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Investors pan Diamond-S3 merger

S3 Inc. (Nasdaq: SIII) said Tuesday it would acquire Diamond Multimedia Systems Inc. (Nasdaq: DIMD) in a deal valued at about $175 million, but Diamond shareholders gave the deal a resounding thumbs down.

Diamond shares plummeted 14 percent, down 25/32 to 4 29/32 in morning trading, while S3 was down 3/16 to 9 1/4. Shares of Diamond are falling because S3 didn't pay a premium for the company.

Under the merger agreement, Diamond shareholders will receive 0.52 shares of S3 common stock for each share of Diamond stock. Diamond has 35.3 million shares outstanding. The deal is expected to close in October of 1999.

Brian Alger, an analyst with Preferred Capital Markets, valued the deal at $175 million, a slight premium after today's slide.

Alger added that the S3-Diamond combination will be accretive to earnings and enable Diamond to expand into other areas. "Long-term S3 is in a strong position to finance future growth," said Alger. "But S3 did get Diamond for a song."

Diamond, a supplier of PC Multimedia and Internet connectivity software, will give S3 the strength to move into the Internet appliance and home networking markets. S3 also plans to maximize the two companies' multimedia strengths to provide silicon, software and PC boards for its graphics business.

Diamond's products include the Rio player, one of a variety of MP3 players recently ruled legal in a court case that boosted Diamond's share prices despite the company's poor earnings.

Ken Potashner, president and CEO of S3, said in a statement that the Diamond acquisition is part of a plan to diversify S3 and return it to profitability. The company had a net loss of $13.9 million in the quarter ended March 31, and net sales fell 46 percent to $44.3 million. Declining revenue was attributed to competitive conditions and net loss did not include a $26.6 million gain on the sale of a joint venture to United Microelectronic Corp. (NYSE: UMC).

S3 competes with ATI Technologies (Nasdaq:ATYT), the market leader, but now is rebounding on news it has signed up big names such as Compaq (NYSE: CPQ), IBM (NYSE: IBM), and Micron (Nasdaq: MUEI) as customers for its Savage4 graphics chip.