3 com valuation analysis- story of JV

**vin** Fri Feb 03, 2006 3:21 pm

3 com valuation analysis- story of JV
Generally, I do not like telecom vendor as ROA of most vendor is extrimely low. But I noticed 3 COM has a nice jump last few month as a result of Joint venture buy back. I study the 10K in detail and find out a nice story. It is a story similar to spin off.

COMS are networkgear vendor, used to be #2 right after CISCO. The industry compitition is intense and cost of developement is high.
Anyway, COMS has 10 quator nagative operation cash flow, R&D expense is decreasing, basically 3 COM future is not bright, or "COMS is gone as a matter of time".

Fortunately, COMS has a good book(or a smart CFO). COMS has around 750 M cash , revenue of 700 M/year and has FCF of -200 M /year for last two year. It seems COMS is going to worth 0 after another 2/3 year.

But COMs CFO bought with his personal money between April untill dec 2005 around 3.5. or in another word, CFO bought COMS when COMS is priced at 1.4 billion. Why?

A detail analysis of 10k, I find out COMS and Huawei has a JV in China since Nov 2003, called H-3C. COMS and huawei have 50% split and COMS has a option to buy another 2% with amount not to exceed 28M within 3 year. H-3C has a sales of aournd 300M/year. so COMS has 150 M/year sales from H-3C, this H-3C is profitable and growing at 60% and have 30% of China switch market share. How much is H-3C worth? it should worth between at least 900M (using P/S of COMS) to 1.7B (using P/S of CISCO). I personal think it is worth 1.7 B because of the growth.
But most importantly, is COMS willing to pay more or less for this 2% of H-3c share so as to maximum achieve COMS Value. . Yes, It will be 28M. So 50% of H-3c is 700M.

So How much COMS worth now? 700 m cash + 700 m H-3C = 1.4 billion, which means COMS US/world wide operation and yearly revenue of 400M worth 0. If you knew this, will you buy this 400M company for free?

So what is the value of 400 M revenue COMS ? (also notice COMS declare it will end loss at the end of 2006. ) wost network/telecom vendor has p/s of 1.2. Let's assume COMS deserve ps =1. That means coms should worth 4.5/share.
If using ps = 2.7 (today's P/S of coms). COMS should worth $7/share.

Conclusion:

1.JV is like Spin-off, can make wall-street re-evaluate company's value, pay special attention to option expired time for JV.
2. Insider info is valuable.

Vin.

**blast_investor** Fri Feb 03, 2006 4:36 pm

Can you add vote portion to qualify for contest?

Just Edit you post -> add poll (poll button is above "revew submit" button.

**blast_investor** Fri Feb 03, 2006 4:51 pm

How much profit the JV division earn?

Joint Venture is not spin-off. It is like subsidiary.

The extra 2% ownership is the price for control. 51% ownership of course is worth more than 49% of ownership because of corporate control.

3com is losing lots of money, if JV works out, this will improve the company's bottom line.

If the company keep losing money as it is right now, the stock can go down more, possibly trading below book value. Price to book of this stock is still pretty high. JV might just be the savior for this stock.

**vin** Fri Feb 03, 2006 5:37 pm

Here is the link for first half of 2005, H-3C sale is 187m (60% increase over last year). earning is 0.38m. I assume sales for whole 2005 year is 300M should be achievable.

http://www.3com.com/corpinfo/en_US/pressbox/press_release.jsp?INFO_ID=230828

Almost all telecom company has EXTREMELY low ROA as competition is high and cost of development is even higher, unless given company has monopoly in technology patent(cisco/qcom...). And there are all not good company for long term investment in telecom industry, at least for now.

however, 400M U.S.operation revenue from 3COM should worth more than zero. Market under valued 3 COM at $3.5. This was an arbitrage opportunity.

JV is not spin-off. However, JV share repurchase also hints wall-street/investor a signal to re-evaluate company. From this prospect, JV repurchase does the same function as spin-off.