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Wednesday, August 30, 2006

Is There an Underlying Value to 3Com? Maybe a Backdoor Play

Stock Tickers: COMS, CSCO, JNPR, ALA, LU, NOK, SI, CY, SIVB, RNWK, MOT, NT, "Huawei,"
"H3C"

3Com (COMS) is a name easy to hate, and it is a crying shame what they allowed to happen to their company. They used to be neck and neck once upon a time with Cisco (CSCO) and other key networking companies, and they even spun off their Palm (PALM) operating system and PDA unit in a separate IPO that was never given out to COMS holders. You will have to hear some additional ranting and some personal attacks, but there may still be some hope for the company.

I personally have come out swinging against this company publicly, privately, under the table, and over the table. I even have used the analogy that management needed to be marched out the back door and gunned down in the alley, but that has such a harsh and mean tone that I won't use that analogy any longer (even to them). Until Mr. Benhamou is 100% gone and completely out of the company to the point that no one inside the company will take his calls there is risk. It isn't fun attacking people personally, but from everything we have been able to deduce he is still active in some of the key decisions since he is still a non-executive Chairman. He is also the chairman of Cypress Semiconductor (CY) and sits on the boards of RealNetworks (RNWK) and Silicon Valley Bankcshares (SIVB), which may make those shareholders worry.

Even with him still wedged in there, COMS has a hidden weapon and may have a hidden value. It is the majority owner of the Huawei joint venture now called H3C that designs and markets enterprise-networking products, including switches and routers, and owns its marketing and intellectual resources. This is the one that has been noted by many industry insiders that was dubbed the "Cisco knock-off" because of so many similarities from the look and feel of the interface all the way down to the basic source code. Those legal issues with Cisco were also settled some time ago. COMS even gets to now count the revenues as its own now since it bought the extra 2% from Huawei to get to the 51% controlling interest. That may be a sketchy practice to count 100% of it as their own and there are have been many complicated and intertwined structures inside the deal, but this is still the remaining hidden value in COMS. I even questioned them in my last article why on earth in their last restructuring why they don't just close all other operations to focus on this H3C.

I have seen several articles (including 2 from contributors here at 24/7 Wall St.) stating that it is too bad that Huawei is not a public company, but very few of them ever refer to the Huawei-3COM 'H3C' venture. This may even be a legitimate "Backdoor Play" into Huawei as I have dubbed it in many other articles discussing IPO spin-offs and other special investing situations. This is the only area growing and industry insiders have said that this is sufficient so long as a company doesn't need massive tech support from their networking equipment makers.

Oddly enough, Juniper Networks (JNPR) was reportedly in talks to buy this venture earlier this year. Unfortunately Juniper has been riddled and plagued with departures and other ongoing problems. Both NorTel (NT) and Motorola (MOT) have agreements with Huawei. Now that Cisco (CSCO) is just about set up to literally offer every single solution (except for laying the actual fiber) for data literally leaving web servers all the way right up to your ethernet port or web device (same analogy for phones and VoIP devices now), you have to wonder if someone else will give any value to COMS. The mergers combining Alcatel (ALA) and Lucent (LU) and combining the Siemens (SI) and Nokia (NOK) networking operations are really forcing the "global one-stop shop" business model, and this hidden value in COMS "could" be one of the ways a company would roll the solution into their portfolio.

Juniper (JNPR) was recently thought of in the same light, but they may have so many issues that need to be fixed outside of their next generation routers and switches that it may just not be in the cards. It is quite obvious that there are still many spots and holes in many networking and communications equipment/solutions companies out there that this argument can still be made.

Regardless of what happens, if anything, this H3C may be the last saving grace at COMS. I criticized COMS back on June 21 and on June 29 and have criticized them on many other occasions before then. On June 21 the closing price was $4.61 and when I questioned the post-earnings rally on June 29 the closing price was $5.10. COMS has traded up to a high of $5.31 shortly thereafter, but the shares now sit at back down at $4.39 after a 3% rally today. The 52-week trading range is $3.29 to $5.70.

COMS now has a mere market cap of $1.73 Billion, which means if you gave the ex-H3C value of $0 from COMS that the entire value of H3C would be approximately $3.45 Billion. It is very difficult to trust analyst estimates, but they have COMS generating a $0.02 EPS for fiscal May 2007 and $0.19 EPS for fiscal May 2008. They will have some substantial charges for their ongoing restructuring, but their balance sheet is actually ok as of the last available report. The company holds $864+ million cash and short-term securities, and it has $178 million in receivables. Its inventories and "other" assets are $206.6 million, but we'll value those as close to Nil for break-up comparison. That leaves their current assets valued at $1.035 Billion. We will allow them to count plant & equipment at 50 cents on the dollar, so $44.5 million, will give them $0.00 for their Goodwill ($354 million on the books), will also give their intangibles and "other" assets a Zero value (combined as $168+ million on the balance sheet). $1.079 Billion is what we are counting the underlying raw assets. We know there is some value in the other assets, but this is how to really break out raw values. The company's total Liabilities and minority interests come to just under $659 million, but $173.9 million of that is a minority interest that also "may" have some negotiated play left. This still leaves a raw $620 million net net left over after all liabilities as far as a raw value, and any company worth their weight in salt would know how to squeeze out some value out of the garbage assets I assigned a Zero value to.

Even after Juniper's (JNPR) massive sell-off they still have a market cap of $7.99 Billion, so you would have to pay way up for what the street feels is a company with a black eye if you wanted to use the same theory for that company. Personally I cannot officially endorse COMS yet because of the management and its SNAFU of an operating history that graduating business students would love to have as their exit case study. But it would just be foolish to not acknowledge that there are many big sharks out there needing to increase offerings that could look at an acquisition. COMS "may" be deemed as a cheap way to play in this group, but we would encourage anyone who was going to acquire the company to unload all non-H3C management without any questions.

In summary we can argue that there is some value here, but it isn't without risk and it certainly isn't without some painful memories.

Jon C. Ogg
August 30, 2006

Jon Ogg can be reached at jonogg@gmail.com and he does not own positions in any of the companies he covers.
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