In Reel Time

2010.39 Francisco Partners makes firm offer for Grass Valley Broadcast business

In January 2009 Technicolor announced that it would spin off its Grass Valley business in its entirety. 18 months later, in July 2010 Francisco Partners has made a binding offer for the broadcast business only, and Technicolor intends to divest the transmission and head-end units separately.

Grass Valley’s broadcast business is a leading provider of video creation and video management equipment for broadcasters and teleproduction companies. As of June 30, 2010, the business unit had 1,457 employees in 23 countries. Revenues were about 272 million Euros for 2009 with an operating loss of approximately 52 million Euros. During 2009 the broadcast division made up 72% of total Grass Valley revenues and 59% of its operating loss; so the other Grass Valley businesses aren’t doing well either.

Per the deal announcements the broadcast business is valued at US$100 million. However, in reality the valuation is nowhere near that, and Technicolor is not receiving any cash; in fact, they are bringing cash to the closing. A promissory note of $80 million with a six year maturity and capitalized interest of 5% will be issued to Technicolor. Technicolor will also provide 20 million Euros of cash to support the business. Additional consideration may accrue to Technicolor based on future results, (i.e., an earn-out). It has not been publicly announced how much capital Francisco Partners is investing in the company.

All assets and employees of the Broadcast business are included, as are patents and license agreements in the professional broadcast equipment space. Active employee retirement liabilities are transferred to the acquiring Newco.

The transaction is expected to close by year end (subject to final agreement and regulatory approval).

Francisco Partners, with nearly $5 billion in capital, is among the world’s largest technology focused private equity funds. Partner David Golob is quoted in online reports of the deal.

Technicolor is attempting to refocus its business around its content creator and network service provider customer base. Having been in business for over 95 years the company is clearly trying to proactively react to cataclysmic changes in its business model. Historically, they have been providing production, postproduction and distribution services to content creators and distributors for entertainment, software and gaming customers. Technicolor is an industry leader in film processing and DVD manufacturing and distribution (a business decimated by industry evolution). They also provide set top boxes and gateways, and operate an intellectual property and licensing business.

No cash upfront after eighteen months on the market? Clearly not the easiest offer to muster. But Francisco Partners is also taking on some industry challenges. Not only does the broadcast industry remain challenged and capex budgets likely more frugal going forward, but the growing significance of IP-based video in professional as well as consumer applications means that Grass Valley’s business will increasingly be coming into contact with technology leaders such as Cisco and EMC.

2010.38 Carl Icahn Sues Lions Gate and Rechesky over Debt to Equity Deal: Why Good Advisors Matter When Contemplating M&A

The ten-day truce between Carl Icahn and Lions Gate management is very clearly over.

Icahn has let it be known that he doesn’t support the merger discussions between Lions Gate and MGM.

On July 20, Icahn also launched a new takeover offer for Lions Gate common stock at $6.50 per share, lower than his previous $7.00 offer. The offer is contingent on management not entering into a major transaction outside the normal course of business. The tender offer will expire August 25; Icahn will then nominate a slate of directors to replace Lions Gate’s current board. The election will occur at the company’s annual board meeting; most likely in October.

Lions Gate, in an effort to reduce debt, issued common shares at $6.20 per share to retire $100 million in convertible debt, the stock price represented a 2.8% premium to Monday’s share price. Icahn’s holdings were reduced to about 33.5% from 37.9%. The move doesn’t only dilute Icahn; it dilutes all existing shareholders. The 16.2 million new shares went to Mark Rachesky (MHR Fund Management), who already held almost 20% of the company’s common shares; his percentage is now 29%. The debt, due in 2026 and 2027, was acquired from Kornitzer Capital. Kornitzer also owns a small number of Lions Gate shares which he hasn’t tendered to Icahn.

Icahn must now acquire almost another 17% of shares to accomplish his takeover goal – assuming that management doesn’t convert more debt to equity.

This morning Icahn filed a law suit in New York state court against Lions Gate and Mark Rachesky seeking damages, an injunction rescinding the debt-to-equity swap and the prohibition of the defendants from voting their shares in a vote to elect directors. Icahn also filed a petition to the Supreme Court of British Columbia – a hearing to be held on Wednesday – regarding whether to grant orders against Lions Gate and Rachesky. Both sides are engaging in some general public mud slinging; the specifics of their accusations won’t be covered herein.

