3Com: Suing Bain to Ease the Pain

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

3Com shareholders on Friday voted to approve the $2.2 billion merger agreement with Bain Capital Partners, despite Bain terminating the deal on Thursday.

Approving the failed deal allows 3Com to aggressively pursue a $66 million termination fee since Bain backed out of the buyout agreement that would’ve made 3Com a wholly owned company of the investment firm.

In a filing with the Securities and Exchange Commission 3Com said Friday that nearly 70 percent of its shareholders voted in favor of the Bain acquisition.

In a statement Marlborough, Mass.-based 3Com said it believes Bain’s termination of the merger agreement was invalid and it will fight Boston-based Bain for a break-up fee.

I’m not familiar with the agreement for the acquisition, I can’t assess whether or not 3Com’s suit is with merit. And as much as I would like to blame the bureaucrats at CFIUS, they don’t appear to be at fault. Bain pulled out after 3Com wouldn’t agree to the reshuffled deal that Bain cobbled together to satisfy the CFIUS apparatchiks:

On Thursday, Bain released a statement saying it has terminated the agreement after merger talks with 3Com dissolved. Bain said the Committee on Foreign Investment in the United States (CFIUS) was going to prohibit the deal, which would’ve given a 16 percent stake to Huawei Technologies, China’s largest networking equipment maker.

“Bain Capital made several alternative proposals to 3Com that we believe could have satisfied the concerns raised by CFIUS,” Bain said in a statement. “We regret that we were unable to agree upon an alternative transaction.”

3Com, however, said the discussions could not produce an agreement that it felt benefited shareholders.

“3Com acknowledges that Bain Capital did submit non-binding, confidential proposals to the 3Com Board of Directors, however, the Board determined such proposals were not in the best interest of shareholders,” 3Com said.

There are two subsidiaries of 3Com that are at the heart of the deal: TippingPoint, because they provide security solutions to the US government, and H3C, the only profitable part of 3Com that is, in effect, an ancillary arm of Huawei in China.

Tippingpoint was said to be packaged for sale or IPO to satisfy CFIUS. As that was the plan all along, I don’t think the latest proposals from Bain to 3Com’s board substantially altered that. It’s something involving H3C. Seeking Alpha has the transcript from 3Com’s latest earnings call, and H3C was the good news:

H3C revenue in its fourth quarter, which as a reminder is October through December 2007, was a record $213 million, 9% year-over-year growth and 16% sequential growth. For its fiscal year 2007, H3C revenue was $758 million compared to $711 million a year ago. In addition to the revenue growth, gross margins continued to climb, reaching a record 57% and operating profits were almost 85% higher than they were a year ago, coming in at $47 million.

This strong performance in the quarter was really driven by two factors. First, direct sales in China were up significantly. You may recall that over the past few quarters, this was an area we believe was impacted by the uncertainties surrounding our ultimate acquisition of the remaining 49% of H3C from Huawei and our subsequent integration efforts once we owned 100% of H3C.

The call goes on to rhapsodize about H3C and its success. It provides something like two-thirds of 3Com’s revenue. 51% of 3Com’s overall revenue came from sales in China. Huawei is H3C’s biggest customer.

H3C is what Bain and Huawei wanted, not 3Com. 3Com is positioning H3C as its manufacturing and Asian sales base, it’s the future of 3Com. North American sales continue their slow decline and the Asian (primarily China) markets represent the best opportunity for 3Com’s growth. Maybe 3Com feels that Bain is now low-balling them on a revised price.

3Com’s non-compete with Huawei has six more months to run. Although the earnings call noted that direct sales in China has been a strong point, Huawei remains the dominant customer for H3C. 3Com should be careful not to rock the boat too much. If Huawei becomes a competitor rather than a partner, they’re in for a very rough ride.