UPDATE 6-Bain, 3Com deal stalled on Chinese stake

(Recasts at the top, adds that Bain never saw Tipping Point as strategic asset, para , closing share price)

By Jessica Hall

PHILADELPHIA, Feb 20 (Reuters) - Bain Capital Partners and China's Huawei Technologies Co Ltd [HWT.UL] have withdrawn their application for U.S. security approval of a $2.2 billion purchase of 3Com Corp (COMS.O) after failing to satisfy the concerns of a U.S. government panel.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 on Wednesday they were still in discussions and the proposed transaction had not yet been terminated, a source familiar with the situation said the failure kills the deal in its current form.

Shares of 3Com fell 23 percent, or 86 cents, to $2.87 on Nasdaq as the possibility of the takeover proceeding seemed remote.

The 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, had been raised by the Committee on Foreign Investment in the United States (CFIUS). The panel, which is led by the U.S. Treasury Secretary, reviews corporate acquisitions involving foreign buyers.

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.

"While we work closely with Bain Capital Partners and Huawei to construct alternatives that would address CFIUS' concerns, we will continue to execute our strategy to build a global networking leader," Masri said.

"It's better to withdraw the application than to have it rejected, but it's a bad sign that they couldn't reach an agreement in the review window," said one arbitrageur who declined to be named.

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 previously 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.

Last week, Bain offered various concessions. including one proposal under which it would divest 3Com's Tipping Point unit, which makes national security software, a source familiar with the situation previously said.

Tipping Point makes "intrusion prevention" systems to protect networks at large businesses and government agencies. 3Com acquired Tipping Point in late 2004 for $430 million.

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 deal, according to a filing with 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, the filing said.

Tipping Point was expected to have fiscal 2008 revenues of $121.0 million, and fiscal 2009 revenues of $158.3 million, according to a filing with the U.S. Securities and Exchange Commission.

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 late January, U.S. 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 into major U.S. banks.

Bush's order spelled out how CFIUS conducts its reviews and informs Congress, including stating that it may impose conditions on a deal to address any potential national security risks after a threat-analysis by the U.S. director of national intelligence. But the order also states that the U.S. remains open for business and welcomes foreign investment.

"The (Bush) administration has worked hard to implement the CFIUS process in a manner that ensures the protection of national security while also encouraging investment from abroad," U.S. Treasury spokesman Robert Saliterman said.

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. (Reporting by Jessica Hall in Philadelphia and David Lawder in Washington; Editing by Gerald E. McCormick, Tim Dobbyn, Gary Hill) (For more M&A news and our DealZone blog, go to here)