3Com Has The Cash-Now It Has To Show It Can Generate Revenue3Com Has The Cash-Now It Has To Show It Can Generate Revenue

Cash is king. Or is it? Well, that depends on what you're doing with it.

Like most investors, I like to see a businesses generating a nice cash flow and maintaining a solid balance sheet. 3Com Corp. (COMS-Nasdaq) falls a bit short in the category of generating lots of cash. But when it comes to the balance sheet, the company's latest financial results show a significant amount piled up. My interest was piqued.

3Com has $1.64 billion in cash and short-term investments. After adjusting for working capital and debt, the networking equipment maker has net cash of $1.41 billion. This equates to $4.14 per share. What makes this intriguing is that 3Com trades at about $4.84, or 1.2 times net cash-not sales, but cash.

3Com is another established Silicon Valley company that has fallen on hard times. The trouble started shortly after it acquired US Robotics in 1997. Since then, an atmosphere of perpetual restructuring has surrounded the company. 3Com spun off Palm last year and recently sold off its analog modem business. These two transactions effectively unwound the US Robotics acquisition.

In March 2000, 3Com reorganized itself around two businesses: Commercial and Consumer Networks (87% of total revenue) and CommWorks (13% of total revenue). The Commercial and Consumer business builds products such as network interface cards, wireless LANs, LAN switches, LAN telephony, and broadband modems. CommWorks focuses on telecommunications carriers and network service providers with IP telephony products, DSL Access Multiplexors, next-generation wireless Code Division Multiple Access equipment, etc.

But the reorganization didn't fix everything at 3Com. The company has already exited the Internet appliance business, which was something of a long shot in the first place. In addition, 3Com plans to stop making DSL and cable modems, a line of business for which it previously had high hopes.

The reorganizations, the lack of a cohesive strategy, and the downturn in IT spending are taking their toll on 3Com's performance. Revenue declined 26% from the previous quarter. Commercial and Consumer Networks declined 26%, while CommWorks was down 21% from the last quarter. Gross margin was less than 10%, excluding an inventory charge.

Gross margin might rebound during upcoming quarters because the last three months included the cable and DSL modem business, on which 3Com was losing money. However, the majority of 3Com's products carry low margins and face intense competition. It needs to increase gross margin substantially to offset marketing, sales, and other expenses. The company has been reducing overhead for the last several quarters, but operating margin still came in at-54%. Obviously, 3Com has its work cut out for it.

What about cash? 3Com actually didn't generate cash this quarter-it used $186 million for operations. This number, though, might not accurately reflect the cash needs on an ongoing basis. The company did a nice job of collecting $104 million on its receivables, but it's unlikely to be able to continue that rate. Actual cash burned probably falls somewhere between $186 million and $290 million. Management stuck to its previous guidance that the company would begin generating cash again from operations beginning with its fiscal second quarter ending Dec. 1. However, confidence must be flagging, since that assumption was based on stabilization of IT spending, slight improvement in 3Com's lines of business, and flawless execution. I have my doubts, given the plethora of falling profit forecasts that keep pouring out of the IT sector.

Although 3Com is trading at close to cash value, the company is still using cash to fund its operations, eating into the cash on the balance sheet. 3Com must stop hemorrhaging cash and show improved sales before its stock will rebound. It's the same lesson a dot-com or two needs to heed. Cash is still king, but having it on the balance sheet isn't enough. 3Com has to return to building, not just burning, cash.

William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the information 100 Stock Index. Reach him at [email protected].