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S3 sells graphics chip unit, shifts focus

In a second day of shake-ups in the graphics hardware market, S3 agrees to turn over its graphics chip business to Via Technologies as part of a joint venture.

In the latest sign of consolidation in the graphics industry, S3 today announced it would sell its graphics chip business to focus on the booming market for Internet appliances.

Under terms of the deal, the company's graphics technology unit will be transferred to a joint venture owned primarily by Via Technologies for $323 million. The business will then work with Via to produce chipsets, a crucial piece of silicon that connects the processor to the rest of the computer, with integrated graphics capabilities.

Although the sale was expected, it highlights an ongoing meltdown in the graphics market that many analysts say is long overdue. Simply put, there are too many graphics chip designers chasing too few opportunities in a market where profits have declined and research and design complexity has increased.

About a year ago, approximately 40 companies officially claimed to be working on graphics processors, said Peter Glaskowsky, an analyst at MicroDesign Resources. Because of recent acquisitions and dropouts, however, "it's down to about 10 or 15 now," he said, adding that the number may still be too many.

"Some people are making money--most aren't," Glaskowsky said.

Although S3's shift to devices looks good on paper, the company is heading into another market fraught with a similar level of low-cost competition, analysts said.

"It is another overpopulated market that is going to be taken over by low-cost competitors from Asia," said Jon Peddie, principal at Jon Peddie Associates, a Mill Valley, Calif.-based consulting group. "They (S3) have no choice. It's either that or back to the beer distributor in Newark."

The graphics industry has been rife with mergers lately. Yesterday, 3Dlabs scooped up Intergraph's graphics division, gutting the remains of its workstation business. In August, Intergraph largely exited the low-end PC and workstation market, focusing more on servers and its core competency of selling software.

Both acquisitions follow others: 3Dfx Interactive last month bought Gigapixel for $186 million, and ATI Technologies in February picked up ArtX for $400 million.

Integrated chipsets have been one of the contributing factors in the decline of the graphics chip industry. Although these chipsets can't match the performance of computers with standalone graphics chips, integrated chipsets cost much less. Most PC manufacturers incorporate them in their business computers and discount consumer models.

Ironically, Intel failed miserably in a 1998 effort to become a major producer of graphics chips but has become a power in the graphics industry because of its integrated chipsets. Via has also made graphics chipsets for some time with the cooperation of, among others, S3. Via bought a 14.9 percent stake in S3 last December.

Via is likely to become one of the major graphics suppliers because of the benefits of integration, said Peddie. "We will end up with three major suppliers, three second-tier suppliers and some uncountable number of ne'er-do-wells," Peddie said.

Although Intel sells far more chipsets than Via, the Taiwanese company, which makes chipsets for both Intel and AMD, has seen sales soar in recent month. The stock has also climbed on the Taiwan exchange.

Via's deal today will likely also add fuel to the ongoing battle between the two companies. Intel and Via are locked in a series of lawsuits in the United States, the United Kingdom and Singapore over a licensing deal that went awry. Intel is trying to block the import of Via's chipsets to the United States, claiming Via violated the agreement. Via hotly disputes Intel's claims.

S3's next phase will be to build on the success of Rio MP3 music players and home networking products, which it acquired with the purchase of Diamond Multimedia last summer.

"In addition, we have signed and expect to soon be announcing key strategic partnerships that will add marketing and brand strength aimed at further propelling our Internet appliance business," S3 CEO Ken Potashner said in a statement.

Whether the company can turn that into a profitable, sustainable business remains to be seen. Music players will continue to decline in price, making them a tough product to build a business around, Glaskowsky said.

S3, however, could forge agreements to integrate its MP3 technology into handhelds and cell phones, so those devices could become voice recorders and personal stereos.

"They've got a good basis for that. I would like to see them get into the cell phone business," Glaskowsky said. "There are a lot of things like that that are going to change the way people live their lives."

Peddie was more skeptical, likening S3 to a stone skipping across water: It has bounced from one dangerous market but is now heading toward another, he said.