In a Form 8-K filing registered today with the SEC, 3Com disclosed that the mutually agreed bid process for the ownership of H-3C, its joint venture with Huawei Technologies, commenced today. Actually, 3Com disclosed more than that, even as it announced that it would be keeping quiet about the disposition of H-3C until it has something substantive to announce.
What follows is the text of 3Com’s 8-K filing. After you’ve reviewed it, I’ll provide my analysis of what I think it means.
On August 8, 2006, we announced our intent to negotiate an agreement with Huawei Technologies, or Huawei, to increase our ownership stake in Huawei-3Com, our Chinese joint venture, or H3C. While we intend to continue to vigorously pursue negotiations with Huawei, on November 15, 2006 we initiated the bid process under the shareholders’ agreement by submitting a bid to buy Huawei’s entire ownership interest in H3C. It is important to note that our initiation of the bid process does not in any way preclude the parties from reaching a negotiated agreement outside of that process. As previously disclosed, under the terms of the shareholders agreement between Huawei and 3Com, beginning November 15, 2006 Huawei can bid to buy 3Com’s entire 51 percent stake in H3C or 3Com can bid to buy Huawei’s entire 49 percent stake in H3C. This process is solely between Huawei and 3Com. Upon the initiation of the bid process, the party receiving the bid has three business days to counter with its own offer that is at least two percent higher on a per share basis, or the received bid is deemed accepted. Unless the parties mutually agree otherwise, this process continues until a bidder prevails.
We believe it is in our interest to keep the current negotiations with Huawei confidential. Therefore, subject to applicable securities laws or unless we otherwise determine it is in our interest, we intend to refrain from further disclosures regarding the status of the negotiations or the bid process until a definitive agreement is executed or the bid process has ended or is deferred pursuant to the mutual agreement of the parties.
While we continue to seek to increase our ownership in H3C through a negotiated transaction or through the bid process, we cannot predict the outcome of either the negotiations or the bid process or assure you that any agreed transaction will be consummated. Further, the bid process may result in 3Com selling its entire interest in H3C to Huawei. If Huawei purchases our interest in H3C, we will need to implement successful alternatives to our current strategy of increasing our investment in H3C. We may also be limited in the types of investments we can make with the proceeds of any potential sale because of the Investment Company Act of 1940.
In addition, while 3Com and Huawei, as shareholders of H3C, have agreed not to compete under certain circumstances with H3C for a period of 18 months after one party wins the bid process, if we are unable to reach a negotiated agreement with Huawei and instead win the bid process, Huawei may reduce its business with and operational assistance to H3C and we may face increased competition from Huawei.
I think 3Com is sending some strong signals here. What I believe it is saying is that it is leaning toward selling its share of the H-3C joint venture to Huawei, which will then sell the entire joint venture — or a majority stake of it — to one of the private-equity firms avidly pursuing it.
Why would 3Com sell its 51-percent share of H-3C, especially after it signaled that it wanted to own the vast majority of the joint venture, if not all of it? 3Com appears to provide the answer by noting that Huawei, whose operations and sales teams have been largely responsible for the success of the joint venture, might choose to compete against whatever becomes of H-3C after the non-compete clause expires.
I believe 3Com knows it cannot make H-3C a success without the ongoing support of Huawei. I also believe that Huawei has indicated, firmly and unambiguously, that it no longer wishes to continue in its business partnership with 3Com. From the Chinese networking vendor’s standpoint, whatever value Huawei saw in working with 3Com has been fully derived or has passed. Huawei has made a decision to move on, and it will not change its mind.
What does that mean for 3Com? It means, I think, that 3Com is preparing its shareholders for the eventuality that it will sell its share of H-3C. That share could be worth as much as $1 billion, which 3Com could reinvest in its remaining business units, even though it has given notice that it might be materially circumscribed in the moves it would be permitted to make.
Considering the track record of 3Com in past years, shareholders should be skeptical of the company’s ability to successfully reinvest the proceeds that might be derived from a sale of its stake in H-3C. Perhaps, if the scenario I have sketched comes to fruition, 3Com shareholders should push 3Com to sell its remaining husk to a networking vendor in a better position to realize gains from 3Com’s assets.
If I were a betting man, I would take today’s filing as a sign that 3Com is preparing itself for a future without H-3C. The company’s shareholders should do likewise.