Wondering About the Machinations and Value of H-3C

LightReading published an article last week on the bidding war for the H-3C joint venture between Chinese networking company Huawei and the ever-changing 3Com Corporation.

That article raised more questions than answers, and it has me wondering about what’s really happening behind the scenes as executives from Huawei,  3Com, private-equity companies, and perhaps a few other networking vendors jockey for position.

Here’s an excerpt from the LightReading piece:

Potential bidders for 3Com or the Huawei JV include a range of private equity players, Juniper Networks Inc., and Nortel Networks Ltd., say several Wall Street sources. The Wall Street Journal had previously reported that the private equity companies Texas Pacific Group , Bain Capital , and Silver Lake Partners were interested in the assets. But interest from equipment vendors such as Juniper and Nortel is a new development that could precipitate a bidding war, sources say.

Okay, who are these "sources," and just what is their interest, if any, in the bidding for the H-3C joint venture? Honestly, I cannot envision Juniper or Nortel getting involved in an auction that already has reached $1.5 billion to $2 billion, and could go much higher. Given all its other challenges and issues, Nortel is in no position to make such a move, and Juniper probably wouldn’t want to buy a company that sells such a high proportion of low-margin networking gear.

Then again, the LightReading article provides a rationale for the reputed interest of Juniper and Nortel in the H-3C joint venture:

Why would Juniper and Nortel get involved? Quite simply, to beat Cisco Systems Inc. to the punch. Cisco likely has the largest revenues of any North American telecom and networking equipment player in China. An acquisition of the Huawei/3Com venture, which is growing fast, would immediately vault somebody into second place in the hot Asian region.

Make no mistake, the H-3C joint venture is exhibiting robust revenue growth. It’s also profitable, unlike nearly any other group within 3Com. H-3C’s products are selling in China and elsewhere in Asia, and, if future growth were assured, it would make an excellent acquisition candidate for a player willing to compromise on profit margins for top-line growth. I just don’t think Nortel or Juniper matches the profile.

The article makes a case, probably constructed by one of the "sources," that one way to buy into the H-3C joint venture is to buy 3Com. I think that’s a stretch. 3Com comes with a lot of baggage, not to mention a muddled enterprise strategy in Europe and North America that seems moribund, if not stillborn. Even 3Com’s Secure Converged Networking (SCN) group, built around its acquisition of IPS vendor TippingPoint, is losing money.

Finally, and most intriguingly, Huawei seems desperate to sell off its stake in the joint venture. Why? What’s the end game for Huawei? Is it trying to extricate itself from a partnership that has served its purpose, whatever that purpose might have been?

If it sells all or most of its stake in the joint venture, will it still have an interest in ensuring H-3C’s success? Or will it compete against whatever becomes of H-3C with its own products in China and the rest of the developing world? Remember, a lot of the success of H-3C has turned on the sales network and the contacts of Huawei in China. If Huawei withdraws from H-3C, or if it minimizes its exposure to the company’s ongoing operations, a lot of the value of the joint venture evaporates.

According to earlier report in the Wall Street Journal, which quoted its own sources, Huawei wishes to retain a 20-percent to 30-percent stake in H-3C. If that is true, then Huawei still will have enough skin in the game to care about H-3C’s fortunes. However, a subsequent report indicated that Huawei wished to eliminate 3Com from the equation entirely and sell the joint venture in its entirety to a private-equity company, taking its payment in a mix of cash and equity.

It will be interesting to see what level of interest and commitment Huawei maintains with regard to the joint venture. It will be a crucial factor in assessing the valuation and prospects of H-3C.

At any rate, there’s a lot of posturing and gamesmanship occurring through the press in relation to the disposition of H-3C. We have no idea what’s really transpiring in private boardrooms, though we do know that 3Com and Huawei can begin bidding for each other’s shares starting November 15, which happens to be this Wednesday.

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