The battle continues. Lions Gate stock closed at $6.90 today, July 26.

The fight over Lions Gate reflects the importance of good advisors. Both sides are now exploring creative transactions and strategies to ensure that the outcome of this M&A battle is in their favor. Clearly the bankers and lawyers involved are working hard on behalf of their respective clients.

2010.34 Update on Sonic Solutions / DivX

As our alert readers already know, on June 1 Sonic Solutions and DivX announced a definitive agreement for Sonic to acquire DivX (see our previous post on this topic).  The point of this post is to give interested readers an update.

Valuation reminder.  Sonic agreed to pay $3.75 in cash and to issue 0.514 Sonic shares for each DivX share.  That represented $9.83 per share to DivX holders on June 1, and the implied enterprise valuation for DivX was $189 million.

Timing is everything.  On the day of the announcement, Sonic’s stock price closed at $11.83, which was up almost 20x from its March 2009 low of $0.60.  However, since the announcement Sonic’s stock price has dropped over 35% to its July 9 closing price of $7.64.  This reduces the per-share value of the offer for DivX to $7.68.  Still a premium to DivX’s June 1 closing price of $6.95, but now only a 10.5% premium.

The S&P 500 closed slightly up today (July 9) vs. its June 1 close, so this is not a market issue more generally.  Nor is there any dramatic news from either Sonic or DivX since the announcement.  To the extent that one can explain short-term trading fluctuations, I think the fallback represents (a) arbitrageurs selling Sonic short and going long DivX to lock in a trading gain on a transaction, and (b) some concern on the part of the market that Sonic is opportunistically using the dramatic run-up in its stock price to execute a stock acquisition.

Updated valuation metrics.  At the July 9 valuation, DivX has an implied transactional enterprise valuation of about $118 million.  This represents a valuation of 1.6x DivX’s LTM revenue and slightly under 13x its LTM EBITDA.

Sonic’s portrayal of the transaction.  Check out this link for a Sonic management presentation at the William Blair Growth Stock Conference in June.

What do the relative stock prices say? As noted above, the current transactional valuation for DivX is $7.68.  DivX’s July 9 closing price was $7.26.  That represents a 5.8% discount to the transaction price.  Sonic and DivX have publicly expressed the expectation that the transaction will close before September 30, so on an annualized basis excluding transaction costs that is a return of over 23%.  Not a bad return, but also a price that suggests the market believes the transaction will close on schedule or close to it.

When do you think the transaction will close?

2010.33 Carl Icahn now owns close to 38% of Lions Gate shares; Mark Cuban did tender his shares

Carl Icahn now owns almost 38% of Lions Gate’s stock. His offer to buy shares from Lions Gate shareholders ended last Wednesday (June 30). Mark Cuban did tender his shares to Icahn. Thursday he purchased 4.64 million more shares on the open market. With other recent purchases he now owns 44.8 million shares, or almost 38%. Due to Canadian law he can’t buy more shares in the open market (Lions Gate is legally a Canadian company). Icahn has declared that he will wage a proxy fight for control.

Later Thursday Lions Gate management adopted a shareholders rights plan triggered at 38% ownership. In it is a provision which allows shareholders excluding a bidder (for the company) to buy shares at a discount. Previously, trying to fend off Icahn, management had raised the “change of control trigger threshold” from in excess of 20% of shares to in excess of 50%. Last April they attempted to put in place a different poison pill but it was voided by the British Columbia Securities Commission. Icahn has already accumulated enough equity to veto mergers and acquisitions, and he has also tripped a provision which grants $16 million in severance to management should they decide to leave the company (they have assured the board that they will stay and fight Icahn).

Management is using classic hostile takeover defense strategies in an effort to slow Icahn down (looking for alternative transactions or ways of building shareholder value). Recent operating results were also strong which helps support their contention that Icahn’s bid is too low. For example, they have discussed a possible merger with MGM and clearly continue listening to counsel with respect to allowable corporate actions. Hostile takeover law is quite sophisticated and management teams must be careful in their attempts to thwart a potential acquirer, or, if the acquirer can’t be thwarted what steps they must take to maximize shareholder value.

