Bolaji Ojo EE Times (02/03/2010 2:50 PM EST)

Microchip Technology Inc.'s $275 million offer for Silicon Storage Technology Inc. represents an improvement upon an earlier agreement the storage semiconductor vendor's board struck in November with a different company but the latest transaction also undervalues SST although it looks like stockholders will accept the offer.

Blame it on an inept board of directors and an equally clueless management that in November agreed to sell SST to Prophet Equity LP for a now glaringly low $2.10 per share compared with the $2.85 offer Wednesday (Feb. 3) from Microchip.

The new offer from Microchip beats Prophet Equity's proposal by 36 percent and is more than 50 percent above SST's stock trading price on Nov. 12, 2009, the day before the company first announced it was being acquired.

Following the announcement of Microchip's offer, SST's stock price bounded up almost 6 percent and nestled just below the offer price in a sure sign stockholders were not expecting a higher offer. In November, SST's stock price surged above Prophet Equity's $2.10 per share offer in anticipation of a higher bid.

In some ways, both proposals undervalue the company and it remains a puzzle why SST's board of directors had accepted the Prophet Equity deal before stockholders turned it down. Microchip's offer, though slightly better, is itself weighted more heavily towards the buyer, which will actually pay only about one-third of the transaction value and use SST's available cash to bridge the gap.

For instance, while the transaction is valued at $275 million, Microchip will actually pay only about $95 million for SST because the target company has $180 million in cash in its accounts, according to Microchip. Analysts using SST's financial data from the third quarter of 2009 when the company reported about $211 million in cash and other liquid assets believe the deal may be even sweeter for Microchip.

"SST has $2.25 per share in cash, investments and net working capital," said Farukh Farooqi, an analyst at Marquis Research LLC. This "means, Microchip is really offering 35 cents per share in value or approximately $35 million for a semiconductor business which generates $280 million in sales and almost $50 million in gross profit and another $40 million in license fees. The license fees alone can be worth $200 million using a 20 percent yield."

How did SST get into this situation where it is literally being purchased by a buyer that has the option of using money from the acquisition target's coffers to close the deal? SST's financial performance has deteriorated in recent years and even after showing some improvements in the recent third quarter, revenue is forecast to decline for the third consecutive year in 2009. The company is scheduled to announce its fourth quarter results on Thursday (Feb. 4.)

The poor performance may be behind SST's management's decision to sell the business although initial plans had been to take it private through a leveraged buyout to be financed partly using available corporate cash.

The Prophet Equity deal did not go down well with most of SST's stockholders and a group of investors challenged the transaction even as its stock price barreled through the $2.10 offer price within hours following its announcement.

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