Options issue clouds M-Systems buyout

Acquisition by SanDisk is country's second hi-tech merger in a week.

The $1.55 billion acquisition of Kfar Saba-based M-Systems Flash Disk Pioneers Ltd. by SanDisk Corp., the world's largest maker of memory cards SanDisk Corp., marks the country's second hi-tech mega-deal in a week but has left some professionals wondering whether the price was the best it could have been. "At the end of the day, in our opinion, increasing pressure from the board of directors due to the options issue pushed the company to sell," analysts at WR Hambrecht told clients. "SanDisk took advantage of the weakness at M-Systems due to options." The deal came as M-Systems attempted to shake off an options backdating investigation that delayed a stock offering planned for this past May. Only last week, Mercury Interactive, which became embroiled in regulatory probes over its grants of options to top executives, sold itself to personal computer giant Hewlett-Packard for $4.5 billion in the largest ever hi-tech acquisition of an Israeli company. "The consolidations are a global trend that we are seeing impact Israel, and the latest SanDisk deal is another example that major players in the world look into the Israeli market to strengthen their leadership, grow into new businesses or enter new niches," said Daniel Meron, vice president and research analyst at RBC Capital Markets. "In the majority of cases, Israeli hi-tech companies are getting similar valuations as their peers." Gary Raskin, an analyst at Psagot Ofek, said that without the options issue, M-Systems' position would have been stronger, and it possibly resulted in the merger price that is lower than Psagot Ofek's $40 target. Under the terms of the all stock transaction, each M-Systems ordinary share will be converted into 0.76368 of a share of SanDisk common stock, representing a 26 percent premium over the average closing price of M-Systems' shares for the last 30 trading days, but just 13% over M-Systems' closing price on Friday "This acquisition is below our target price for M-Systems at $46, and we had hoped for a better price. At $36 a share, while not a significant premium, it is still an attractive price and close to the 52-week high," WR Hambrecht noted. M-Systems CEO Dov Moran, a Zionist who is known to be very emotional about the company he founded 17 years ago, has been downplaying the likelihood for a merger with SanDisk for some time. But, analysts said the potential risk of changes in management because of an options investigation and the company's need for a steady supply of flash chips turned the deal inevitable. Nevertheless, the merger, which joins two Israeli-rooted companies, creates a mobile powerhouse. "The two companies complement each other. M-Systems will benefit from using SanDisk's production capacity, which is jointly held with Toshiba," said Judy Bruner, SanDisk executive vice president and chief financial officer. "Over the next two years, SanDisk intends to invest $5 billion in expanding its production capacity. In any event, there will be no change in M-Systems' activity in Israel." The merger provides fabless M-Systems with the supply of NAND processors after the break up of several potentially promising deals with big manufacturers such as Samsung Electronics Ltd. and Korean manufacturer Hynix Semiconductor had increased M-Systems' worries about a shortage of flash chips. Instead of sleepless nights, M-Systems gave in to the easier option and joined forces with SanDisk. California-based SanDisk, which produces flash processors and memory cards for the retail market and is headed by several Israelis in addition to its founder and CEO Eli Harari, has a branch in Tefen in the Galilee. "We believe that in searching for a partner the fact that both companies are influenced by 'Israeli roots' gives a significant benefit from a cultural perspective," WR Hambrecht said. "Both companies are highly synergetic, share the value of strong R&D, innovation and pioneer in their own respective markets. Therefore, M-Systems selling to SanDisk is more like a pea in a pod." The deal, which is expected to be closed during the fourth quarter of 2006 still awaits Israeli court approval, regulatory approval, and M-Systems shareholder approval.