Wednesday, November 12, 1997
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An Investment Opinion by Randy Befumo

3Com Disconnects

3Com (Nasdaq: COMS) took a header today, dropping $2 1/2 to $32 5/8 as a result of concerns over modem sales and Southeast Asian economic turmoil. Shares of the Santa Clara-based connectivity hardware maker slumped after Morgan Stanley's George Kelly and Goldman Sachs' Ajay Diwan lowered their ratings on the stock. Both analysts expressed concern about the amount of inventory in the sales "channel," worrying that distributors and retailers have too many unsold modems. Kelly also reignited concern about 3Com's exposure to Southeast Asia, disclosing in a research note that as much as a third of the 15% of total revenues the company gets from the area "could be in jeopardy." The analysts reduced fiscal 1998 EPS estimates by $0.15 and $0.25 to $2.15 per share and $2.05 per share respectively, leaving fiscal 1999 estimates untouched for now. The continued uncertainty that these downgrades reflect has worn down 3Com shares, off by $22 1/2 in the past 30 days.

Hand wringing about 3Com's modem inventories has intensified over the past month. The trouble began with company's confusing October 14th 10-Q filing that revealed only $15.2 million sales were booked by its U.S. Robotics subsidiary for the two months ended May 24. A mention by the San Francisco Chronicle's Herb Greenberg and a scathing piece by Floyd Norris in the New York Times alleged that 3Com was using accounting legerdemain to its maximum effect as a tool to hide the fact that U.S. Robotics modems were not selling very well. 3Com has been struggling to get an estimate of how much inventory is in the sales channel, but Chief Executive Eric Benhamou stated at a recent gathering of the Society of American Business Editors and Writers that 3Com will have an accurate measurement of U.S. Robotics inventory levels in January of 1998.

That 3Com does not currently have solid estimates for channel inventory has forced the company to let charges that wholesaler inventories are "higher-than-optimal" and "demand appears weaker than previously anticipated" stand unchallenged. Some are even using allegedly weak modem sales to prop up a secular case that so-called NetPCs are killing off the market for high-end PCs and peripherals. The Asian worries are even more difficult for the company to refute because the real damage to Asian economies over the past few weeks will only be known in a few months -- right now everyone is simply guessing. At roughly $33 per share, 3Com trades at 16 times reduced fiscal 1998 earnings estimates. Should 3Com trade at 16 times trailing earnings in two quarters, it will touch lows seen only three times in the past seven years -- in late 1990, September 1993, and May 1997. Annualized returns from each of these low points were 52%, 56%, and 24%, respectively.


Clothing retailer Abercrombie & Fitch Co. (NYSE: ANF) rose $3 1/2 to $30 after posting Q3 EPS of $0.20, crushing estimates of $0.14. Net sales for the third quarter increased 69% to $148.5 million.

Air courier company AirNet Systems (NYSE: ANS) announced Q3 earnings of $0.29 per share, which beat estimates of $0.28 and raised the stock $1 1/2 to $21. The results for the company are excellent considering that the benefits of its recent Data Air integration will not be seen until 1998.

Gartner Group (Nasdaq: GART), a provider of a wide range of services in the information technology area, gained $2 3/4 to $29 3/4 after reporting Q4 EPS of $0.17 and fiscal year 1997 EPS of $0.71, versus estimates of $0.16 and $0.71 respectively. Gartner Group also acquired a minority interest in Interactive Learning Centers and purchased Informatics Management Consultants in Sweden.

Data communications hardware and software provider Digi International (Nasdaq: DGII) rose $1 11/16 to $16 7/8 after reporting a Q4 loss of 0.29 per share, missing estimates. The company is up because it expects fiscal 1998 first quarter earnings to be "significantly" above analysts' expectations of $0.06 to $0.08 a share.

Fax and electronic messaging company Xpedite Systems (Nasdaq: XPED) added $2 11/16 to $30 1/16 after announcing that it is considering a sweetened $34 per share stock-for-stock merger offer from Premiere Technologies (Nasdaq: PTEK).

