HP's 3Com Acquisition Will Challenge Cisco

Through its acquisition of networking gear maker 3Com, Hewlett-Packard will accelerate competition with Cisco Systems (CSCO), especially in China, practically overnight. Then comes the hard part. To make the most of the $2.7 billion deal, HP also needs to revitalize 3Com's faded brand and persuade Western companies to take a chance on its products, designed largely in Asia. Analysts were quick to see the logic in the planned acquisition, announced on Nov. 11. HP (HPQ) is attacking Cisco's dominance of the market for gear that connects computers just as Cisco moves more aggressively into the market for computer systems, where HP is strong. Cisco on Nov. 3 struck a partnership with storage company EMC (EMC) and software company VMware (VMW) aimed at supplying bundles of computers, storage, networking, and software. 3Com's (COMS) products, which connect computers inside corporate data centers, complement HP's ProCurve networking equipment, which is used to link PCs to corporate networks and generates about $1 billion in annual sales. "HP had a huge hole" in its product line, says Mark Fabbi, an analyst at market research company Gartner (IT). "There's clear pent-up demand for these capabilities." HP's lack of competitive data center switches "was literally preventing HP from playing in hundreds of millions of dollars' worth of business," says Fabbi. HP's bigger challenge in making the deal a success will be removing the tarnish that remains on the 3Com 's brand in the U.S. and Europe as a result of years of mismanagement. While 3Com's data-center networking gear has about 35% of the Chinese market, it's practically absent from the largest companies in the U.S. and Europe, analysts say. 3Com's Turnaround3Com has turned around under CEO Robert Mao and Chief Operating Officer Ron Sege, who came on board in April 2008. The company has become a viable competitor to Cisco in China, where it claims customers including China Mobile (CHL), China Telecom (CHA), and PetroChina (PTR). 3Com prices it products 25% to 40% below Cisco's in China, Sege said in an interview earlier this year. "This is the only place where anyone has battled Cisco to a tie," he said. Cisco couldn't be reached for comment by press time. HP plans to keep hammering away at Cisco on price. Networking "has become one of the more expensive line items in the IT budget," Marius Haas, a senior vice-president for networking at HP, says in an interview. Yet 3Com has also suffered years of financial losses, and had bolstered its business with cash from an initial public offering in 2000 of the original Palm Computing, which it acquired when it bought modem company U.S. Robotics in 1997. "They always made no money and were living off the $1 billion in cash they made during the dot-com time frame," says Samuel Wilson, an analyst at JMP Securities (JMP), who has a market outperform rating on Cisco and a market perform rating on HP. At its height, 3Com also owned the naming rights to the San Francisco stadium where the city's 49ers football team plays. Those days are long gone. In 2007, 3Com bought the remaining share of a joint venture with Chinese networking company Huawei Technologies that analysts say sapped 3Com's cash. In 2008, Huawei and Bain Capital aborted an attempt to take 3Com private. HP Raises Profit ForecastHP said it would pay $7.90 for each 3Com share, valuing the deal at $2.7 billion after accounting for 3Com's cash and debt. Shares of HP fell 0.6% in extended trading after the deal was announced, after closing Nov. 11 up 4¢, or 0.1%, at 50. Shares of 3Com surged 35% in extended trading, after HP said it would offer a 39% premium over the company's closing share price of 5.69. While announcing the 3Com acquisition, HP also released preliminary results for its fiscal fourth quarter and raised forecasts for the first quarter, which ends in January, and the full fiscal year. During the fourth quarter ended Oct. 31, sales fell 8%, to $30.8 billion, while earnings, excluding certain one-time items, were $1.14 a share. Analysts surveyed by Bloomberg News had expected HP to earn $1.11 per share. The results were helped by strong sales in China, HP Chief Executive Mark Hurd said in a statement. HP is scheduled to report its final fourth-quarter results on Nov. 23. HP also raised its forecast for full fiscal 2010 revenue to $118 billion to $119 billion, from $117 billion to $118 billion previously. The company raised its forecast for 2010 per-share earnings to $3.65 to $3.75, from $3.60 to $3.70. Boom in Tech MergersHP's acquisition of 3Com comes amid a rash of merger activity in the tech industry. Oracle is trying to acquire computer and software maker Sun Microsystems (JAVA) for $7.4 billion while fighting antitrust delays in Europe. On Sept. 21, Dell (DELL) announced a $3.9 billion acquisition of technology services company Perot Systems. A week later, Xerox (XRX) bought service company Affiliated Computer Services for $6.4 billion. HP's Haas concedes that 3Com's reputation needs to be refurbished, but says its products are robust enough to serve the needs of Western companies. Before agreeing to buy 3Com, HP extensively tested its products, he says. "Let's distinguish the brand from what's below the surface," says Haas. "People don't understand this platform…and how broad it is." To pry market share away from Cisco, HP will need to make that argument repeatedly in coming months.

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