolving enterprise with a good brand name and a sharp focus. I don't think it can own the service provider market."

Asked if she knows what 3Com might actually do, Bracco replied, "Nothing I can talk about. I think something will be announced probably in early to mid-April."

Others believe 3Com will do just what Bracco says - spin off and rename its service provider business; retain the 3Com name for low-end, small-enterprise and consumer-oriented operations; and sell or spin off its large enterprise operations, which oversees development and marketing of the CoreBuilder Layer 2/Layer 3 Gigabit Ethernet and ATM switches.

3Com has had trouble gaining traction in large enterprises with these switches.

The company's market share in Layer 3 Ethernet switching decreased from 19.9% in 1998 to 6.4% in 1999, according to The Dell'Oro Group in Portola Valley, Calif. In Layer 2 it actually increased to 14.6% in 1999 from 13.9% in 1998, but it decreased from 15.7% in 1997, Dell'Oro reports.

Indeed, rumors are circulating that 3Com is looking to jettison its large enterprise business. 3Com broke its "quiet period" silence to attempt to dismiss that option.

"We are not selling off the enterprise business unit," the 3Com spokesman says.

Asked specifically about divesting the CoreBuilder operations, he replied, "I know nothing of that. Anything else is rumor."

Nonetheless, an analyst who was briefed by 3Com on its imminent restructuring plan describes it as "radical." He would not disclose what the plan is.

Another analyst who was briefed also would not comment on the company's plan.

He says, though, that 3Com has to transition its brand-name success in low-end enterprise networking to the hot service provider broadband-access market - cable modems, DSL and wireless.

It will require a fundamental shift in the company's sales strategy, from retail channels to service provider bundling, and then perhaps back to retail, he says.

"3Com needs to get into that business, establish its products and some of the infrastructure pieces to bridge that distribution gap until the market becomes more of a retail business again," the analyst says. "If it gets cut out of the loop early, then the only thing it's doing is more of that commodity, low-margin business without the benefit of having its stuff sitting on people's desks over that transition period."

As for spinning off some operations, he's not convinced that's the right strategy for 3Com.

"Whether you go through these spinoffs is dependent on where the company sees itself focusing, who it sees as its competitors, and potentially who it sees itself not beating," the analyst says. "I think that's part of the discussion that's taking place right now."

CoreBuilder users would like the company to deliver some of the promised new features.

"I'd like to see 3Com concentrate its efforts in the policy-based management stuff," says Gary Habermann, director of network operations at Widener University in Chester, Pa. "I see an opportunity to focus on that again. I'd also like to see the F5 server load-balancing products it announced come to ship."

"We are looking at what its strategy should be. I do not believe it needs to spin off anything else in order to compete," says Roderick White, vice president of telecommunications at Home Shopping Network in St. Petersburg, Fla.

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