From Staff Reports
China's No. 1 network-equipment maker – a firm alleged to have ties to Beijing's military, as well as past links to Saddam Hussein and the Taliban in Afghanistan – could gain access to U.S. defense-network technology in the proposed buyout of 3Com Corp. (COMS), the Washington Times newspaper reported yesterday (Wednesday).
3Com on Friday agreed to be acquired by the duo of Bain Capital Partners LLC and Huawei Technologies in a deal valued at $2.2 billion. Bain Capital is a Boston-based private-equity firm that was co-founded by former Mass. Gov. Mitt Romney, currently a Republican presidential candidate, who retired from Bain in 1999.
In announcing the buyout last week, 3Com said that Huawei will "become a commercial and strategic partner of 3Com."
Huawei, a privately held firm based in the southern China city of Shenzhen, is China's largest network-equipment company, and will own less than 20% of 3Com when the deal is done, according to all parties involved. Unfortunately, it doesn't have a pristine reputation. Its highly reclusive CEO, Ren Zhengfei, is a former officer in the People's Liberation Army – the Chinese military. The company was founded in 1988 and got its start building military communications networks for the Chinese army. That's bad enough, but Ren and other company officials now repeatedly deny that there is any kind of a connection between Huawei and the PLA – a protestation virtually no one believes. As Business Week columnist Bruce Einhorn recently noted: "The company does have an image problem that makes expansion in the U.S. difficult."
And Huawei apparently really does want to expand in the U.S. market. Its domestic arch-rival, ZTE, a company that is based in the same city and that plays to the same market as Huawei, recently cut a deal to sell equipment to Sprint Nextel Corp. (S). And last year, ZTE managed to sign a collaboration deal with U.S. leader Cisco Systems Inc. (CSCO). At the same time, all Huawei was able to achieve was to get hauled into court by Cisco for allegedly infringing on its technology patents (a Texas judge ordered the Chinese company to change its products so that Cisco's technology wasn't utilized).
Huawei Technologies has been linked to the United Nations 'oil-for-food' scandal, which is alleged to have involved millions of dollars in payoffs to Saddam's regime during a time of U.N. sanctions.
The Washington Times article and other published reports say that Huawei has been involved in illicit projects in several "hot spots" around the world, especially in areas hostile to the United States. Huawei technicians also allegedly violated U.N. sanctions in Iraq in the early 2000s, by providing a fiber-optic telecommunications network that Iraq military is said to have used to tie together its air-defense network. The CIA-led Iraq Survey Group stated in its final report that Huawei and two other Chinese firms "illicitly provided transmission switches" for fiber-optic communications in Iraq from 1999 to 2002. When the United States discovered the network and what it was being used for – the air-defense system fired missiles at allied aircraft enforcing the "no-fly-zone" rules – it launched an air strike and bombed the China-engineered high-speed fiber-optic network.
Huawei did work for the ruling Taliban militia before it was pushed from power in the early part of this decade. The Chinese company either provided components for, or helped build, a telecommunications-switching network in Kabul, Afghanistan.
The newspaper reported that the merger deal follows a July computer attack on the Pentagon that U.S. intelligence officials say was engineered by Chinese military hackers. The hackers were detected breaking into Pentagon computers, including an e-mail system close to Defense Secretary Robert M. Gates. An unnamed defense official told the newspaper that this deal comes just as the Pentagon has moved to thwart the "large numbers" of attempted computer intrusions from Chinese computer "hackers and spies."
"And now we are proposing to sell the PLA a key to our front door. This is a very dangerous trend," that unnamed defense official told the Washington Times.
Said another defense official, who is also very concerned about this deal: "Huawei is up to its eyeballs with the Chinese military."
California Republican Rep. Duncan Hunter, a ranking member of the House Armed Services Committee, said he is worried the deal will lead to the loss of sensitive technology to China.
According to The Associated Press, Bain announced yesterday that it would submit the deal to a national security review, a process usually conducted by the federal Committee on Foreign Investment in the United States, or CFIUS, a 12-member group of top White House economic-policy experts and several cabinet-level officials. CFIUS was formed in 1988, the same year as Huawei. The group will study how much control, influence and involvement Huawei will have, including access to both core and defense-related technologies.
According to published reports, a 3Com subsidiary does provide both the U.S. Army and the Pentagon itself with intrusion-detection equipment, and some defense insiders worry that these contracts will enable Huawei to deduce vulnerabilities in key computer networks.
Despite the security concerns, a business case can be made for the deal.
In a conference call that discussed the deal, 3Com CEO Edgar Masri said that Bain has great connections in China as well as in Europe, markets where the networking company is seeking to expand.
Although there's been tremendous concern about the involvement of Huawei, and China, 3Com already previously operated a joint venture with Huawei in China called Huawei-3Com Ltd.
But 3Com bought out its partner earlier this year, paying $886 million to do so. The joint venture had been started in 2003, and was said to have been fairly successful. Indeed, 3Com's China business may well be the most valuable part of the company going forward, which makes sense that Huawei would want it all.
3Com was once a much bigger player in the U.S. market, but kept losing ground to Cisco Systems and others and its stock has basically traded in a fairly narrow range ever since, as it has struggled to regain past greatness.
In its most recent fiscal year ended in May, however, 3Com experienced somewhat of resurgence, aided in large part by its Chinese venture. The company boosted revenue by nearly 60%, to $1.27 billion from $794 million generated during fiscal 2006.
Masri said 3Com reviewed a number of "strategic alternatives" before settling on a sale to Bain and Huawei. The deal is expected to close in early 2008, 3Com said.
Because Huawei ranks as the largest maker of network equipment in China, that company increasingly finds itself squaring off against such traditional industry rivals as Cisco Systems (MOT), both of which already do extensive business there.) and Motorola Inc. (
Experts theorize that any more by U.S. lawmakers to block Huawei would likely lead to retaliation in China.
The all-cash offer values Marlborough, Mass.-based 3Com Corp. (COMS) at more than $5.30 a share. The bid represented a 44% premium over 3Com's closing price last Thursday of $3.68. The shares gained 34.24% for the week.
News and Related Story Links:
3Com to be Sold to Bain and Huawei.
The Washington Times:
The Associated Press:
Bain Capital agrees to security review of $2.2B buyout of 3Com.
Why Huawei Wants a Part of 3Com.