Insiders Are Bullish on Jilted 3Com

Failed Marriage, Not a Failed Business

When I see these "crash-and-buy" insider patterns, it is usually the result of an earnings miss or other fundamentally generated concern. When insiders buy into these scenarios, the stock-price bounce their action often wanes when investors realize that it will take more than a quarter to fix the fundamental problem. It usually pays to wait for the fundamentals to catch up with insiders' optimism. But the crash in COMS came primarily from government intervention, which emboldened me to get into the stock soon after seeing the insider activity.

Fundamental risk was not absent back in April, however. Although Bain used the government as the excuse to call off the buyout, it is likely that they made extra efforts to wiggle out of the deal because of the weakness evident in 3Com's sector since its September 2007 bid was announced. The weakness was evident in the sharply lower share prices of peers such as Nortel (NT Quote) and Cisco (CSCO Quote) beginning last fall.

But fundamental concerns haven't panned out. 3Com's third-quarter results (ended February), though hardly fantastic, were not disappointing. The firm's fourth-quarter (ended May) actually beat expectations. Ditto for results for 3Com's first quarter, released at the end of September.

After ratcheting up sales by 2% last fiscal year, 3Com's revenue increased 7.3% in its first quarter (ended Aug. 29). Gross margin for the latest period jumped nearly nine percentage points to 55.3%. Earnings per share (EPS) for the first quarter rose from 2 cents last year, to 11 cents on a non-GAAP basis. The company also generated another $39 million in cash flow from operations in the quarter. China sales represented 51% of 3Com's total for the period, and generated 61% of its gross profits.

Earnings are presently expected to increase 65% in the coming year, to 38 cents per share. Yet 3Com trades for just 6.4 times this expectation -- even though the firm also has 59 cents a share of net cash on hand. OK, so the estimates are non-GAAP. But the growth -- and solid balance sheet -- is undeniable, as is management's execution.