S3 to buy Diamond Multimedia

S3 said today that it has entered into a definitive agreement to acquire Diamond Multimedia Systems.

The deal is worth roughly $173 million, based on S3's trading price. S3 executives further indicated it won't be the last purchase either. The company has $130 million in cash reserves and is slated to receive $600 million in stock from United Microelectronics in Taiwan due to a sale of manufacturing plant assets.

By the acquisition, S3 expects to "emerge as a key player in the Internet appliance and home networking markets" and to combine the two companies' strengths to become a "total solutions provider--silicon, software, and PC [circuit] boards--for its graphics business," the company said in a statement. The stocks of S3 and Diamond, however, declined 7 and 16 percent, respectively, after the news today.

Diamond Multimedia makes the Rio series of Net audio devices and a range of graphics products for PCs including the Stealth and Viper series of graphics accelerators. It also makes the Supra series of modems and the HomeFree line of home networking products.

Diamond is expected to unveil a new version of its Rio portable MP3 player tomorrow that carries twice the digital music as its current device, according to Bloomberg.

Diamond confirmed that tomorrow evening in Los Angeles, it's unveiling a "new digital audio platform." The new Rio will hold about an hour of near compact-disc quality digital music, more when an extra memory card is inserted, analysts told Bloomberg.

But, like the older Rio, the device will play files exclusively in the MP3 format and won't include any of the copyright security features called for by the music industry, Bloomberg reported.

At this time last year, S3 appeared to be a has-been in the graphics chip market, posting losses and falling further and further behind ATI Technologies, the market leader. But now it seems to be rebounding somewhat on the back of new deals despite reporting losses in the first quarter.

Recently, S3 has signed on a number of large, new customers for its Savage4 graphics chip including Compaq, IBM, Packard-Bell-NEC, and Micron.

S3 has also finagled a few fairly strategic agreements with other companies. Last year, it entered into a cross-licensing agreement with Intel which will let S3 get into the chipset business. Under the agreement, Intel received access to the patents S3 acquired from Exponential, which many said gave S3 an intellectual property case against Intel. In turn, S3 got access to Intel patents and millions in return, said soruces.

And earlier this week, United Microelectronics of Taiwan announced that it was consolidating operations and buying out partners. As a result, S3 will receive $600 million in UMC stock.

"Today's announcement represents a significant strategic shift for S3, which was focused solely on the PC graphics market," Ken Potashner, president and CEO of S3, said in a statement. "By merging the strengths of both companies, we intend to create a major force in the industry for Internet appliances, broadband communications, home networking, and complete graphics solutions."

He added: "The acquisition is part of our ongoing strategic plan to return S3 to profitability."

Under the terms of the agreement, S3 will acquire Diamond Multimedia Systems in a purchase transaction in exchange for S3 common stock, the companies said. "Diamond shareholders will receive 0.52 shares of S3 common stock for each share of Diamond stock. S3 will assume Diamond's outstanding options. The deal is expected to close in October of 1999, subject to various conditions including customary regulatory approvals and approval by the shareholders of both S3 and Diamond Multimedia. The deal is expected to be tax-free. Diamond Multimedia has approximately 35.3 million shares outstanding."

News.com's Michael Kanellos contributed to this report.