Dubai Ports redux over China deal

(Fortune) -- Get ready for the possibility of a sequel to the Dubai Ports fracas. Only this time, the outcome of the deal under consideration will have implications for U.S.-China economic relations.

Political fire crackers are popping across Capitol Hill over Bain Capital Partners' announced acquisition of 3Com Corp (Charts)., which will provide a minority stake to Huawei Technologies Co., China's largest telecommunications equipment manufacturer.

"We are deeply troubled by the national security implications of the sale," Arizona Senator Jon Kyl says in a draft letter, obtained by Fortune and addressed to Treasury Secretary Henry Paulson. The draft is circulating in the Senate for additional support. In the House, eight members have introduced a resolution urging the government to reject the deal on national security grounds, citing the Chinese company's military ties.

The Bain deal has elements of the perfect political storm: A foreign company's proximity to technology; the involvement of China -- Capitol Hill's favorite foreign bete noir -- and a Huawei executive's eyebrow-raising links to the Chinese military.

It comes up for government approval just months after Dubai Ports World spun off a British company that manages six U.S ports; the Dubai-based firm had run into the hysterical headwinds of politicians and pundits insisting its management contracts provided seaport entrée to Arab terrorists. This time, the country involved carries at least as much political baggage as a tiny capitalist Islamic emirate by the sea: China.

The Bain deal is one to watch for broader weather patterns in Chinese-American economic relations. Rejecting it -- and sources close to the government panel examining the deal say there are serious and legitimate national security concerns under review -- would be a shot across the bow to the Chinese, whose companies are awash in cash and shopping overseas.

"It would say you can't invest in U.S. technology," said one Washington trade lawyer.

The transaction once again puts the spotlight on a little known interagency panel, recently retooled by Congress and bearing the pedestrian name of Committee on Foreign Investments in the United States, or CFIUS. (A trade lawyer recently joked, in the Washington Post, that before the Dubai Ports debacle most members of Congress probably thought CFIUS was a venereal disease. Try saying "syphius" three times, and you'll get his point.)

So far, resistance on Capitol Hill has been limited to the brand of conservative Republican who invariably refers to the PRC as "Communist China." Critics include Michigan's Thaddeus McCotter, chair of the House Republican Policy Committee, who recently warned against allowing "the Beijing Olympics of 2008 to become this generation's Berlin Olympics of 1936." But there are plenty of fierce China critics among Democrats, too, and Hill sources say they considering whether to jump into the fray.

CFIUS officials who approved the Dubai deal late last year were surprised by the ensuing firestorm. But this time the panel has its own concerns. "CFIUS was taking this seriously before anyone in Congress asked them to take it seriously," said Christopher P. Simkins, an attorney at Covington & Burling who until recently filled the Justice Department seat on CFIUS.

Huawei is a leading global telecom-equipment manufacturer with 2006 revenues of $8.5 billion that competes with companies such as Alcatel-Lucent (Charts) and Nortel (Charts). The firm operates R&D centers in places like Dallas, Silicon Valley, Moscow and Bangalore.

For Bain and 3Com, giving Huawei an equity stake in the deal is a way to provide incentives to a profitable global customer.

"A driving force behind the transaction is that 3Com's future success is highly dependent on its Chinese business unit, and the company's commercial relationship with Huawei is important to 3Com's growth and operations in China and other emerging markets," according to a Bain memo provided to Fortune.

Fifty percent of 3Com's revenue for 2007, and all of its profits, were derived from its China-based unit, called H3C, which sells infrastructure products such as routers and switches. H3C grew out of a joint venture between Huawei and 3Com, and Huawei remains one of its biggest customers.

But China critics on Capitol Hill take a more nefarious view of Huawei. They say the firm has ties to the Chinese military and a history of supporting U.S. enemies. The House resolution denouncing the deal cites 2001 Pentagon charges that Huawei laid optical communications cables for Iraq's Saddam Hussein and more recent allegations that the Chinese military hacked into a Pentagon computer network. (Hauwei was also sued by Cisco Systems (Charts, Fortune 500) for patent-theft, a suit that the American firm recently agreed to suspend.)

Lawmakers in both chambers note that Huawei President Ren Zhengfei is a former official of China's People's Liberation Army (PLA). "After leaving the PLA," Kyl writes, "[He] founded Huawei with PLA funds and built his business through strong ties to the PLA including through sales, after-sales services, and research and development."

CFIUS is likely to be more concerned with the company's existing military ties than Ren's personal background. And the panel, which is chaired by Paulson, wants to be assured that Huawei won't gain a controlling interest in 3Com, so it is examining concerns that Bain will sell off the new company after the deal closes.

Officials at all three companies are declining to speak to the press, saying the CFIUS process should play out without public comment. But a four-page document of talking points compiled for Bain provides a glimpse into the arguments the company will be making before CFIUS.

Huawei won't have access to US technology that isn't already available commercially, the company argues. "All are widely available, off-the-shelf products," says the document.

Bain also stresses that "U.S. persons and a U.S. company will be in complete control of 3Com. Huawei will have no operational control over 3Com and no ability to make decisions for it." In the final deal, Huawei will have a 16.5 percent ownership position that can rise to 21.5 percent, and the authority to appoint 3 out of 11 board members.

Bain clearly sees this as another smart and profitable global transaction. But the firm is getting a painful political lesson -- one that should be a warning to others: With a souped-up CFIUS and agitated lawmakers on Capitol Hill, business with China isn't just about business.