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Monday, September 18, 2006

3Com Earnings Preview: Time to Do or Die

3Com Corp. (COMS) has what may be one of the most important earnings releases in recent history this coming Thursday (Sept. 21). 3Com is now the 51% owner of the Huawei-3Com merger called "H3C" so they now count all the revenues as 3Com revenues. This is over the Huawei router, and is perhaps one of the only remaining good things going on inside 3Com.

The company has been shedding jobs and we'll see how many jobs and locations they have cut in the last quarter as part of their global restructuring into a more focused company. How many times can one company restructure? The answer is "How many times has 3Com restructured."

The street is looking for a pre-restructuring earnings of -$0.01 on EPS and revenues of about $321.5 million. This quarter will look like a significant pop in revenues on a year-over-year basis because it now gets to count all the H3C revenues as its own since it is the majority owner of that Huawei venture.

I criticized COMS back on June 21 and on June 29 and have criticized them on many other occasions before then. On June 21 the closing price was $4.61 and when I questioned the post-earnings rally on June 29 the closing price was $5.10. COMS has traded up to a high of $5.31 shortly thereafter, but is still back down at $4.36 now. The 52-week trading range is $3.29 to $5.70.

On August 30, this was the listed balance sheet break-down we gave: COMS now has a mere market cap of $1.73 Billion, which means if you gave the ex-H3C value of $0 from COMS that the entire value of H3C would be approximately $3.45 Billion. It is very difficult to trust analyst estimates, but they have COMS generating a $0.02 EPS for fiscal May 2007 and $0.19 EPS for fiscal May 2008. They will have some substantial charges for their ongoing restructuring, but their balance sheet is actually ok as of the last available report. The company holds $864+ million cash and short-term securities, and it has $178 million in receivables. Its inventories and "other" assets are $206.6 million, but we'll value those as close to Nil for break-up comparison. That leaves their current assets valued at $1.035 Billion. We will allow them to count plant & equipment at 50 cents on the dollar, so $44.5 million, will give them $0.00 for their Goodwill ($354 million on the books), will also give their intangibles and "other" assets a Zero value (combined as $168+ million on the balance sheet). $1.079 Billion is what we are counting the underlying raw assets. We know there is some value in the other assets, but this is how to really break out raw values. The company's total Liabilities and minority interests come to just under $659 million, but $173.9 million of that is a minority interest that also "may" have some negotiated play left. This still leaves a raw $620 million net net left over after all liabilities as far as a raw value, and any company worth their weight in salt would know how to squeeze out some value out of the garbage assets I assigned a Zero value to.

In the next 48 hours we should start to get some last minute revisions from Wall Street bulge bracket firms that cover the company. The most closely followed event is going to be the results out of the Huawei venture, and that is where we expect the analysts to focus. If they do not focus on that aspect then they are driving only by watching rearview mirror.

What is becoming clear is that the language coming out of 3Com on the forward market acceptance and penetration will be THE factor. If 3Com doesn't make everyone on the conference call feel like they are going to be a substantial force with the router sales, then you could probably expect the rest of the crowd that hasn't thrown in the towel to do so. This could be the do or die quarter for 3Com, and it is going to get harder and harder for the company to hide behind perpetual restructurings.

I have noted that there is arguably some value left in the company, but that isn't without risk and certainly isn't without painful memories in the name. As far as we are concerned the company has this quarter and maybe one more to prove they have the right to live.

If they cannot convey this message then we won't even continue to bother calling for more management changes. We'll be calling for them to just liquidate and try to return whatever value is really there for shareholders. The short interest grew from July's reading of 22.5+ million to over 23.3 million shares in August.

There is also a wave of consolidation that has been going on as Cisco (CSCO) has been leading the path to "We will control all you see and hear." Lucent (LU) and Alcatel (ALA) are merging. Nokia (NOK) and Siemens (SI) are combining their networking operations. Motorola (MOT) has been said to be in need of making a more rounding out acquisition, and it is no secret that NorTel (NT) seems to be fighting for their right to life too. Juniper (JNPR) and Foundry (FDRY) have come way off of their highs and have more than a long way to go.

The company could be a part of this consolidation wave or they could get left in the dust, but the street is going to try to make that decision after earnings this Thursday. It is time for the company to Do or Die!

Jon C. Ogg
September 18, 2006
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