3Com Deal: Bain and Huawei Take Their Money and Go Home

Posted on February 25, 2008
Filed Under Apparatchiks, China Business |

Bain Capital’s pending US$2.2 billion purchase of 3Com Corp was thrown into doubt after the leveraged buyout firm and its Chinese partner failed to settle national security concerns with a United States government panel.

Bain and Huawei Technologies withdrew their application to the Committee on Foreign Investment (CFIUS) after the panel raised questions about 3Com’s TippingPoint unit, 3Com and Bain said yesterday.

TippingPoint sells security software used by US government agencies.

The move may scuttle the acquisition of 3Com, which also makes equipment for computer networks, and would add to the list of private equity buyouts that have foundered amid fears of a recession and limited access to debt financing.

The deal may not be officially dead, but it certainly looks terminal. The Post had Huawei’s reaction today:

“Due to the complexity of the acquisition process, the increase in acquisition costs and the significant change in stock-market conditions since last year, Bain and Huawei have announced their intention to withdraw their application relating to the proposed acquisition,” Huawei said in a statement on Saturday.

Huawei, according to an unnamed insider, really means protectionism when they say “complexity”. People’s Daily:

Industry insiders say Huawei initially wanted to go it alone in the acquisition, but later invited Bain to dilute its stake to ease political concern.

…The Huawei source said the security fears about the acquisition are being hyped by the looming US presidential election.

“The US is almost the last market where we have been unable to build a significant presence (due to protectionism),” he said.

Huawei last year reported $16 billion in contract sales, with 72 percent from overseas. It has been selling products in more than 100 countries, but its US expansion has been bumpy.

…”We have had great difficulties in securing contracts from US operators although we outperformed our rivals in technology tests,” the Huawei source said.

I’m not sure who invited whom to the table on this, but Bain is pretty clever. Along with Goldman, Sachs, the investment bank behind the deal, they anticipated the national security considerations that were sure to raise a red flag. Heidi Moore, at the Wall Street Journal’s Deal Journal blog, makes a great observation about 3Com’s recent amendment to the proxy filing for the deal:

But 3Com didnâ€™t sound as glum in Tuesdayâ€™s exceptionally interesting amendment to the proxy filing for the deal. The amendment, which was filed last night, indicates Bain and 3Com always expected to divest Tipping Point. (Not that they told anyone else before, but ok). In fact, the proxy says Goldman Sachs Group, 3Comâ€™s adviser, has spoken with seven potential buyers for Tipping Point, including four corporate parties and three private-equity firms, one of which was Bain itself.

The Goldman bankers even went to the trouble of valuing 3Com both with and without Tipping Point. With Tipping Point, 3Com was valued at as much as $5.85 a share; without it, only around $4.50 to $5 a share.

Clearly Bain knew that Tippingpoint was going to be problematic from a national security perspective and was ready to unload it at the first opportunity. This was almost certainly communicated to CFIUS during the second phase of the review (if not the first). Yet despite this effort to mollify CFIUS, they weren’t satisfied and signaled that the deal wouldn’t be approved.

The mysterious Huawei insider is wrong. The rejection has nothing to do with protectionism. 3Com may not be owned by Huawei, but 3Com sales to Huawei via its H3C subsidiary in China are what pay the bills. Its data and voice business unit bleeds money and Tippingpoint barely covers operating expenses. There really isn’t much of a 3Com to protect anymore. It’s just a captive vendor of Huawei’s.

The rejection has everything to do with politics. The only question that remains is which politics? Was it because of Blue Team (a loose grouping of anti-communist China politicos) antipathy or was it squelched so that it wouldn’t become grist for the election year mill? I really don’t know, and that’s the biggest problem here. There’s no public standard by which the deal was judged. There were no hearings that explained what the national security implications were. CFIUS hasn’t even deigned to explain itself. All we are left with are anodyne corporate statements, unattributed complaints, and the implied judgment of some cross-border M&A star chamber.

Tippingpoint may get sold or listed anyways, Huawei could buy H3C and wash its hands of 3Com, Bain will find other deals, and 3Com will go gently into that good night.

Who’s really the victim here? Shareholders who have seen a quarter of 3Com’s valuation knocked off courtesy of a heavy-handed bureaucracy. And not the Chinese one, either.