Can Plummeting Cable Modem Prices Be Good for Companies That Make Them?

Also, more Lernahoulians, another ka-thump at Heartport and one analyst's nightmare.
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Thursday Thud

Modem melee:

It was only a few weeks ago that

Credit Suisse First Boston

analyst James Parmelee told clients he thought price declines at

Com21

(CMTO)

, a leading maker of cable modems, were "tracking" with his expectations. Then, earlier this week, Parmelee, whose firm took Com21 public, rattled investors with a special note that said the company's management had "adopted a more aggressive near-term pricing strategy to pre-empt competitive threats."

That raises the question of whether the cable modem biz is headed toward the same commodity morass that buried the noncable modem industry and has, at one time or another, trapped virtually every other fast-growing high-tech company. Only faster.

At Com21, the proof is in the profit margins, which appear to have passed their peak. Gross margins increased from 33.4% in the first quarter of 1998 to 44.1% in the first quarter of 1999, thanks largely to cost reductions. Now Parmelee has revised his second-quarter gross margin outlook to between 38% and 39%; his original estimate was 39%.

Price declines are hardly unexpected in the cable modem market. In its most recent 10-Q, Com21 said sales prices of cable modems continued to decline "during the first quarter of 1999 due to competitive pricing pressure." The company added that it expected prices to fall at a faster rate over the next few quarters. But Parmelee's comments, which caused Com21's stock to fall by 18%, suggest they're falling even faster than the company had expected.

Com21 officials couldn't be reached, but a spokesman for rival

Terayon Communications

(TERN)

says his company has been expecting 5% price declines per quarter. "There are no surprises," he says. "It's part of building a market. There's a huge market opportunity, and we're just at the beginning of it."

Indeed, and it's a market that's already attracting competition from the likes of

3Com

(COMS)

,

Samsung Electronics

and

Toshiba

. The more competition, the lower the price. Terayon CEO Zaki Rakib agrees, but adds, "The faster the price goes down the better for Terayon because the faster it will get those guys out of the market." What's more, he likens Terayon, which uses its own chipsets, to

U.S. Robotics

, which used its own chipsets. Everybody else, he says, buys from

Broadcom

(BRCM)

much the way the old-line analog modem makers bought their chips from

Rockwell International

(ROK) - Get Report

. The result, he insists, is that he'll have the cost advantage.

He very well may be right, but skeptics worry this is too soon in a product's life cycle to worry about margins. Having a cost advantage in a business with razor-thin margins, if that's what this industry becomes, is nothing to brag about.

Lernahoulian alert:

An item

here Wednesday noted how

Lernout & Hauspie's

(LHSP)

receivables jumped to 112 days from 95 days outstanding. The suggestion was that the company granted favorable terms to certain customers, artificially helping sales and earnings. Earnings wound up narrowly beating the Street, despite an 8% decline in sequential sales. (A decline in sales at a growth company? Hmmm.)

Longtime Lernout short-seller Marc Cohodes of

Rocker Partners

figures if receivables days outstanding had merely stayed the same, Lernout's sales would have been down by 25%, which in turn would've wiped out virtually all of the company's profit in the quarter, which in turn wouldn't have played into the hands of the Lernahoulians, who bid up the stock 1 9/16 yesterday to close at 38 7/8.

I did not seek an explanation from Lernout because representatives there still haven't responded to any of my prior inquiries from recent weeks.

Blame it on the press (ka-thump):

Heartport's

(HPRT)

just-published 10-Q includes an unusual disclosure that blames some of its latest problems on a May 5 negative story in the

Wall Street Journal

. Heartport, no stranger to this column, makes devices used in minimally invasive open-heart surgery.

"Among other things," the company says, "the article implied that the Company's

Port-Access

products were not safe and that the U.S.

Food and Drug Administration

is considering regulatory action. The article did not reflect the excellent clinical outcomes surgeons have achieved with Port-Access minimally invasive cardiac surgery. With regard to the FDA, the Company has a longstanding working relationship with the agency, and in late 1998 as part of a routine inspection the FDA conducted a comprehensive review of the Company's facility and quality systems, including complaints and adverse events. The inspection was satisfactorily concluded with no formal observations.

"In reaction to the article, some of the Company's customers have suspended the Port-Access program at their hospitals until they have a better understanding of the issues raised in the article.

"Although it is too early to assess the full impact of the article on the Company's business, the Company believes that it may have a material adverse effect on the Company's net sales and results of operations for the quarter ended June 30, 1999, and possibly longer."

That can't be good at a company that, as of last quarter, had $43 million in cash and burns through roughly $8 million per quarter. Heartport has shifted its strategy to become a full-service shop for all products used in cardiac surgery, putting it in the line of fire of some well-heeled competitors. CEO Frank Fischer says they don't have all of the products his company has, and he believes Heartport has plenty of cash to get the new products out later this year.

That puts Heartport in the category of being a "show me" company. "We've been a show-me company for a long time," Fischer says.

True, but based on the company's stock price, which closed yesterday at 4, investors are tired of waiting for the show to start.

Oops:

Goldman Sachs

analyst Robert Hottensen now knows better than any analyst that timing is everything. On Tuesday he put out a table-pounding re-recommendation of

Providian Financial

(PVN)

, saying the company has developed "the most compelling and differentiated Internet platform within the credit-card industry." His 12-month target: 175. Wednesday the stock dropped 17 3/16, or 14%, to 106 15/16, after the company announced, on the heels of a

San Francisco Chronicle

story, that it was being investigated by the

San Francisco District Attorney's

office for possible fraud. Hottensen couldn't be reached.

Herb Greenberg writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at

herb@thestreet.com. Greenberg also writes a monthly column for Fortune.