Too Much Risk with 3Com Shares
On September 28, 3Com Corporation (COMS) agreed to be acquired by affiliates of Bain Capital Partners and Huawei Technologies for approximately $2.2 billion in cash, or $5.30 per share. The transaction, which is expected to be completed by the first quarter of calendar year 2008, has been delayed due to security concerns over Huawei's affiliation with the Chinese government.
Though 3Com Corporation has achieved growth in all its business units, much of this was the result of H3C. Moreover, the company's cash position is significantly impaired and the company has been hurt by Cisco's (CSCO) recent focus on the market. 3Com expects going private will free it from short-term financial expectations.
Also, as part of the transaction, Huawei will acquire a minority interest in the company and become a commercial and strategic partner of 3Com. If the Department of Defense blocks the sale on matters of security concerns, this deal will not take place and the stock will continue to languish at under $4, struggling with its weak balance sheet and unfavorable market demand.
We still believe that the chances of the deal closing are good; however, we would recommend COMS holders take profits by selling shares now, rather than take the risk that the transaction is not completed. Assuming a 50% chance that the deal closes at $5.30 per share and 50% chance that the deal does not go through and drifts towards our earlier $3 price target, we arrive at a fair value of $4.15, or ($5.30x50%) + ($3.00x50%). We, therefore, reiterate a Sell recommendation on COMS shares.
Revising Target for Allscripts
Allscripts Healthcare Solutions, Inc. (MDRX) reported lower-than-expected fourth quarter revenues on weak bookings. Delays in implementing TouchWorks Version 11 and continued large deal slippage affected the quarter.
Although increasing headcount, MDRX is straining to implement deals and provide adequate support services. Excluding the tax benefit, EPS also fell short of our estimate. The company has missed estimates in 2007, with deals slipping and software deployment taking longer to implement, but we believe Allscript's growth outlook continues to be favorable in a fairly robust market.
Management provided its outlook for 2008. Given the lumpiness, management suspended bookings guidance but did reaffirm its 2008 guidance. However, it now includes $20 million in ECIN [Extended Care Information Network] revenues, suggesting much slower organic growth.
Revenues are expected to increase by 20%-25%, including the $20 million incremental ECIN revenues expected, to approximately $338-$353 million. The ECIN transaction adds approximately $4-$5 million of additional deal-related amortization in 2008, and adds approximately $4-$5 million of additional interest expense related to the $50 million of new borrowings.
Nonetheless, while keeping our previous 2008 $350 million revenue target, our 2008 EPS estimate declines, below management guidance, on higher SG&A hiring costs, increased amortization and interest expense, as well as reduced gross margin. At the current price, MDRX trades at 27x our $0.42 GAAP 2008 EPS estimate. Our revised $13 target is roughly equivalent to the 2008 1.0x P/E/G average of comparables.
NDS Group Expands Away from U.S.
NDS Group Plc (NNDS) reported a solid second quarter of 2008, despite a currency headwind and beat our revenue and earnings estimates handily. Continued strength in conditional access, gaming and DVR technologies, as well as new deals in emerging markets helped drive revenues and growth. We have maintained our revenue estimates while lowering earnings outlook for 2008 and 2009 and expect the company to continue to expand in emerging markets while adding additional revenue streams in developed markets.
The results for the second quarter were much better than our estimates due to the new technology initiatives. We expect the company to continue to grow revenues in excess of 18% while growing earnings by more than 17% for 2008, as the company has now established a presence in several emerging markets and can now begin to leverage its presence in these markets to fuel growth through add-on service revenues.
Additionally, the continued add-on acquisitions help to improve its technology and could be leveraged into further revenue growth opportunities in the longer term. As the company continues to take advantage of the move towards connecting DVR boxes to broadband, we expect the shares to perform well.
NDS continues to focus on emerging markets and away from the U.S., where it is not readily known. This strategy has worked well for the company and bodes well for the future. The company is a leader in the smart card-based conditional access system.
