3Com, USR merger raises questions

It's the biggest merger in the history of the networking industry, but analysts are wondering today if it's such a good deal after all.

3Com (COMS) yesterday announced plans to acquire U.S. Robotics (USRX) in a stock deal valued at $6.6 billion, the largest U.S. networking merger to date.

The deal will create a company with $5 billion in annual revenues and is supposed to give 3Com customers one-stop shopping for both local and wide-area networks from the network interface cards to hook PCs to the network to high-speed modems.

But analysts aren't sure if the corporate marriage will be a combination of strengths, or a combination of weaknesses that will undermine both companies' hold on their respective markets.

"U.S. Robotics has had a disappointing performance in the last three to six months, and 3Com's results have been disappointing for the past six to nine months," said Paul Johnson, an analyst with Robertson Stephens. "I don't see how this will help, to combine two companies in flux and expect to get a strong company out of the merger."

Johnson assessed the proposed merger as neutral to negative for the two companies.

He thinks the merger will have "zero" impact on 3Com's adapter board market or U.S. Robotics' modem market since both companies are already market leaders in those niches. Also, since both companies already run extremely efficient manufacturing operations, he doesn't think merging operations will gain either company much. And lastly, he said that the merger won't help both companies' main problem: severe price competition in the adapter board and modem markets.

Not everyone is so negative about the deal.

Amar Senan, an analyst with Volpe, Welty & Company, thinks a merged company might be a more attractive partner for large corporations.

"Networking is a complex thing and big corporations may know how to put out their products, but they don't want to have to do the ins and outs of their network," Senan said. "So I can see how this one-stop shopping could benefit 3Com. Networking customers are looking for end-to-end solutions."

He added that the merger will also give 3Com a better position up against rival Cisco Systems, which Senan said offers its customers more of an end-to-end solution than 3Com currently does.

But as with any merger, it will take time for 3Com and USR to prove the wisdom of their merger. "I think it will be the end of the year before they get anything going," Senan said.

As the home networking market heats up, 3Com expects to take advantage of U.S. Robotics retail distribution channel. The company also expects to cut costs from its manufacturing operations and expand its geographic market.

The deal is expected to close this summer and 3Com will take a significant one-time charge. But the merger may bring a slight improvement to earnings as soon as fiscal 1998, which begins in June.

The combined companies will operate under the 3Com name. Eric Benhamou, 3Com's chairman and chief executive officer, will retain his title under the combined company. Casey Cowell, U.S. Robotics' chairman and chief executive, will join 3Com's board of directors as vice chairman.

Under the terms of the stock swap deal, each share of U.S. Robotics' stock is to be exchanged for 1.75 shares of 3Com stock. As of Tuesday, that meant the deal was worth $6.6 billion but if 3Com's stock continues to fall, the value of the deal will decline.

3Com has had a hard time on Wall Street recently; with investors afraid that Intel is catching up in the adapter board pricing, 3Com's share price has dropped from around 75 a share in mid-February. U.S. Robotics has seen its stock fall to the 60 range after having traded around 80 a share in late November.

But 3Com chief financial officer Christopher Paisley assured investors yesterday during a press conference that the merger will make for more profitable operations in the long-run and therefore will eventually elevate 3Com's stock.

"We could have waited [for the stock to rebound], but the boards of both the companies felt this deal was in the best interest of our shareholders, customers, and companies for the long term," Paisley said.

Cowell also said that the combined companies would be able to provide faster, more intelligent, and easier-to-use products for connecting a broad array of users to local and wide area networks.

U.S. Robotics new x2 technology for high-speed modems and wide-area-network access was a key draw of the deal. 3Com also viewed the deal as way to expand its presence in the market for desktop networking products, which it thinks will make up a growing share of its business.

The combined companies will have a slight overlap in the WAN business since 3Com has begun to heavily invest in both the WAN and LAN market that U.S. Robotics has begun exploring, Paisley said. The overlap represents about two to three percent of revenues of the combined companies.

Paisely said the companies began negotiating in earnest in mid-December. The two agreed to mutual lock-up provisions that would make it more difficult and costly for either company to get wooed away with a higher bid from a third party.