Does 3Com's Report Justify Its Rally?

3Com (COMS) stock is performing well today, up over 10% at $4.89, after its earnings report that showed strong results from the Huawei partnership (H-3C) and announcing yet another restructuring (job cuts and facility closures). The company lost $0.01 on EPS before restructuring and other charges and posted revenues of $255.3M. The loss was -$0.04 after items, but the street was expecting -$0.04 EPS and $176.55M in revenues. Even with slightly under-street revenues, there was relief that the picture may be getting better.

This UBS analyst upgrade from Long Jiang lifting the rating from a Neutral up to a Buy is likely contributing to these excessive gains. Pre-market the stock was only up about 3%, but then after this upgrade the shares made a steady march to its 10%+ gains on the day. This is an interesting upgrade, and after reading the research note it looks more like a sum of the parts valuation (he says $6.40 value now) than a call that is endorsing the old legacy 3Com before Huawei. Without the additional analyst push this would probably not be as strong as it has been today. The FOMC decision hasn't yet posted and there has already been double the normal trading volume with 150 minutes until the close.

The Huawei partnership, H-3C, is now 51% owned by 3Com and is perhaps the only good thing going on there at the company. Since it is majority-owned by 3Com, they now get to count the revenues from the partnership since it is the majority holder. That is why the company had revenues grow 44% year-over-year. The company's job cuts are in the lagging Secure Converged Networking (SCN) segment, which saw a 6% drop in segment revenues. This shows there is still a steady erosion in the legacy 3Com business.

3Com ended the quarter with $864 million in cash, cash equivalents and short-term investments (including the consolidated cash, cash equivalents and short-term investments of H-3C which totaled $169 million).

The company believes the restructuring supports long-term profitability and long-term growth and will focus on reducing components of the SCN operating segment cost structure to achieve future profitability. It will close approximately 21 facilities around the world and cut 250 full-time employees (15 percent of its SCN headcount). It will also focus on its sales, marketing and services efforts and will record restructuring charges of approximately $10-$13 million. These charges are expected to be recorded principally during 3Com's first and second quarters of fiscal 2007 (the next 2 quarters). Shouldn't the focus have been this newer thought process all along? Machiavelli would say to instill all the changes in the village at once.

Scott Murray, 3Com's president and CEO, said, "I am pleased with the progress that we have made in the past quarter in moving 3Com toward a profitable business model. H-3C delivered strong results, and we have continued to reduce the operating loss of our SCN business through solid cost control.....We believe that the cost realignment announced today will be a significant part of achieving our goal of future profitability."

3Com has been a serial restructurer. It has restructured so many times you would compare it to a Motorola or Gateway of the old days, but we are not comparing these names and not even providing tickers on them to avoid distractions. To prove a point, we are talking about the company that spun-off Palm (PALM). The company had 3,900 employees at the end of March, 2003 and had thousands more back in the 1990's. What you have to wonder is how much of the Huawei JV sales are actually tied to or indirectly a result of the current SCN sector that is still spiralling downward. This is the hardest question to answer. If the answer is "Not Very Much" then why doesn't the company just jettison that whole segment? or why nottry to go find a buyer for it? It is a declining business. The reasons may be very clear.

Does this headcount reduce the dead weight? Will there be further dead weight they can trim? There has to be some. It looks like the Chairman (Benhamou) is paid $100,000 and is no longer well thought of on the street, even though he is no longer the face of the company. Under his watch they lost the data communications war with Cisco (CSCO) and others, went through restructuring after restructuring, lost Billions of dollars in market cap, and even spun-off Palm. maybe they could even try a name change to H-3C.

Will the old legal fight between Cicso (CSCO) and Huawei ever creep back up? Cisco was suing Huawei in 2003 because so much of the core router was reportedly identical in many cases down to the source code. This was resolved in July of 2004. Huawei agreed to make many surface and interface changes and to stop selling the products at issue and only sell new modified versions. So what prevents more look-alikes down the road, and what prevents Cisco from wanting to try to block 3COM's efforts as the H-3C joint venture starts to take more sales? Some in the US have referred to the H-3C routers as "the poor man's Cisco router without the support." If "the poor man's router" starts to take away too many sales from the rich man's salesforce what will prevent a re-initiation of this fight. It was resolved in 2004, but the verbage back at the time of the resolution just didn't feel the same as other resolutions between other companies. This is not predicting a legal issue will arise, but it is simply alerting that there is at least a remote possibility of it down the road. If it does, then who do you think has deeper pockets to fight it?

They carry almost no debt and the balance sheet is still manageable, but the core balance sheet has contracted through all the restructurings and through each stock-drop. The intent is not to just batter this company while it is trying to get up off the floor, but there are still issues. The stock is up 52% from the 52-week lows and up over 60% from the lows in the last 18-months. The stock would have probably been up on its own and with the market today, but it would appear that at least a large portion of the gains today are probably tied to this one influential upgrade from UBS.