Wednesday, November 29, 2006

Calls of Note Part 1

- RBC Capital's Mark Sue is back commenting on 3Com (NASDAQ:COMS) following news the co will pay $882M to wrap up the remaining 49% of the Huawei-JV (near the high-end of firm's range of $750-$900M). 3com will be left with only $32M in net-cash or $0.08-per/share, an uncomfortable amount considering that 3Com is operating in a net loss.

3Com will need some financing and the uncertainty of the amount and structure may weigh on the shares. Considering RBC's view that 3Com may not be investment grade, they think 3Com will choose a convertible note due in 2011. 3Com may raise up to $500M and the notes may pay interest seminually at a rate of 1% per annum. Firm expects a call spread convert deal with some proceeds ear marked for a potential share buyback.

The JV has been successful from a top-line growth perspective but 3Com will need to provide incentives to key managers in order to sustain the +50% YoY top-line growth. It's a positive that the deal will wrap-up and it does provide some closure but the business uncertainty is now replaced by financing uncertainty and increased execution risk.

So what's this thing worth? Considering the revenue base of almost $850M in CY07 for the JV, 3Com's potential 100% ownership combined with 3Com's estimated base-business of $650M and the remaining cash balance, they believe 3Com's shares may be fully valued at $5.50. With that being said the firm thinks an entry point near $3.50-$4.00 may make it worthwhile for equity-investors looking for some year-end beta. Maintains Sector Perform rating.

Notablecalls: As I suspected, Mark was indeed calling for a fall in COMS' stock price on Nov 6 (check the archives) and it worked out that way. Nice call. For those hoping for a quick bounce, check out the comments on the likely upcoming convert deal. That may limit the upside.

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