U.S. concerns stall Bain, 3Com deal on Chinese stake

PHILADELPHIA/SHANGHAI Thu Feb 21, 2008 5:23am EST

3Com President and CEO Edgar Masri in an undated photo. Bain Capital Partners and China's Huawei Technologies Co Ltd have withdrawn their application for U.S. security approval of a $2.2 billion purchase of 3Com Corp after failing to satisfy the concerns of a U.S. government panel. REUTERS/Handout

3Com President and CEO Edgar Masri in an undated photo. Bain Capital Partners and China's Huawei Technologies Co Ltd have withdrawn their application for U.S. security approval of a $2.2 billion purchase of 3Com Corp after failing to satisfy the concerns of a U.S. government panel.

Credit: Reuters/Handout

PHILADELPHIA/SHANGHAI (Reuters) - Bain Capital Partners and China's Huawei Technologies HWT.UL have withdrawn their application for U.S. security approval of a $2.2 billion purchase of 3Com Corp COMS.O after failing to satisfy the concerns of a U.S. government panel.

While the companies said they were still in discussions and the proposed acquisition had not yet been terminated, a source familiar with the situation said the failure killed the deal in its current form.

Shares of network equipment maker 3Com fell 23 percent to $2.87 on Nasdaq on Wednesday as a takeover seemed more remote.

The Committee on Foreign Investment in the United States (CFIUS) had raised concerns about the deal, through which Huawei -- China's top telecom equipment maker -- would have initially owned as much as 16.5 percent of 3Com, whose Tipping Point unit makes national security software.

The panel, which is led by the U.S. Treasury Secretary, reviews corporate acquisitions involving foreign buyers.

Despite winning deals with top-tier carriers such as Deutsche Telekom's (DTEGn.DE) T-Mobile and Vodafone (VOD.L), Huawei remains hampered by concerns over its founder's connections to the Chinese military, said Duncan Clark, chairman of Beijing-based investment advisory firm BDA.

"They are just perceived as an extension of China, and China is perceived in the U.S., in this charged political environment, as somewhat of a menace or unknown threat," he said, adding that the ending of the deal was not likely to improve trade tensions between the two countries.

Ren Zhengfei, a former People's Liberation Army soldier, founded Huawei in 1988. The firm has always maintained it is a private company and wholly owned by its employees.

China said its firms deserved better treatment.

"This was a normal business investment in accordance with market rules," Chinese Foreign Ministry spokesman Liu Jianchao told a regular news conference.

"We hope relevant U.S. management departments can deal with this issue fairly and in accordance with the law, to create a fair and favorable environment for Chinese companies in the United States."

SECURITY CONCERNS

In October, eight U.S. lawmakers had backed a bill suggesting that the planned buyout of 3Com "threatens the national security of the United States."

Although Congress has no direct role in CFIUS reviews, the panel is still smarting from a storm of criticism two years ago when it approved state-owned Dubai Ports World's acquisition of several U.S. port operations.

Congress was so enraged by the approval that it enacted a tougher law requiring CFIUS to spend more time vetting deals and to keep lawmakers better informed. Dubai Ports later relinquished the port operations it had purchased amid the political pressure.

"We are very disappointed that we were unable to reach a mitigation agreement with CFIUS for this transaction," said 3Com President Edgar Masri.

Bain agreed in September to buy 3Com in a deal that would also give Huawei the 16.5 percent minority stake. Huawei could increase its stake in 3Com by up to an additional 5 percent.

3Com has said Huawei would not have access to sensitive U.S. technology or U.S. government sales and it would lack operational control or the ability to make decisions for the firm.

CONCESSIONS OFFERED

Last week, Bain offered various concessions, including one proposal under which it would divest the 3Com unit that makes systems to protect networks at large businesses and government agencies, a source familiar with the situation previously said.

Last year, 3Com had planned to spin off Tipping Point through an initial public offering, but that plan was pulled when the Bain deal was announced.

Bain never viewed Tipping Point as a strategic asset in the buyout, according to a filing with the U.S. Securities and Exchange Commission. Bain told 3Com last year that it would value the company at $4.50 to $5 per share without Tipping Point.

A Treasury Department spokesman confirmed that Bain and 3Com had withdrawn their CFIUS application but declined to comment on the specifics of the case.

In January, President George W. Bush issued an executive order clarifying procedures for such security reviews in the wake of several deals by sovereign wealth funds to invest billions of dollars in major U.S. banks.

Bush's order spelled out how CFIUS conducts its reviews and informs Congress, but also stated that the U.S. remains open for business and welcomes foreign investment.

Without a buyout, 3Com would face some challenges in the network equipment sectors, analysts said.

"We remain concerned about (3Com's) core business on limited upside and continued muted fundamentals in an increasingly competitive switching market," said Lehman Brothers analyst Inder Singh.

BDA's Clark added: "The U.S. should be careful of just fending off these advances. Some of these companies need help. This costs the U.S. ultimately."

(Additional reporting by Sophie Taylor in Shanghai, David Lawder in Washington and Ben Blanchard in Beijing)

(Editing by Kim Coghill)

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