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Shares in 3Com Corp. have perked up in the past two months on rumors of a takeover bid. Volumes were also heavy in 3Com’s call options over the same period, according to TradingMarkets.com.

Buying stocks on the basis of takeover rumors, especially those in the headlines like this one, is a practice likely to average out to a random walk. But in this case, there is a fallback option should the tape and rumors turn out to be head fakes.

According to hedge fund Goodwood Inc. (annual compound return of 21.7% over the past ten years), 3Com’s shares (COMS) have been pummeled so much over the years by competition from Cisco Systems and Juniper Networks that they are now trading below intrinsic value. So, if the recent excitement fades, one can settle back as a value investor and wait for a catalyst to emerge.

3Com has a large cash hoard equal to nearly half of the current share price. It also has a 51-per-cent interest in a rapidly growing Chinese joint venture, Huawei-3Com Technology (H3C), that Goodwood values at just over half the current share price (using a conservative price-to-sales multiple to extrapolate) .

Thus, investors in 3Com are getting the rest of its business for free, including Tippingpoint Technology -- reportedly worth more than US$1.00 per share. For the details of the Goodwood’s analysis, see their September report.

Perhaps the catalyst will emerge from 3Com’s current negotiations to buy out its Chinese partner in H3C. Or it might come from Goodwood itself, which has a track record of proactively realizing value for its investments.

Andrew Schmitt of Nyquist Capital fears Cisco’s recent acquisition of Greenfield Networks, a chip supplier to H3C, takes the wind out of 3Com’s sails. But the refusal of Greenfield’s VC backers to pump in more money, and the fire-sale price paid by Cisco (reportedly around US$10 million), would indicate that the company was not a supplier of a strategic offering.

COMS 1-yr. chart

COMS Investment

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Source: 3Com Ready For Technical and Value Investors