The recent operating results? Lions Gate recently reported adjusted earnings for the fiscal year ended March 31, 2010 of $128 million. Film library revenues were up 15% to $323 million, with television revenues rising 60% to $351 million.

Icahn has taken his battle not only to the shareholders but also to the press. Will he start spending more time in the courts as well? Hostile takeover attempts very often involve costly litigation; under Delaware law it is often the only way for a potential acquirer to scuttle anti-takeover provisions. Icahn must act under Canadian law. Indeed, he has already gotten a Receipt of Approval under The Investment Canada Act, in which he made several commitments to government entities regarding how he would run certain Lions Gate businesses should he gain control.

Icahn wants management to clean up the company’s balance sheet, stop producing independent films and just distribute them, stop trying to acquire other film libraries and cut “absurd” overhead costs. Clearly, some shareholders still aren’t siding with him in this battle. The final tally? We’ll find out.

Note for Tuesday, July 5, Lions Gate shares dropped below $7.00 last Friday and remain there today.

2010.31 When to declare bankruptcy or call a turnaround expert; thoughts after the Turnaround Management Association’s 8th Annual Night of Excellence

Last Thursday I attended the Turnaround Management Association’s 8th Annual Night of Excellence – a charity event benefitting the City of Hope. It was held at The Petersen Automotive Museum and included dinner and a wine tasting. One wine was named “Ponzi” which in this crowd means you just drink it while hearing about their recent Ponzi scheme related assignments.

I was talking to George Blanco from Avant Advisory Group, who headed the event and he said something interesting: that many restructurings or bankruptcies were transactions that didn’t happen. My mind automatically recalled a few CEOs I’d worked with that had turned down capital because they thought the deal valuations was too low and then proceeded to go bankrupt.

When I mentioned this topic idea to David he said, “Why not. We advise business owners cradle to grave, right?” So in that spirit, when to call a turnaround or bankruptcy expert:
1. Management has exhausted all other forms of capital and the company is not cash flow positive.
2. Your top line business continues to decline with little hope for an upswing.
3. Burdensome contracts or leases can’t be re-negotiated any other way (and are too expensive to afford as is).
4. Management lacks the specific expertise or skill set to turn the company around or has already tried and failed.
5. Creditors are threatening aggressive actions.
6. Industry wide challenges are creating disruptive results for all market participants and a speedy, well crafted response is required.
7. And, at the extreme, there is little value left in the business and you need experts skilled at liquidating or winding down.

And the transaction that didn’t happen? History does repeat in that funding is not always available or at least not available on reasonable terms. Raise money before you’re running out (if you are going to or just might need it); sell the company before business deteriorates to the point at which little value is left. Turnaround and bankruptcy experts have very specialized skills, relationships and knowledge that are valuable when a company or industry hits a rough patch.

Bottom line: business is a series of tough judgment calls. When to run a struggling or over leveraged business in the ordinary course, versus when to pursue a restructuring, is one of the toughest judgment calls there is. You will be disappointing equity holders and dashing expectations to push the restructuring button – but it may be the necessary step to maximize the value of the business for creditors, business partners, employees and maybe even existing shareholders. And get specialized help if you need it.

2010.25 Sonic Solutions to acquire DivX

On June 1, Sonic Solutions and DivX announced a definitive agreement for Sonic to acquire DivX.  Your intrepid bloggers at Hadley Partners wanted to bring you some scoop and prompt commentary on the proposed transaction.

Deal terms / premium

DivX shareholders are to receive $3.75 in cash and 0.514 shares of Sonic stock per DivX share.  Sonic stock closed on June 1 at $11.83, so total per-share consideration at announcement was $9.83.  With DivX’s pre-announcement share price at $6.95, the premium was 41%.  However, Sonic’s stock price dropped 12% in the two days after the announcement, reducing the deal premium to 31%.

Post-transaction, DivX stockholders will hold approximately 35% of the equity of the combined company.

