IN THE MONEY: Genesis Microchip Premium Is Now A
Haircut
By ERIC J. WEINER
A Dow Jones Newswires Column
(This article was originally published Thursday.)
NEW YORK -- When you're dealing with mergers and acquisitions, sometimes a premium can turn into a haircut.
Take, for example, Monday's announcement that Pixelworks Inc. (PXLW) and Genesis Microchip Inc. (GNSS), two West Coast visual
technology companies, agreed to merge into a new outfit called Genesis Pixelworks. The deal is a reverse merger where PixelWorks, the
smaller company, will acquire Genesis Microchip by issuing 2.3366 PixelWorks common shares for each Genesis share.
If you do the simple math, you'll notice that based on Pixelworks' $7.65 closing stock price on Friday, the day before the merger was
announced, the deal originally valued Genesis at $17.87. That was a 36% premium over Genesis Microchip's Friday close of $13.17.
But that's not the what the deal values Genesis Microchip at today. As of Thursday afternoon, PixelWorks shares had tumbled to $5.48 while
Genesis shares had fallen to $12.34. Based on the terms of the merger, Genesis shares are now worth just $12.80, which actually is less than
their price before the merger was announced.
What's worse is these stock prices are falling against the backdrop of a rising stock market. Since Friday the tech-heavy Nasdaq Composite
Index has climbed 4% to 1,397.
Now, under normal circumstances you would've expected that after the deal was announced Genesis shares would start to climb close to the
$17.87 value established in the merger while Pixelworks shares remained somewhat stable. Obviously that didn't happen.
Instead, almost immediately after the companies announced their merger, PixelWorks shares sunk like a stone and continued to fall, while the
value of Genesis shares slowly started to slip. Since there's no collar built into the merger to protect Genesis shareholders if Pixelworks stock
keeps falling, the value of Genesis Microchip could keep on tumbling.
What's going on? Well, to put it bluntly, it appears that at least one person who owns shares in these companies doesn't like this deal and has
been unloading the stock, although no shareholders have been willing to admit it so far.
One New York trader said market chatter indicates a major institutional shareholder unloaded its entire position in PixelWorks after the deal
was announced, and another institution sliced its PixelWorks stake in half. The names of the institutions and the size of those positions were
not available.
"The market doesn't like the deal," said Kalpesh Kapadia, an analyst at C.E Unterberg Towbin who follows Genesis Microchip and rates the
shares market perform.
"It's a whole weird thing," Kapadia said. "There should've been a collar. They should've been able to lock in the ratio so Genesis shareholders
would get $18 no matter what. Imagine if people bought Genesis thinking it's actually a $20 stock? What are they thinking now?"
There could be a handful of reasons why the market doesn't like the deal.
First, there's the fact that Pixelworks currently has a public float of about 36 million shares, but the new company will have a float of more
than 70 million shares. There's going to have to be plenty of demand to soak up all of that stock, and several market watchers said this fact
alone could've caused PixelWorks shares to tank.
Second, there's the timing of the announcement itself. With the U.S. markets braced for a war with Iraq investors have been skittish. The
deal's closing is set for the third quarter, which is a long way off and lots of things could happen between now and then. The general
skepticism that's been hovering over the market could be creeping into the trading patterns here.
Additionally, numerous shareholders this week said part of the problem is arbitrageurs are driving down the values of both companies. Arbs
who specialize in mergers make money by exploiting differences between the value of shares in a deal and the current value of the shares in
the stock market.
In this case, however, several arbitrageurs denied that they had anything to do with it based on the number of shares traded on Monday, the
day the deal was announced. The volume in PixelWorks shares on Monday was 3.46 million. Based on the ratio established in the deal, you'd
expect more than eight million Genesis shares to trade if it was a straight arbitrage play. But the volume in Genesis Microchip that day was just
5.74 million. So there probably has been some arbitrage trading going on in these stocks, but that alone is not causing the decline.
"It's not the arbs because you would've seen much higher volume in Genesis if it was us," one arbitrageur said.
Then, there's the structure of the deal itself that could be causing investors to get a little hung up.
Genesis Microchip, of San Jose, Calif., makes image processing chips for consumer electronics and PC-display products, while Pixelworks of
Tualatin, Ore., supplies something called system-on-a-chip integrated circuits. The companies expect the merger to enable them to speed up
the development of new technologies for the makers of televisions, LCD monitors and multimedia projectors, and at the same time save the
combined firm $4 million per quarter once the integration is complete.
The way the deal is structured the management and board of the new company will be dominated by PixelWorks. Genesis Microchip's
Chairman and Chief Executive James Donegan will be chairman of the new company. But Allen Alley, PixelWorks chairman, president and
chief executive, will be president and chief executive of the new company, and Jeff Bouchard, PixelWorks chief financial officer, will be chief
financial officer of the new company. In addition, five of the nine seats on the new company's board will be controlled by PixelWorks.
So PixelWorks executives and directors will control the new entity, but PixelWorks shareholders will control only one-third of the votes since
Genesis Microchip's shareholders will have a 62.5% stake in the new company. It seems PixelWorks executives sold out their shareholders'
control of the company in return for staying in charge themselves.
Executives at both PixelWorks and Genesis Microchip did not return phone calls this week.
Shareholders of both companies said this week that the deal makes sense from a strategic point of view because the merger will require
management to cut costs, which hasn't been the forte of Donegan and his team. Furthermore, they said the products the two companies make
will fit well together in a new company.
"We really like the deal," said Pat Becker, Jr. of Becker Capital Management, which owned roughly 1.6 million PixelWorks shares as of Dec.
31. "Strategically it's a great fit."
But questions about the new company remain. Can the new management successfully integrate its 650 employees spread across five locations
in three countries? Will the new management be able to take advantage of the assumed operating synergies? And, finally, would the valuations
of both companies have been helped if their managements had waited to be swallowed by a bigger fish rather than combining into a bigger fish
themselves?
With all this uncertainty, perhaps it's not so surprising after all that premium built into the merger of PixelWorks and Genesis Microchip has
evaporated, and that, based on their stock prices today, both companies have taken a bit of a haircut. |
