Bain Capital Walks Away from $2.2 Billion Acquisition of 3Com

Published: March 24, 2008

by Timothy Prickett Morgan

The drama in the private equity markets continued last week as credit continues to tighten despite the efforts of the world's central banks, and in the case of the $2.2 billion proposed acquisition of VOIP wannabe 3Com, one of IBM's key partners as it pushes server-based telephony, the drama has taken a political turn as Bain Capital Partners, which said it would buy 3Com last September, said the deal was coming under pressure from Uncle Sam and therefore killed it.

In a statement released last Thursday, Bain Capital Partners said that the Committee on Foreign Investment in the United States (CFIUS), an interagency body of the federal government composed of members from the Department of Homeland Security as well as the Departments of Commerce, Defense, and State, were going to put the kibosh on the deal because of national security issues. While Bain Capital Partners did not say exactly what the concerns of the U.S. government were, the takeover deal for 3Com did include a minority investment by Huawei Technologies, a Chinese networking equipment manufacturer who is already a 3Com partner. Presumably the China angle and the sensitivity of Internet-style communications was too much for the government, particularly since Huawei Technologies was going to eventually be the manufacturer of all 3Com gear after the deal closed.

Bain said in its statement that it has approached 3Com with a number of tweaks to the deal to try to pass muster with CFIUS, but to no avail. "Bain Capital made several alternative proposals to 3Com that we believe could have satisfied the concerns raised by CFIUS," the statement said. "We regret that we were unable to agree upon an alternative transaction." Exactly what had CFIUS concerned was not specified, nor were the proposals put forth by Bain Capital. But it seems likely that what Bain was proposing was a deal without cash being kicked in from Huawei Technologies, thereby skirting foreign ownership issues. There may have also been proposals to keep some manufacturing under control of 3Com or another third party as well, but again, these things are rarely made public.

3Com has a long history in networking and communications. It was founded by Bob Metcalfe in 1979 to commercialize Ethernet networking that he helped create at Xerox's Palo Alto Research Center, the birthplace to many of the modern ideas that have gone into the PCs that sit at our desks. 3Com acquired modem maker U.S. Robotics in 1997 for $6.6 billion to try to take on networking giant Cisco Systems, and ultimately had to spin out its Palm Computing, which was not very bright, but that's what happens when you let Wall Street make your business decisions for you. 3Com posted sales of just under $1.3 billion in its fiscal 2007 ended June 1, up 60 percent, but it has lost money for five years straight. In fiscal 2007, 3Com lost $88.5 million, which is a vast improvement over the prior four years, when the company lost a total $929.4 million. Yikes.

3Com must have known this deal was going bad, and on Wednesday last week it said that it was going to proceed with its shareholder vote on Friday on the acquisition. The March 19 statement from 3Com also fessed up that CFIUS was raising some eyebrows and that 3Com and Bain had withdrawn their joint filing with the interagency body as they tried--without success--to work a new deal.

"Since the withdrawal, 3Com, Bain Capital Partners, and Huawei Technologies have been working to construct alternatives that would address CFIUS' concerns," the 3Com statement said. "To date, the parties have been unable to agree upon an alternative transaction that addresses CFIUS’ concerns and is acceptable to 3Com's board of directors." Edgar Masri, 3Com's president and chief executive officer also tried to put the best face forward on the situation. "While we remain committed to exploring alternatives that would enable us to complete the merger transaction contemplated by our existing merger agreement, we also remain confident in our long-term prospects" he said. "The company and our strategy, which attracted Bain Capital to 3Com in the first place, have not changed."

Last Thursday, 3Com released another statement saying that it did not believe that Bain Capital's withdrawal of the acquisition deal was valid and that it would continue with its vote on Friday morning while at the same time pursuing a $66 million deal termination fee from Bain Capital.

Predictably, 3Com's stock has been hammered as the credit markets had tightened. When the deal was announced in late September 2007, 3Com's stock price jumped nearly 50 percent to above $5 per share, giving 3Com a market capitalization of $1.8 billion (yes, that was less than what the Bain Capital deal was paying for the company). After holding up through October, the shocks to the stock market and 3Com's continuing economic woes--it had a loss of $35.6 million on sales of $317.8 million in the quarter ended November 30--combined to push the company's share price below $3 a pop. As we go to press on Friday, 3Com's shares are at $2 apiece, giving the company a value of $796 million. Which means it is a potential takeover target again--provided someone has the cash to do the deal, of course.

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