NY hedge fund pushes for sale of analog chipmaker Micrel
Micrel pointed out that insiders own 30% of the outstanding shares, which means the hedge fund faces an uphill battle given they need a majority of outstanding shares to vote for them.
By Ann Steffora Mutschler, Senior Editor -- EDN, April 4, 2008
San Jose-based analog and mixed-signal chipmaker Micrel Inc is fighting a battle with NY-based hedge fund company Obrem Capital Management (OCM), which is demanding the company be sold.
Other companies that have recently faced angry shareholders include Atmel, Vitesse Semiconductor, Cypress Semiconductor, Mosaid, and most notably, Motorola.
Micrel’s trouble began on March 20, when NY-based OCM filed a letter with the Securities and Exchange Commission (SEC) that demanded the pursuit of a process that could lead to the sale of the company.
Four days later, Micrel issued a statement regarding OCM’s filing, which stated that the Micrel board of directors and management team are committed to enhancing shareholder value.
“As OCM acknowledges, Micrel has established the foundation for future success by securing key competitive strengths including a leading reputation in the industry, strong technology platform, valuable manufacturing competency and attractive customer base,” the company’s statement said.
“The board and management also have overseen an active share repurchase program under which the company has repurchased over 10% of its outstanding common shares since the beginning of 2007 alone. Furthermore, to provide a more direct return to Micrel shareholders, the board initiated a quarterly dividend payment in April 2007,” Micrel continued.
“While the board recognizes that industry challenges and market volatility have resulted in recent stock price declines, the board feels strongly that this solid foundation, combined with continued financial and operational improvement initiatives, as well as capital structure discipline, will drive returns and maximize long-term shareholder value.”
Ray Zinn, chairman, president and CEO of Micrel, reminded that Micrel has been profitable on a GAAP basis for 28 years of its 29 year existence, while growing annual revenues in 24 of those years. “Although recent market conditions have resulted in a reduced valuation of Micrel's shares along with most other semiconductor companies, I believe our investment in best-in-class new products should result in continued profitable growth in future years,” he said.
Zinn owns 11.2 million shares, or approximately 15.6% of Micrel's outstanding shares. The company also pointed out to EDN that Micrel insiders own 30% of the outstanding shares, which means the hedge fund faces an uphill battle given they need a majority of outstanding shares to vote for them.
Warren Muller, a founder of Micrel, owns 10.1 million shares, or 14.1% of outstanding Micrel shares.
Following that letter, Micrel said on March 26 that it received a request from OCM to call a special meeting of the shareholders on May 20, which also includes proposals to remove the company's current board of directors, to amend the company's bylaws to permit a majority of the outstanding shares to set the size of the board, to change the size of the board of directors to six, to rescind the company's shareholder rights plan, and to elect six directors designated by OCM.
On that day, Micrel said its board would review the notice and consider it in light of the best interests of all shareholders of the company.
On April 1, Micrel issued a letter to shareholders which stated that Micrel believes OCM has made a number of inaccurate and self-serving assertions in their letters and proposals in relation to their efforts to take control of Micrel’s board of directors and reiterated some of its previous statement and detailed its business plans to improve value for shareholders.
Micrel also clarified that contrary to OCM's statements, Micrel outsources manufacturing where it makes sense to control costs, including the outsourcing of all of its assembly and over 90% of its test operations. “We believe there are substantial benefits to both Micrel and customers of our vertically integrated front-end manufacturing strategy. Our captive wafer fabrication facility, together with third party foundries, allows us to optimize the company's cost, quality, delivery, customer service, time-to-market, and technology roadmap,” Micrel said.
Further, Micrel said: “We believe OCM's statements about Micrel's cost structure and operating margins reflect their lack of in-depth knowledge about the industry and that their filings contain factual errors and inconsistencies, such as the mixing of GAAP versus non-GAAP metrics in their comparisons and the use of an extremely narrow and 'cherry-picked' set of comparables.
“As compared to a broader and more representative set of analog companies, (1) our operating margins are in line with or, in the majority of instances, superior to these peers. In 2007, our GAAP operating margin was 18.4%, compared to a median of 13.9% for such peers. The company's 2007 GAAP SG&A as a percent of sales was 17.5%, placing us at the lower end of the peer group and significantly below the median of 20.5% for our peers. It is also worth noting that Micrel has lowered SG&A expense by more than 20% over the past eight quarters,” the company wrote.
Micrel also mentioned that it’s the company has been investing for future growth including the development of what the company believes are industry-leading technologies, such as the patent-pending Hyper Light Load power capability and the Super LNR devices, as well as what it believes are the world's fastest switching regulators.
