Gennum: Being big by design

Gennum is on the acquisition path. Its latest target: Canadian firm Tundra.

Franz Fink can barely sit still. The CEO of Gennum (TSX: GND), sans tie and clad modestly in shirt sleeves and dress loafers, leans out of his chair onto the high polish of a sprawling boardroom table in his sparse Burlington, Ont., corner office, and thumbs quickly through a stack of papers. Full of acronyms and high-tech jargon, the printed presentation slides detail his company’s proposed friendly acquisition of Ottawa-based Tundra Semiconductor (TSX: TUN). “It clearly expands our market presence; it increases our TAM [total addressable market]; and in doing so it gives us more opportunities to win more business with a global customer base,” he says in a German-tinged stream-of-consciousness, with a grin even wider than his eyes. “Most importantly, it creates scale and let’s us leverage R&D much better than as a stand-alone.”

Never mind that he is speaking less than 24 hours after Gennum reported grim first-quarter results — revenue of US$19.4 million, down 35.5% year-over-year for the three months ending Feb. 28, and a net loss of US$800,000. And let’s not forget that the entire semiconductor industry is convulsing as the economy plunges. Fink is a believer that things are slowly turning around. “From recent order patterns we have seen, we believe that end-markets are stabilizing,” he says. “We’re very confident that things will progress throughout the year, and in 2010, the growth will come back.”

All the more reason, in Fink’s mind, to snap up Tundra now, especially since the price tag of $4.43 per share seems too good to be true — perhaps too good, say the deal’s detractors.

The proposed acquisition is Fink’s biggest move since joining Gennum in 2006. Over the past 2½ years, Fink has radically re-engineered the 35-year-old company that once made specialized parts for hearing aids. Fink has discarded those vestiges to focus on niche semiconductor components for advanced video broadcast and data communication technologies. Tundra is similarly a niche player in the chip industry, although it designs different components for different customers. That’s why few investors initially saw the two companies as a natural fit. Some are still waiting to be convinced.

The surprise acquisition, announced March 19, will bring together two of the three biggest remaining Canadian semiconductor companies — although each are small caps — and challenge Ottawa’s Zarlink Semiconductor as the largest such firm by revenue. As development costs rise for new, ever-more miniscule chip designs, smaller players are finding it increasingly hard to compete. For Gennum and Tundra, a merger would let each expand their customer bases, bundle some products and combine R&D forces to kick growth into a higher gear — and get big enough to avoid becoming an easy acquisition target. “As the market is down this year, it’s the right time to put something together to really accelerate short-term opportunities with customers,” says Fink, “but also to create a product road map such that, as the market returns in 2010, we are better positioned to come out as a much stronger force, with larger scale.”

Fink’s high-energy enthusiasm for the deal may not be enough, though. He might have to put up more money first.

Gennum looks like it’s getting a very good deal — too good a deal for some. In a dramatic reversal from what typically happens in tech-industry acquisitions — a maturing incumbent rashly overpays for disruptive technology — Gennum is offering to buy the profitable Tundra for not much more than its cash in the bank. Gennum’s cash-and-shares offer puts a 44% premium over Tundra’s closing price of $3.07 on March 19, initially valuing the company at about $86 million, even though it has $63.4 million in cash and short-term investments on its balance sheet as of Feb. 1. Over the past four quarters, Tundra reported revenue of $68.8 million and $10.4 million in EBITDA. “So there’s no value to your own intellectual property, there’s no value to your earnings potential of your business? Nothing?” asks BMO Capital Markets analyst Brian Piccioni. “It is not a defensible position.”

According to various news reports, several of Tundra’s major institutional shareholders object to the low price, and they hold enough votes to potentially block the deal, which requires two-thirds approval. Fink admits to being “a little” concerned that investors will see the deal as opportunistic, but brushes it aside: “As long as they are committed to stay in, they will reap the benefit anyway.”

If the deal goes through as is, Tundra shareholders will own approximately 18% of the combined company — although, as Piccioni calculates, Tundra will contribute 37% of revenue and 32% of gross profit, according to financial results from the past four quarters of both companies. Besides, he says, “From a shareholder perspective, what happens to Tundra after they no longer own it is irrelevant.”

Tundra CEO Daniel Hoste, who was unavailable for an interview, commented through a spokesperson that due to the cash-and-shares structure of the acquisition and the rising price of Gennum’s stock during the week of March 30, the implied value of the deal has risen as well. At press time, the deal was worth $94.7 million.

Tundra came into Gennum’s sights last fall. Over the previous year, Fink, who spent 15 years at American communications equipment giant Motorola and its semiconductor spinoff, Freescale (Hoste also clocked 16 years there, and briefly reported to Fink), had laid the groundwork for Gennum to focus on developing chip components that, in short, maintain a high-quality signal in multimedia and data networking devices.

In 2007 and 2008, Fink sold two divisions not part of that plan (a third was divested in March 2009), and acquired two companies that have semiconductor intellectual property: Toronto-based Snowbush Microelectronics and ASIC Architect, which has offices in Santa Clara, Calif., and Bhubaneswar, India. The deals let Gennum expand its product portfolio into new vertical markets, and begin developing more complex chip components.

“Ultimately, semiconductor design is all about scale, and the affordability of R&D,” says Fink. That same message hit home with Tundra. “We felt for a long time that Tundra was at the low-end of the revenue range where we could sustain ourselves competitively because of the cost of R&D,” says chairman and founding CEO Adam Chowaniec, who, along with another Tundra director, will join Gennum’s board. “We could see our potential to continue growing just organically was going to get eroded, and that got compounded by the downturn.”

When they compared portfolios, Chowaniec says it became clear they could create a company with $250 million in revenues and global clout. And when Tundra surveyed other potential parties, no bids were in the offing.

On paper, the combination works, with complementary geographic strengths — Tundra in China with customers such as Huawei Technologies, and Gennum in Japan, where it gets 30% of its revenue — and modest overlap in customers. Fink figures Tundra will expand Gennum’s total addressable market from US$1.3 billion to nearly US$2 billion.

But perhaps most importantly, the deal creates a company with financial heft. “These days, customers are looking at a supplier’s ability to expand its product line, and still be there in five years time,” says Jag Bolaria, a senior analyst with the Linley Group, a market research firm in Mountain View, Calif. “If you combine a Tundra with a Gennum, that makes the company financially much stronger and increases its ability to win designs.” But he notes engineers will have to pick their targets carefully.

As for Fink, who wants to turn Gennum into one of the top 10 semiconductor design companies in the world by market cap, he’s already looking ahead. He makes no secret that once Tundra is part of the business, Gennum will consider further acquisitions, probably in Silicon Valley. “With this, we are not done,” he says, leaning back from the boardroom table.

Of course, depending on investors’ reaction to his latest deal, he may not even be done with Tundra.

For more on this story, see the following updates on Andrew Wahl’s blog:
Gennum withdraws, IDT to acquire Tundra
Gut-check for Gennum, as Tundra receives rival bid
Gennum sweetens the pot for Tundra