Why 3 Com Is Handing Off Palm

It will free up brains and cash to fix all the rest

As recently as July, 3Com Corp. CEO Eric A. Benhamou was still smitten with the Palm computer. At 3Com's board meeting that month, he floated a strategic vision that would have woven the popular handheld into every facet of the company's business. But the board didn't buy it. Concerned that Benhamou and his team had taken their eyes off the company's networking business--source of 90% of its $5.7 billion revenues--they endorsed a management plan to divest the Palm and get 3Com back to its network knitting.

On Sept. 13, Benhamou did just that, announcing a plan to spin off Palm Computing Inc. in a public offering early next year. The timing was odd: The very next day, startup Handspring Inc., a startup founded by three former 3Com employees, was set to launch a Palm-compatible handheld called the Visor, priced at $149--$100 below the cheapest Palm. What made the timing doubly odd was that the Handspring trio, creators of the original PalmPilot, left 3Com a year ago after failing to persuade Benhamou to spin off Palm. 3Com claims that the date of the announcement was a coincidence and that the spin-off will promote Palm software, which is used by both companies, as an independent standard for handhelds.

STAR PRODUCT. No matter the reason, 3Com's move was another whipsaw change for the beleaguered No. 2 maker of networking gear. 3Com has suffered brutal competition, sagging prices, and huge inventory writedowns since its $7.4 billion merger with modem-maker U.S. Robotics Corp. in 1997, the deal that brought it Palm. While Cisco Systems Inc. has seen revenues soar 89% in the last two years, to $12.2 billion, 3Com's have climbed less than 3%. Its stock is off 50% from a postmerger high of 56 3/4. Says Martin Pyykkonen, an analyst with CIBC World Markets: "The U.S. Robotics deal was a real distraction." Its saving grace was Palm, which U.S. Robotics bought for $44 million in 1996. With nearly 5 million units sold, Palm holds 68% of the handheld market. Now, Benhamou is letting go so he can fix the rest of 3Com. "We need an unequivocal focus on networking in the minds of customers and analysts," he concedes.

No kidding. The non-Palm parts of 3Com grew by less than 1%, or just $40 million, in its most recent fiscal year, ended May 31, while Palm accounted for 87% of 3Com's $350 million revenue growth.

So why dump Palm? 3Com figures it can get more value out of the unit by selling it, and the $5 billion or more raised from an IPO would go a long way toward paying for the U.S. Robotics deal. And, admits Senior Vice-President Janice Roberts, "Palm has diluted our management focus."

It also hid some sins. Without the boost provided by Palm, analysts say, 3Com would see flat or slightly lower revenues this year. "3Com's mature markets are fading faster than emerging areas can pick up," Pyykkonen says.

Now, Benhamou is beefing up 3Com's home and small-business lines and has forged a sweeping partnership with Microsoft Corp. Indeed, Benhamou says getting rid of Palm will let 3Com get closer to Microsoft, whose Windows CE competes with Palm software. The alliance is key to keeping 3Com at the center of the PC business.

TRICKY SEAS. But it may not be enough. Benhamou continues to insist that 3Com will be the leading seller of communications gear, such as modems and network-interface boards for PCs, for individuals. But those markets are in flux--and 3Com may be falling behind: While it dominates sales of conventional modems, 3Com isn't No. 1 in either cable or digital subscriber-line modems used in broadband links. And it hasn't been a strong player in home networks.

The Palm spinoff is only one step on the road to 3Com's recovery. If Benhamou can't squeeze more growth out of networking, the company could still be bought or sold off in pieces. The spinoff "will give us a new clarity," Benhamou says. True, but that clarity unmasks a really tough job ahead.

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