Storm clouds gather over international acquisitions

Outcry from the pending Chinese investment in 3Com sets industry on edge

Recent attempts by Congress to thwart Chinese investment in 3Com Corp. because of perceived national security risks are having a chilling effect on other federal contractors with global operations.

The proposed purchase of 3Com of Marlborough, Mass., for $2.2 billion in cash by affiliates of Bain Capital Partners LLC, of Boston and Huawei Technologies Co., of Shenzhen, China, almost immediately stirred security fears on Capitol Hill.

"As currently structured, the proposed transaction involving Huawei threatens the national security of the United States and should not be approved," states House Resolution 730, introduced Oct. 10 by eight members. On the Senate side, Sen. John Kyl (R-Ariz.) wrote a letter Oct. 19 signed by 13 other senators requesting a rigorous review of the 3Com deal.

The congressional outcry was weaker than the protest against Dubai Ports World's proposed acquisition of several U.S. port facilities 18 months ago. And some foreign investment experts say that because of the company's small size, the risk of the 3Com transaction is relatively minor in comparison to hypothetical acquisitions involving larger contractors. For this and other reasons, the acquisition is expected to eventually receive a green light from U.S. officials.

"For China to invest in a Lockheed Martin Corp. or a Northrop Grumman Corp. would be a big deal, and I don't think it [would be] a particularly feasible situation," said Jeremy Grant, senior vice president at Stanford Group Co., an investment banking research group in Washington.

Even so, the 3Com debate has renewed the sense that fiery national security concerns may arise at any time to derail potential merger and investment deals involving international partners, especially from China and other countries believed to be the source of hackers and other security risks.

"We're all watching what happens with 3Com," said an executive at a large defense contractor who asked not to be identified because of the political sensitivity of the subject. "People are definitely concerned about it."

Treading a fine line

The congressional reaction also has raised questions about whether the changing global political environment is affecting how Congress and the administration go about defining, evaluating and protecting technologies considered sensitive to national security.

"The bigger question is, 'We are all operating in a global technology environment: How do you wall off parts of it?' " said Stan Soloway, president of the Professional Services Council (PSC) and a columnist for Washington Technology.

"There has always been a fine line between the kind of technologies that raise hackles and the kind that are relatively commercially available off the shelf," Soloway said. He noted that radar parts were in the high-security category at one time. Export prohibitions apply to various electronics, computers, telecommunications, information security, sensors and lasers, and navigation devices and expertise.

The possibility that the fine line will be redrawn unpredictably in the era following the 2001 terrorist attacks is putting some federal contractors on edge. Soloway cited the example of a member company of PSC, which he declined to name, that produces a commercial software application in use at several U.S. airports. When the same software was proposed for sale to a Chinese military airport authority, it was put on the Commerce Department's export control list.

"It is a very difficult challenge in separating out the issue of what should be under export controls and what should not. Sometimes it is a political reaction. There is always a need to balance the security risks against the need for legitimate commercial activity," Soloway said. "Contractors that I know are extremely sensitive to it and trying like the dickens not to run afoul of the export controls."

In the 3Com case, the technologies produced by the company, according to H.R. 730, include Federal Information Processing Standard-certified security local network solutions for the federal government, including the Defense Department. Huawei was proposing to own a 16.5 percent share of 3Com, which could rise to 21.5 percent.

U.S. companies are not required to undergo a national security review for foreign investments, but under the Exon-Florio Amendment to the Defense Production Act of 1950, the president has the authority to block objectionable transactions so parties are encouraged to voluntarily seek clearance from the Committee on Foreign Investment in the United States. Bain and 3Com have said they will seek a CFIUS review.

After the Dubai Ports snafu, Congress passed the 2007 Foreign Investment and National Security Act to strengthen and clarify its role in the CFIUS process. CFIUS will conduct a 30-day review and then may recommend an additional 45-day investigation and 15-day review by the president, with a total of 90 days possible for a final determination. Under the new 2007 law, foreign takeovers of critical infrastructure are required to submit to the additional 45-day review.

3Com issued a statement Oct. 11 stating that Huawei will not have operational control or decision-making authority in the company and will not have access to sensitive U.S. technology. Furthermore, it stated that all of 3Com's products are available for commercial sale.

Looking for an edge

The Defense Science Board is expected to issue a report soon that may tighten rules on commercial cybersecurity tools in government applications because of the fear of hidden malicious code, Grant said.

"While the business perspective is pointing toward China as the next big market, and Chinese investments abroad increase, many companies will be looking for an edge or even extra capital from China," said Jeremy Potter, senior analyst at market research firm Input Inc. "However, it puts federal contractors in a precarious position."

The items of concern mentioned in H.R. 730 include Huawei's possible links to the government of the People's Republic of China, including the People's Liberation Army, and Huawei's identification by U.S. intelligence agencies as a supplier of fiber-optic equipment to the Iraqi military in the late 1990s.

More recently, German government officials have reported on Chinese spyware allegedly linked to the People's Liberation Army, and there have been media reports of Chinese attacks on a Pentagon computer network in June.

With Defense Department officials worried about cyberthreats from China, the emphasis on national security is likely to continue, Potter said.

Similarly, the Justice Department last month stepped up its prosecution of individuals illegally exporting U.S. technologies and is creating task forces in regions with a high concentration of high-tech companies. Recent prosecutions have involved China, Iran and Pakistan and items such as nuclear and missile applications, fighter jet components, and Navy warship databases. At least 108 nations are trying to obtain controlled technology, Justice officials said.

Nonetheless, it is likely that the 3Com investment eventually will be approved, industry experts say. Half the company's sales are already in China.

"Despite some of the political hype, 3Com actually has a very small amount of federal government business and security business," Grant said. "We think the odds favor ultimate approval."

Staff Writer Alice Lipowicz can be reached at alipowicz@1105govinfo.com.

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