At announcement, the price being paid for DivX’s equity was $325 million.  However, as of March DivX had no debt and over $135 million in cash on its books.  In fact, Sonic is paying less in cash to acquire DivX than the cash it will inherit at closing, so in economic terms this is really an all-stock acquisition.

The transaction is expected to close in September, and is subject to a vote of both companies’ stockholders.  If DivX terminates the transaction under certain circumstances prior to year-end, it is required to pay a termination fee of $8.35 million.

Sonic Solutions

Sonic supports the creation and management of digital media with products, software and services.  It generates the majority of its revenues in its “Roxio Consumer” segment, where its offerings enable consumers to create, manage and share digital media content (data backup, media transfers, DVD burning, etc.).  Sonic bought the Roxio brand name and some of this consumer business in 2004 from what is now remembered as Napster.  The Roxio Consumer segment generated 87% of company revenue and all of its operating profit for the nine months ended March 2010.  These sales come through digital storefronts such as Digital River, distributors such as Ingram Micro and Navarre, and the company’s own website.

Sonic’s second business unit is what it calls its “Premium Content” segment.  Most prominently, Sonic offers digital media solutions that enable major studios and other content producers to render their media in different digital forms.  Historically, this has been primarily DVD authoring tools.  However, this business is evolving rapidly, first toward Blu-ray and ultimately toward digital distribution (streaming, downloading, etc.).  The Premium Content business has recently been shrinking and losing money, but the company is optimistic about its positioning for the digital distribution growth opportunity.

DivX

DivX is a leading provider of digital media encoding and decoding formats and solutions, and also supplies digital rights management (DRM) tools.  Encoding/decoding tools (“codecs”) are proprietary offerings that make the delivery of media, in particular video, more bandwidth-efficient without sacrificing image quality.

Since its inception, DivX has been vying against the likes of Microsoft, Apple, On2 Technologies (recently acquired by Google) and Real Networks to become the industry standard for video compression.  DivX technologies have shipped in over 300 million hardware devices worldwide including digital televisions, DVD and Blu-ray players, game consoles and mobile handsets.  The end game is to make high-quality digital content accessible anywhere, anytime on any device.

The company generates over 90% of its revenue by licensing its technologies to consumer electronics OEMs (70%) or to software vendors that include DivX technologies in their offerings (22%).  The company is also very strong internationally, with less than 20% of its 1999 revenues derived in the U.S.

Business logic / strategic rationale

Both Sonic and DivX operate within a complex value chain where their solutions work best if broadly available.  The value chain involves content creators (both professional and personal), content distributors, consumer electronics/hardware companies, PC/software companies and online and offline retailers.  Both companies license their technologies to key consumer electronics OEM’s as well as content creators and distributors.

As the industry evolves from one dominated by hardware distribution (DVD and Blu-ray discs) to one dominated by digital distribution, Sonic is betting that DivX’s technology strengths, licensing relationships and installed device base can all accelerate Sonic’s momentum.  Direct synergies from a combination are not obvious – the companies have been working together for years, and will continue to work with other partners – but the ability to bring more value to key business partners and licensees should create some benefits.

It is possible that the transaction has an opportunistic element for Sonic as well.  The dramatic rebound in Sonic’s stock in the last year – almost 20x from its low of $0.60 in March 2009 – is arguably ahead of its business, where revenue for fiscal 2010 was down 12% vs. the prior year and the business lost money for the full year (albeit profitable in the March quarter).  DivX’s top line has also been down due to lower consumer electronic sales and related licensing revenues, but its absolute profitability currently exceeds Sonic’s.

The acquisition is intended to enhance Sonic’s recently released RoxioNow content platform, the technology behind the virtual video storefront services that Sonic currently runs for Best Buy, Blockbuster and Lionsgate aimed to provide consumer with access to digital media content from virtually anywhere.  Sonic also bought CinemaNow last year and is offering studio content via that website.

Valuation / Metrics

DivX equity valuation – $325 million

DivX enterprise valuation – $189 million

DivX LTM revenue (March 2010) – $75.2 million

DivX – LTM EBITDA – $9.2 million

TEV / LTM DivX revenue – 2.5x

TEV / LTM DivX EBITDA – 20.6x