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In the wake of the spring meltdown, lots of technology stocks look like good values compared to the lofty heights where they once traded. But you still won't find many that look cheap using more traditional valuation methods -- adding up the value of a company's tangible assets and comparing that to the market cap.
But S3 is one company that does look cheap on that basis to some analysts. It's in the midst of a transition out of the low-margin, highly competitive market for computer-graphics chips and into the hot (and hyped) market for Internet appliances. Its shares are now trading at about $17. Tejas Securities initiated coverage on June 6 with a $35 price target. And Lehman Brothers started its coverage in late March with a similar target valuation of $34.
But, as with many value stocks, S3 is far from a simple story. By completely overhauling its strategy, the Santa Clara (Calif.) company is open to exciting new growth opportunities, but it's also exposed to plenty of risk. It has yet to complete the deal to unload its core chip business in a complex transaction with Via Technologies. Meantime, it's ramping up in its new digital-media market, in which it became an instant force last September when it bought Diamond Multimedia, maker of the Diamond Rio MP3 player, home-networking equipment, and modems.
RISK FACTORS.
The few analysts who cover S3 think CEO Ken Potashner, a turnaround specialist and architect of its transition, is making the right move to get out of the graphics-chip business and into a new growth market. But there's some concern that he may not be able to pull it off as neatly as he hopes.
For example, Via is in litigation with Intel, which has a cross-licensing agreement with S3. Brian Alger, a research analyst at Pacific Growth Equities, sees risk in the fact that Intel has a stake in intellectual property shared with S3. That, he worries, could lead Intel to challenge the partnership with Via after the fact, once new products are produced.
Such risks aside, analysts think the deal (essentially a transfer of assets to a joint-venture company formed with Via) will close in the next month or so and result in Via paying $323 million in cash and stock to S3.
OPERATING LOSS.
S3 already has a massive war chest. The company has nearly a billion-dollar holding in UMC, a Taiwanese semiconductor foundry, which S3 gained when that company bought another chipmaker S3 had invested in. When S3 recently marked up the value of those securities on its books, the one-time gain lifted its first-quarter net income to $493 million, or $5.04 a share, and helped it earn 19th place on Business Week's Information Technology 100 list. On an operating basis, however, S3 lost 31 cents per share the first quarter of this year and isn't expected to make a profit until late 2001, if then.
UMC is an important hidden asset. Peter Labe, an analyst with Buckingham Research estimates it's worth $10 or $11 a share to S3. "There are ways you can get that monetized," he says, suggesting that S3 could issue a convertible bond that would convert to UMC stock. Lehman Brothers cites another hidden asset -- S3's roughly 40% share in music portal RioPort.com. If that site succeeds in going public, a plan recently put on hold due to market conditions, it could add $3 1/3 to S3's share price, according to Lehman.
Most important, these holdings gives S3 the cash to back up its move into digital media, says Fred C. Bush of Tejas Securities. That money can go into building Diamond's promising home-networking and MP3 player line. Although revenues from its leading Rio player are limited by the relatively small size of the current market for such devices, Bush expects S3 to expand its product line into radios, car stereos, boom boxes, and more. "This is a big market when you look at everything else they could get into," he says.
HIGHER PROFILE.
Once all these deals are done and the value of the hidden assets becomes clear, "Then you have a clean company that is engaged in one business, Internet appliances," says Labe. That should give S3 a higher profile on Wall Street, which may have been confused by the complex transition. As it gets out of the chip business, which accounted for the bulk of its revenues in the past, the stock is plenty risky.
But Labe says he takes heart that, unlike some Internet companies, S3 has hard assets underneath it. Adding up the value of its digital-media properties, its graphics business, and its cash, he puts the stock's value $25 to $35 a share. "It is one of the few stocks I don't worry about," he says. "We see the direction they are going. It will take several quarters to execute the plan, but the value is there in the stock."
No doubt. But only if Potashner doesn't run into any roadblocks on the road to reinventing S3 as a digital-media company.
Amey Stone covers investing for Business Week Online
Got a question or comment? Go to our Ask Amey Stone Forum now! EDITED BY DOUGLAS HARBRECHT
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