3Com: IPO Hand-Off

3Com’s purchase of U.S. Robotics looked like an unmitigated disaster
several years ago. It was the classic situation of buying at the top. Of
course, in hindsight, the purchase looks like a stroke of brilliance. In
the deal,
3Com (COMS)
got Palm.

The stock of 3Com has been lackluster, that is, until the company decided
to spin-off the Palm division. Since then, 3Com has been surging to
incredible heights. Yesterday, the stock was up 18-15/16 to 98. The company
is now selling at a lofty 58 times earnings and a $33 billion market
capitalization.

However, investors should be wary of 3Com. First of all, while Palm is a
pure-play on wireless, 3Com is an amalgam of a variety of businesses. The
company sells network cards, modems, hubs, switches and routers. In fact,
Palm accounts for only 15 percent of total sales. What’s more, much of the
business lines of 3Com have been flat, as they have become increasingly
commoditized.

Next, there is lack of a coherent strategy from the company. 3Com will
often make an announcement and then back-peddle. One example is the storage
area network industry. 3Com said it would enter the business and then, in
quick order, said it was not interested. Actually, the chief executive officer of 3Com said
last May that Palm was a core business asset. Now, of course, it is going
to be spun-off.

If anything, the Palm IPO looks like a smart way to deflect attention away
from the problems with 3Com. Unfortunately, once Palm is completely
independent, investors will be left with a company that has a slowing
business.

True, 3Com plans to distribute its remaining shares of Palm to existing
3Com shareholders (after the IPO, 3Com will own about 94 percent of Palm).
According to Palm’s prospectus: “3Com will, in its sole discretion,
determine the timing, structure and all terms of its distribution of our
common stock that it owns.” In other words, there really is no concrete
way to value the distribution. It is at the discretion of 3Com.

Finally, it is typical in spin-offs for the parent company to surge before
the IPO and then, afterwards, to fall back to earth. Investors will want to
instead purchase the spin-off, which is a pure-play and offers much more
growth potential. This is a very likely scenario with 3Com.