3Com Is Now Really Going After Cisco

I just got off the phone with Eric Benhamou, with whom, as you know, I have been discussing 3Com and Palm recently.

I said earlier that 3Com is trying to take on Cisco with its Chinese JV H3C in my Online Video Beneficiaries series, and that Cisco is a fat company that deserves to be gone after by someone who has his act together with a lower cost alternative, especially in emerging markets.

Well, 3Com has agreed to be acquired by private-equity firm Bain Capital Partners LLC for about $2.2 billion in cash.

The $5.30 a share offer is a 44% premium to Thursday’s closing stock price. Shares of 3Com surged ahead of the announcement as The Wall Street Journal reported a deal was imminent and the rest of the financial media started picking up the news. At the time of writing this piece, the stock has surged to $5.10.

As part of the deal, set to close in the first quarter, Chinese networking giant Huawei Technologies Co. will acquire a minority stake in 3Com. The stake, currently at 10%, may increase over time to 15-20%, as the strategic alliance gets sorted out in more detail.

The obvious reasons for the market’s excitement is that this is the first large private equity transaction since the subprime credit meltdown, and also this is one of the first major China deals this year. Huawei is China’s largest telecommunications-equipment maker, and with their low cost structure can give Cisco and others a run for their money.

3Com had a JV with Huawei called H3C which they bought the outstanding 49% of last year at a cost of $882 Million. At this time, Bain Capital tried to buy H3C as well, and in the process got close to 3Com. The investment thesis for both Bain and 3Com have been the same: to go after Cisco with a substantially lower cost alternative, starting with emerging markets. In fact, although 3Com’s strategy has been to go after Small Medium Enterprises (SME) in the US, in the emerging markets which are far more price-sensitive, the H3C cost-structure is incredibly important. And now, with Huawei’s air-cover, they can meaningfully penetrate both small AND large enterprises in China, as well as expand into Latin America, Eastern Europe, etc. through 3Com’s channels.

It’s an exciting deal, and finally, Cisco would need to sit up and watch!

Contrary to the Wall Street Journal’s reporting, Tipping Point, 3Com’s secure networking arm, which is believed to be a valuable asset and which 3Com has announced would be spun off and taken public separately, is still on track to be spun off. The only difference may be that the company could undergo a strategic sale, rather than an IPO. That is yet to be determined.

Of course, there have been lots of concerns about 3Com’s ability to integrate the H3C merger and be able to execute on the market opportunity which clearly is there. The Bain transaction, so far, is silent on any management team changes, although it is fair to assume that whatever changes are necessary will be made.

I asked Eric to comment on the similarities between the 3Com and Palm Private Equity deals.

“Yes, there are similarities between the two transactions, in that each have one Private Equity sponsor with a clear strategic insight. The investment thesis is one of a large market opportunity, and under-execution on the part of the public company. In the case of Palm, Elevation Partners is betting on the Convergence Device movement, and that Palm has been under-executing. They have also brought to the table a unique strategic value, in form of John Rubinstein, father of the iPod.

In the case of 3Com, the bet is on the networking market, the growth of online video, the tremendous emerging market opportunity, and the strategic value addition is Huawei.

In both cases, I came to the conclusion that the market at present is not rewarding steady execution in a turnaround. We could return to profitability and produce better products, but the market continues to ignore us. Incremental improvement is not what the market rewards. It is looking for bold moves, and so we have, in each case, gone ahead and included a private equity player to signal that bold move.”

3Com’s stock went from a Friday opening price of $3.70 to $4.94 at the close. 116 million shares traded hands.

Comments

[Lisa]

Changing the capital structure alters nothing. 3Com has been going after Cisco for years -- including setting up its JV with Huawei -- to no avail.

[bobber]

as a 20-year networking veteran, I'd like to point out that 3Com has traditionally been a hardware company and its forays into software have been generally disasterous - viz their 'remote access' and the joke "NetBuilder"... However, if they ever change their culture and develop software competitive to Cisco IOS, they could have a decent chance as, IMO, Cisco is falling behind in innovation and customer friendliness.

[User 110352]

I'm another networking vet, worked for cisco for 11+ years, been pushing bits through pipes for 10+ more years besides.

3Com existed before cisco did. 3Com could have prevented cisco from becoming as big as it has at multiple inflection points in the market in the last 14 years. 3Com didn't, and the reason why is that 3Com's engineers cannot write software, mostly because their management won't allow them to.

3Com cranks out lots of hardware, but they cannot successfully add deep functionality to it.

As more security, traffic shaping, etc is pushed down into the network fabric, the need for software grows, and 3Com becomes a weaker competitor, not stronger. 3Com might find some success at the very margins of the fabric, but they're not going to knock cisco off anytime soon unless they get rid of their current management and infuse the company with some people that know something about software.

We can see from the history & landscape of the tech industry that there are very few hardware-centric companies that successfully create a software organization within them. It is really quite difficult, and it really does require a wholesale change in management, because the hardware-centric management just doesn't "get" software. Never have, never will.