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Networkers Falter
by Randy Befumo (TMF Templr)

ALEXANDRIA, VA, (June 3, 1997)/FoolWire/ -- CABLETRON SYSTEMS (NYSE: CS) plunged 33% to $30 this morning after the manufacturer of networking equipment warned it would not meet first quarter earnings expectations. This news sent networking-related shares reeling in sympathy. The Rochester, New Hampshire-based concern will report earnings well below consensus earnings estimates, causing many analysts to re-evaluate their ratings on Cabletron this morning. Management at Cabletron is at a loss to explain why their performance was such a complete bust, although management did hold a conference call for analysts this morning.

Cabletron will meet or slightly exceed the $0.37 earnings per share (EPS) it reported in the first quarter of last year, well below consensus estimates of $0.50 EPS. Revenues will come in at $360 to $370 million, only 11% to 14% higher than the $324 million that the company booked in the same period last year. Flat profits on a slight increase in revenues indicate that the company's net margin will contract. What could explain an unexpected disappointment of this magnitude? Slow growth in older products, weak European sales, and production delays for a new product were the only things the company could point out that explained the severity of the shortfall.

Cabletron stated that revenues from shared media hubs and some other "mature" products were "soft" in the quarter. "Mature" is an industry codeword for "receding edge" technology, meaning that growth in the product category has slowed substantially as customers have moved on to newer, better solutions. Shared media hubs have undergone a series of price cuts in the last four months as market-share leader 3COM (Nasdaq: COMS) has chopped prices, and INTEL (Nasdaq: INTC) introduced new, lower priced hubs in April. Widely viewed as a 15% per year grower, the price cuts in the segment have probably taken all of the growth out of the product category for this year.

European sales were also well below internal targets, perhaps exacerbated by production delays for Cabletron's new SmartSwitch 6000 product. Europe has been an area of disappointment for software and computer equipment companies for the last few quarters, including major names like ORACLE (Nasdaq: ORCL) and COMPUTER ASSOCIATES (NYSE: CA). The unexpectedly weak revenues came in spite of a strong sales effort by the company, adding insult to injury as more spending on the sales, general and administrative (SG&A) line failed to bring tangible benefits in the form of higher revenues. Add to all of this that the company is experiencing these problems right as it begins its summer quarter, traditionally the company's weakest, and it is easy to understand why there is a flurry of selling from investors with six to eighteen month investment time frames.

The disappointment is ironic considering that until yesterday Cabletron was the only member of the networking group within $1 of its 52-week high. Although many of the networking-related companies have come back strongly since their lows in mid-April, Cabletron by-and-large has side-stepped a lot of the carnage. By market capitalization and revenues, Cabletron is number four in an industry increasingly dominated by multi-billion dollar end-to-end systems providers like CISCO SYSTEMS (Nasdaq: CSCO), 3COM and BAY NETWORKS (NYSE: BAY), so it tends to get less press -- a good thing when investors are tripping all over themselves to sell networking stocks.

This disappointment at Cabletron comes only weeks after Wall Street had managed to develop renewed confidence in the industry after 3COM (Nasdaq: COMS) led the group lower throughout the first quarter. Price cuts from Intel in February and again in April caused many analysts to conclude that 3Com's substantial network interface card (NIC) business was about to become Intel roadkill. Networking-related shares plunged in sympathy with 3Com as investors became increasingly concerned about the vitality of the group, particularly after comments by some industry executives that implied corporate sales were weakening in the first quarter. At that time, Cabletron's stock price was hit, but its fall was nothing like larger and more widely owned institutional darlings like Cisco and Ascend had to endure.

Cabletron has long been one of the smaller players in an industry increasingly characterized by consolidation as providers seek to provide a complete solution for an enterprise's networking needs. Although the company's stock has shown resiliency in the past few months -- a fact the company bragged about in its last conference call in what in retrospect was a moment of hubris worthy of Oedipus Rex -- there have been some lingering questions about whether the number four company can make it in a business where number three based on revenues (Bay Networks) has been getting crushed for more than two years.

Very few mature industries have a significant number four player. The number four name in personal computers, database software, petroleum, discount retailing or designer clothing is not something most investors can normally name, although many can get the top three pretty easily. Based on sales, the company is larger than the ASCEND COMMUNICATIONS (Nasdaq: ASND) and CASCADE COMMUNICATIONS (Nasdaq: CSCC), but Cabletron specializes in bread and butter enterprise networking gear instead of ultra-hot, fast-growing remote-access solutions like Ascend and Cascade. Without a roster of products that allow it to differentiate itself from its larger competitors, Cabletron may face increasing challenges as it tries to sell networking gear to skittish information technology managers who need some kind of guarantee that their system will be reliable. Whether or not the company is up to this challenge in the coming months remains to be seen.

RELEVANT MESSAGE BOARDS: 3Com Corp. (COMS) * Ascend Comm. (ASND) * Cabletron Systems (CS) * Cascade Comm. (CSCC) * Cisco Systems (CSCO) * US Robotics (USRX)

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