3Com in World of Hurt Without Huawei

For years, 3Com’s H3C business unit has ridden on the coattails of Huawei Technologies Co. Ltd., tapping the Chinese networking vendor’s contacts and customer relationships for all they were worth — which turned out to be a lot.

Almost three years ago, however, 3Com and Huawei officially went their separate ways, with 3Com assuming control of H3C when it bought Huawei’s stake in the erstwhile joint venture. After the formal split, H3C continued to benefit from its relationship with Huawei, which agreed to a non-compete clause that precluded it from selling its own products — or those obtained from a third-party vendor — in place of the H3C gear.

Now, however, the non-compete period has long expired. Huawei is aggressively moving away from selling H3C gear, looking to sell its own products whenever possible. 3Com revenue derived from Huawei is destined to fall precipitously, with the decline having begun already.

Reporting its latest quarterly results, 3Com said Huawei accounted for $230 million, or 17 percent, of revenue for the year ended May 29. Sales to Huawei will fall to $50 million to $100 million this year, according to 3Com. My guess is that the Huawei contribution will be even smaller than that.

Jay Zager, 3Com’s CFO, knows what’s coming:

“When the non-compete clause expired, the question was always when they would produce their own products. It didn’t happen in 2009, when we anticipated it would. We expect two years’ of reduction coming in the next two or three quarters.”

That obviously represents a problem for 3Com. What makes it worse is that 3Com will not be able to compensate for the loss of Huawei business in China, where it is attempting to build its own channels and customer base; nor in Europe or North America, especially the latter, where 3Com’s name has been tarnished severely by its historical cut-and-run lack of commitment to enterprise customers and markets.

3Com has done a masterful job with PR earlier this year, driving up its stock with a narrative about its comeback as an end-to-end purveyor of networking gear capable of taking share from an allegedly distracted and vulnerable Cisco Systems, longtime hegemonic power in enterprise networking.

Indeed, Cisco is heading off in many directions, and it might be exposed to other players, but HP, with its ProCurve gear, looks set to pick up whatever marbles slip from Cisco’s grasp. IBM, thanks to OEM deals with Juniper Networks and Brocade Communications, also is well placed to take some business — and don’t be surprised if IBM doesn’t acquire Juniper or Brocade at some point.

Both HP and Cisco see the opportunity of data-center consolidation — servers, storage, networks, the whole shooting match — aided and abetted by virtualization. IBM sees it, too, but it hasn’t yet committed to direct ownership of a networking business unit, perhaps still reeling from the field-sales hangover that resulted from its former addiction to Cisco as a networking partner.

Nevertheless, the 3Com marketing story was good. It had just enough plausibility to turn analysts’ and invesetors’ heads. Moreover, the story diverted attention from 3Com’s own problems with diminishing Huawei-derived revenue. During the marketing push, 3Com shares surged, hitting a 52-week high in early June. Some deluded souls even thought the company might be acquired at a juicy premium.

Those people should have followed the sage aphorism of Friedrich Nietzsche, presumably coined when he was not afflicted by syphilis:

Hope in reality is the worst of all evils because it prolongs the torment of man.

Torment for 3Com shareholders might last for a while, too. I do not see how 3Com can extricate itself from the conundrum of having to generate significantly higher revenue from its non-Huawei engagements. 3Com is in a difficult bind, one that it readily acknowledges.

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