Graphics accelerator products company 3Dlabs Inc. (Nasdaq: TDDDF) gained $1 1/4 to $22 1/4 this morning, ostensibly on the news that it is working with Intel Corp. (Nasdaq: INTC) to design and develop 3D graphics processors to complement Intel's forthcoming IA-64 family of microprocessors.

Operator of 120 Vitamin World stores, NBTY Inc. (Nasdaq: NBTY), jumped $1 5/8 to $22 3/4 after announcing that fiscal year 1997 results would come in at $1.11 per share (before a one-time charges), beating estimates of $1.10.

Cytoclonal Pharmaceutics (Nasdaq: CYPH) announced today that it received a U.S. patent for an antigen (protein) associated with malignant melanoma, which boosted the biopharmaceutical company $1/2 to $8 15/16.


American Home Patient (Nasdaq: AHOM) fell $2 to $22 1/2 after yesterday reporting Q3 EPS of $0.35 (before charges), in line with estimates. The home healthcare company reported restructuring charges totaling $67 million pre-tax, resulting in a quarterly net loss of $2.68 per share. Prudential lowered its rating on the company to "hold" from "buy" this morning.

X-ray and ultrasound equipment company Hologic Inc. (Nasdaq: HOLX) lost $1 15/16 to $25 13/16 on reporting Q4 revenues of $24.6 million, up slightly from Q4 1996. EPS of $0.29 for the quarter met the analysts' mean estimate.

Specialty insurance company Frontier Insurance Group (NYSE: FTR) slid $9 9/16 to $26 9/16 after reporting Q3 net income of $0.42 per share, missing the analysts' mean estimate of $0.47 and drawing downgrades from Merrill Lynch and Smith Barney. Reducing earnings was a higher-than-expected push-off of insured risks to the reinsurers, which was not overcome by a better combined ratio compared with last year.

MasTec Inc. (NYSE: MTZ) lost another $2 15/16 to $25 after the telecom infrastructure construction firm reported Q3 EPS of $0.43, up 7.5% over last year but well below revenue growth of 24% and the mean analyst estimate of $0.54.

Group health insurance and services company John Alden Financial Corp. (NYSE: JA) was scalped for $3 15/16 to $27 9/16 after reporting Q3 EPS from continuing operations of $0.10, falling well short of the mean analyst estimate of $0.34. The company's medical loss ratio declined in states where it is continuing operations, but group health premiums for the quarter declined about 21%, adjusting for discontinued operations.

Argentine supermarket company Disco SA (NYSE: DXO) fell $4 5/16 to $31 11/16 on reporting Q3 net income of 6.45 million pesos for the third quarter, apparently disappointing analysts.

With some data networking companies and the entire disk drive industry in the dumper at the moment, the reiteration of analyst worries on 3Com's inventory levels pushed electronics contract manufacturing leader Solectron (NYSE: SLR) down $2 3/8 to $31 11/16.

Benton Oil & Gas Co. (NYSE: BNO) declined $1 3/4 to $18 after reporting a 17% decline in gross cash flow per share in its third quarter. EPS for the oil & gas exploration and production company came in at $0.09, below the mean analyst estimate of $0.13.


Please see the Motley Fool's Conference Calls page for call information and links to synopses.

FOOL PORTFOLIO BORING PORTFOLIO AMZN up $2 at $49 3/8 ATLS unch. at $27 7/8 AOL unch. at $73 BGP dn $1/8 at $28 13/16 CHV down $5/16 at $84 7/16 CSCO dn $1 3/8 at $79 1/4 COMS down $2 3/8 at $32 3/4 CSL down $1/8 at $44 DJT up $1/16 at $8 15/16 FCH down $1/4 at $37 GM down $1/2 at $63 1/8 GNT dn $9/16 at $42 15/16 INVX down $1/16 at $24 15/16 ORCL down $11/16 at $34 1/4 IOM up $9/16 at $28 1/2 PMSI down $1/16 at $13 1/16 KLAC down $1 3/16 at $41 13/16 TDW up $9/16 at $66 5/16 LU down $3/16 at $78 15/16 MMM down $9/16 at $95 11/16 T down $3/8 at $47 7/8

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