Suitors Eyeing 3Com/Huawei JV
Potential bidders for 3Com or the Huawei JV include a range of private equity players, Juniper Networks Inc. (NYSE: JNPR), and Nortel Networks Ltd. , say several Wall Street sources. The Wall Street Journal had previously reported that the private equity companies TPG Inc. , Bain Capital , and Silver Lake Partners were interested in the assets. But interest from equipment vendors such as Juniper and Nortel is a new development that could precipitate a bidding war, sources say.
"If you have Nortel bidding, Juniper bidding, and the private equity guys, I could see it getting stupid," says Fred Hickey, editor of the High Tech Strategist, who has followed the 3Com/Huawei partnership from the beginning.
Hickey says there are "all sorts of rumors," about the bidding process, and that valuations for the partnership have ranged from $1 billion to $2 billion. He said he once owned shares of 3Com but has sold all of them.
Why would Juniper and Nortel get involved? Quite simply, to beat Cisco Systems Inc. (Nasdaq: CSCO) to the punch. Cisco likely has the largest revenues of any North American telecom and networking equipment player in China. An acquisition of the Huawei/3Com venture, which is growing fast, would immediately vault somebody into second place in the hot Asian region.
The JV is referred to by 3Com and Huawei as "H-3C." It was formed on November 17, 2003, and appears to be exceeding expectations with steady revenue growth and juicy profit margins. According to 3Com's quarterly earnings for the quarter ended August 31, filed on Oct. 11, 2006, the H-3C venture generated $170 million in revenue and $18.2 million in net profits. For comparison, 3Com's other business unit, the Secure Converged Networking (SCN), lost money -- it posted a $32.5 million loss on $156 million in revenue.
H-3C is located in Hong Kong, and has its principal operating center in Hangzhou, China. This year, 3Com exercised an option to acquire a majority stake in the business, and it has the right to bid for more shares from Huawei, which analysts expect it to do.
With 3Com holding a majority 51 percent stake in the unit and Huawei holding another 49 percent of the business, bidding for the business could get complicated. Potential bidders could negotiate with both parties to aquire the business in entirety, or they could negotiate with 3Com or Huawei separately to buy out the majority or minority stakes. Another option would be to acquire the majority stake by acquiring all 3Com shares outright.
Several analysts think that because H-3C assets are buried within 3Com, its value has been heavily discounted.
Matt Shimao, an analyst with Bear Stearns & Co. Inc. , wrote in a report on October third that he valued the H-3C assets at $3.75 per 3Com share. Adding up the rest of 3Com's assets, including $1.75 per share in cash, Shimao thinks 3Com's share are worth $6. They recently traded hands at $4.
"H3C's success in China should continue due to rapid growth," wrote Shimao. "H3C's ability to leverage low-cost R&D is a key differentiator."
Others concur that 3Com's shares may be undervalued due to the growing value of the H-3C asset. One hedge fund manager who spoke to Light Reading points out that, on the current trajectory, H-3C could be generating revenues of $1 billion over the next 12 months. If you put a 2x revenue multiple on that, the business unit would be worth at least $2 billion, making 3Com's stake worth at least $1 billion.
Other 3Com assets of interest include its SCN revenue, the assets of Tipping Point (a security company it acquired), and the potential carryover of net operating losses (NOLs) -- tax losses that could be used by an acquiring company to offset taxes on profits.
"To a buyer, 3Com's NOLs could be worth $1 per share," wrote Shimao in his report.
To add intrigue to the deal, those familiar with the bidding say that outside buyers have a deadline to beat. According to the terms of the agreement between 3Com and Huawei, they can begin to bid for each other's shares starting November 15.
"Under the terms of our existing shareholders’ agreement, and as previously disclosed, we and Huawei each have the right, commencing on or after November 15, 2006, to initiate a bid process to purchase the equity interest in H-3C held by the other," says a recent 10-Q statement filed by 3Com.
Sources say that Huawei is interested in selling more of its stake to 3Com beginning November 15. That makes some people nervous.
"You have to ask yourself why Huawei is determined to sell it," says High Tech Strategist's Hickey. "The Chinese want to slow the economy. This makes me nervous. The value of the deal is having Huawei involved."
That doesn't appear to be slowing down the hungry bidders. With the November deadline approaching, several sources say the bidding action is "heating up."
So far, the vendors reportedly involved are keeping quiet. "We can't comment on rumor and speculation," says Jay Barta, a spokesman for Nortel. Juniper did not respond to a request for comment.
— R. Scott Raynovich, Editor in Chief, Light Reading