“We introduced 82 new products in 2007 and believe we have amassed one of the largest patent portfolios of any analog company of similar size. In our opinion, OCM's assertions about the company's growth and margins completely miss a key point -- our investments are positioning the company to outpace industry growth. We do not believe that Micrel's stock price today fully reflects this potential,” Micrel said.
“As OCM apparently only commenced acquiring Micrel shares a few weeks ago, the lack of understanding of Micrel's business and the industry is not surprising. However, this obvious lack of knowledge and experience is troubling to the board and should be troubling to other long-term shareholders as OCM is seeking control of the company,” the company continued.
According to recent SEC filings, OCM purchased approximately 10.7 million shares of Micrel common stock over the past five weeks at a weighted average cost of approximately $8.01 and by undertaking these purchases at prices near Micrel’s five-year lows, OCM may have different objectives as to their returns and Micrel’s board is concerned that OCM is trying to force action to secure their own near-term gain without any reference to Micrel's fundamental value, long-term potential or the interests of all shareholders, the company added.
This week, OCM launched its own missive back to Micrel stockholders in a seeming attempt to counteract Micrel’s letter.
On April 1, OCM wrote that it was “disappointed that Micrel management has chosen to attack Obrem Capital Management rather than address our primary concern: creating permanent value for stockholders.”
OCM purports that Micrel improperly blames the market for company-specific issues such as blaming semiconductor market conditions for the company's ongoing underperformance; and points out that the last five years have been strong for the analog semiconductor industry, with analog industry revenue up 36% from 2003 to 2007, according to the WSTS. However, OCM said, “Micrel, in the corresponding period, has only increased revenues 22%. In addition, current sentiment and market conditions might explain why Micrel's stock is trading at the lower end of its 'range' but does not explain why Micrel's shares have underperformed peers.”
Further, OCM said it is "disappointed by Micrel's personal attacks and misstatements. Micrel makes several inaccurate assertions in an attempt to disparage our nominees. Contrary to Micrel's assertion that our nominees 'have very limited semiconductor industry and operating experience,' two of our nominees, Keith Kolerus and Bill Bradford, collectively have 60 years of semiconductor industry experience in top leadership roles, with the vast majority of that time spent at companies significantly larger than Micrel.”
Also, OCM said it is, in fact, not proposing that Micrel CEO Ray Zinn be removed from his post. “Obrem wishes to install our slate of nominees to take action to maximize stockholder value. We have not currently proposed replacing Mr. Zinn as CEO or pursuing any action that will disrupt the company's operations,” OCM said.
Following this, OCM announced on April 2 that it has made a Rule 14a-12 filing with the SEC with respect to its request to the board of directors of Micrel to call a special meeting of shareholders, and in advance of filing additional materials detailing its position more fully.
“This filing further highlights the relative lack of operational and semiconductor experience of OCM’s nominees when compared to Micrel’s current board of directors," Micrel responded in a statement. "It reinforces our view that OCM, which only started investing in Micrel 41 days ago, lacks a deep understanding of our business and is simply looking to take control of Micrel in order to secure a quick, opportunistic gain for themselves at the expense of other shareholders.”
As a result, this morning American Technology Research analyst Doug Freedman downgraded Micrel to “neutral” from “buy,” due to the involvement of activist shareholders.
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“While we are still recommending a strong overweight stance on the semiconductor sector, we feel the risk/reward ratio has become less favorable at Micrel given involvement of activist shareholders. We feel investors should be more cautious from an investment standpoint until the present board battle is resolved (and after investor reaction fully digests the outcome of a special shareholder meeting on May 20),” Freedman said in his report.
Further, “the board seat battle is likely to limit some upside to near-term numbers, even though we believe the company is doing better than [Wall Street] expects. The board seat vote is likely to increase SG&A expenses by $1 million to $1.5 million over the next two quarters. We believe revenue growth is likely to drive estimates higher even as the mix shift of new product traction is in lower-margin markets,” he said.
“Our concern is the added risk that one or more of the major holders exits his position as a result of an unfavorably perceived vote. We have just seen what a 15% buyer can do to the stock price of a small-cap name. We are also very afraid of what will happen when and if Obrem Capital decides to divest its position. Our bias is that the Obrem directors are unlikely to win given the inside ownership and strong management-shareholder relationship, with some holders owning Micrel for more than 10 years. Our calculations lead us to believe that Obrem needs between 70% and 87% support of outside shares that are likely to vote,” Freedman believes.
“Regardless of the outcome of Obrem’s take-over efforts, we see a short term-SG&A impact, followed by the potential of major shareholders exiting their position. We believe investors should be cautious until the board battle is resolved, at which point the revenue and EPS impact from new product revenue ramps will be better understood. We are therefore downgrading to Neutral from a Buy rating while maintaining our $9 price target as our forward EPS estimates remain unchanged,” he concluded.
