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Genesis-Sage deal: A marriage for growth

The engagement of flat-panel chipmakers Genesis Microchip and Sage barely drew attention when it was announced last week, but the nuptial plans merit a closer look.

    The engagement of flat-panel chipmakers Genesis Microchip and Sage barely drew attention when it was announced Friday, but the nuptial plans merit a closer look.

    The marriage presents an example of a rare thing in the technology industry these days: a merger for growth.

    Sage's board agreed to sell their company for more than $240 million in Genesis stock. If the deal succeeds it would join the two largest makers of controllers for liquid-crystal displays, flat-panel monitors and similar devices, creating a company that controls roughly two-thirds of its market. And industry observers believe the engorged Genesis would thrive even more with Sage.

    "We believe that the combination makes for a stronger, better-positioned company in the near and short term, and that without dilution the combination makes sense financially as well," wrote Bradley L. Mook, analyst with Investec PMG Capital, which has a "buy" rating on Genesis.

    "Consolidation was in all likelihood a necessary eventual path in this space for specialized companies," Mook added. "The specialized firms will need scale, technology breadth, and strong customer relationships to defend market share effectively. This aggressive move by Genesis to acquire Sage is a favorable step toward that end."

    Or put another way: As diversified and larger--in some cases, much larger--companies like Philips Electronics and STMicroelectronics charge into flat-panel chips, independent competitors like Genesis need to bulk up to avoid being steamrolled.

    "This pushes back the timeline for any competitors coming in," CE Unterberg Towbin analyst Kalpesh Kapadia said.

    The fact that multinational giants like Philips are eyeing flat-panel controllers speaks well for the industry as a whole. Demand may have plunged this year for PCs, servers, networking equipment and enterprise storage, but a niche field like flat panels has been defying the technology trend.

    Mergers and acquisitions underscore the contrast well. Many analysts and investors believe Hewlett-Packard and Compaq Computer are two wounded beasts merging to survive, but that's not the case for Genesis, whose stock this summer flirted with all-time highs. Nor is it true for Sage, whose shares tripled in value over the spring and summer.

    "They certainly didn't have to do this," said Prudential Securities analyst Tristan Gerra, noting that Genesis was already regarded as formidable, and Sage was catching up.

    Genesis and Sage have competing products, but each company leads a subset of the overall flat-panel market. Sage dominates in all-digital flat panels and has products for DVDs, set-top boxes and other video products. Meanwhile, Genesis' strength lies in analog and dual analog-digital displays. And as the larger company, Genesis has a wider distribution network.

    "Sage has good products and good engineers," Kapadia said. "But it lacked the aggressive marketing and sales force."

    If current expectations are correct, those sales representatives will be needed for the company to take full advantage of a surging market. Market research firm DisplaySearch estimates the flat-panel industry will produce 14 million units this year and 22 million in 2002, which would translate into 57 percent growth.

    According to First Call, analyst consensus for Genesis' current fiscal year has been predicting sales of $108.88 million, which would be a 71 percent annual gain. First Call was forecasting that Sage's revenue growth in the same period would be 26 percent--much more modest than that of Genesis, but far better than many technology companies expect this year.

    The flat-panel industry's ability to keep up strong sales growth amid slow growth for PCs and an economic slowdown for PCs in general boils down to price, Gerra said. With 15-inch flat-panel displays now selling for $350--not much more than the cost of a high-quality 17-inch standard monitor--the thin screens are affordable for many people.

    Just as important: Although PCs are a maturing market, flat panels are not.

    "The penetration rate for PCs is very high," Gerra said. "But flat-panel display (market penetration) last quarter was 12 percent...You still have more than 85 percent of people with PCs who will, at some point, replace their monitors with flat panels."

    And even though prices are falling for flat-panel monitors, the same isn't necessarily true for the components inside--such as the chips made by Genesis, Sage and Pixelworks. Buying Sage and the accompanying market share means Genesis will have even more muscle to keep prices relatively stable, especially because the silicon controller is only a small part of the overall monitor, analysts said. Display makers can cut prices without a concurrent drop in prices for the flat-panel chips, which sell for about $12 to $15 apiece, Gerra said.

    Analysts are divided on whether the deal would make Genesis the best stock in its niche. Salomon Smith Barney, for instance, believes Pixelworks still represents a better buy, largely because of its stock valuation.

    And continued growth in the flat-panel market doesn't mean there won't be cost cutting once Genesis closes the Sage purchase. In fact, analysts said, cuts are required for Genesis to meet its goal of making the acquisition immediately profitable. Kapadia estimates that Genesis will have to cut $2.5 million from the companies' combined quarterly operating expenses of $15 million.

    But the mere fact that Genesis can even think about absorbing one of its biggest rivals without a hiccup in earnings per share makes the deal stand out in today's technology industry.