Randy Fay

3Com Corp.: Undervalued by Half

Remember, the market can stay irrational longer than you can stay solvent. Funny 3com is mentioned as perhaps the most textbook case of irrational pricing.
On March 2, 2000, 3Com sold 5 percent of its stake in Palm to the public through an IPO for Palm. Pending IRS approval, 3Com planned to spin off its remaining shares of Palm to 3Com's shareholders before the end of the year. 3Com shareholders would receive about 1.5 shares of Palm for every share of 3Com that they owned, thus the price of 3Com should have been 1.5 times that of Palm. Investors could therefore buy shares of Palm directly or by buying shares embedded within shares of 3Com. Given 3Com's other profitable business assets, it was expected that 3Com's price would also be well above 1.5 times that of Palm.

The day before the Palm IPO, the price of 3Com closed at $104.13 per share. After the first day of trading, Palm closed at $95.06 per share, implying that the price of 3Com should have jumped to at least $145. Instead, 3Com fell to $81.81.

The day after the IPO, the mispricing of Palm was noted by the Wall Street Journal and the New York Times. The nature of the mispricing was easy to see, yet it persisted for months.

In cases of equity carve-outs, a negative "stub value" indicates an extreme case of mispricing. The stub value represents the implied stand-alone value of the parent company's assets without the subsidiary, a projection of what the company will be worth after it distributes these shares.

In the case of Palm and 3Com, after the first day of trading, the stub value of 3Com, representing all non-Palm assets and businesses, was estimated to be negative $63, a total of negative $22 billion. Since stock prices can never fall below zero, a negative stub value is highly unusual.