3Com Corp is negotiating to increase its interest in its Huawei-3Com Co Ltd (H-3C) joint venture from 49% to a controlling 51% in a move that it would enable it to consolidate its share of the company’s results into its own figures and give them a considerably improved appearance.
H-3C was set up in November 2003 and has expanded rapidly, selling enterprise networking products. According to 3Com’s 10-K annual statement filed with the SEC, in the year to March 31, 2005, H-3C cut its net loss from $34.1m to $14.1m while sales increased from $61.5m to $297.9m.
Jim Freeze, 3Com’s global marketing director, told Computerwire that H-3C’s growth in China has been mainly at the expense of Cisco, and it aims to increase its 35% market share to be the number-one provider within two years, toppling Cisco from that position.
The big advantage to 3Com, where sales fell 6.8% to $651.2m in the year to May 31, is that the addition of 51% of H-3C’s sales would put it back on a growth path. With a minority stake in the company, it is treated as an investment, and only its share of H-3C’s losses are included in the profit-and-loss accounts.
The opportunity to increase its holding is a one-time opportunity to buy an additional holding for a price of up to $28m on the second anniversary of the original deal. Freeze said the success of the negotiations could not be guaranteed. Any deal will also be subject to regulatory approval by the Chinese government.
More attention will be focused on what happens in the year ahead as both partners have the right to purchase all of the other’s ownership interest through a bid process at any time after the third anniversary of H-3C’s formation. Freeze insisted that such a get-out clause is a normal safeguard in any joint venture agreement and does not imply that the relationship is going to change.
When the company was set up, 3Com contributed $160m cash, its assets in China and Japan, and licenses related to certain intellectual property. For its part, Huawei contributed its enterprise networking business assets, including LAN switches and routers, engineering, sales, marketing resources and personnel, and licenses to its related intellectual property. These assets were valued at $178.2m.
Freeze justified the deal as an economical way of getting into the world’s biggest growth market that will also give 3Com access to low-cost engineering talent. He said that while 3Com has approaching 2,000 staff in total, H-3C employs 2,000 engineers, the majority of whom have advanced degrees.
H-3C has also broadened 3Com’s product line both at the low and high end of the market, and Freeze said it could now offer a complete range of products from the edge to the core of the network.
SEC filings have to include worst-case scenarios, and 3Com said that as Huawei expands its international operations, there will be increasing instances where it competes directly with Huawei in the enterprise networking market, particularly as its access to the H-3C product line will enhance Huawei’s competitive ability.
This does not appear to worry 3Com, which sees its strength as brand identity, breadth of products offerings, and professional services capabilities.
In its last financial year, 3Com recorded a net loss of $195.7m, down from $349.2m, though with cash and equivalents of $844m, it can survive for some time. But with a stock market value of $1.26bn, 3Com looks vulnerable to a takeover. Given their close relationship and its global ambitions, it is a prospect that must have occurred to Huawei.