01 October 2008

The move by conditional-access and interactive TV technology specialist NDS Group to go private is not unexpected, and not without controversy. The technology company has been controlled by News Corp (with 72% of the shares and 95% of the voting rights) for many years, but in June News Corp and private-equity outfit Permira announced a buy-out offer for the company of US$60 (€41) a share, a 21% premium to the most recent closing price and an 18% premium across the most recent six months of trading.

The fact that News Corp wanted to change its relationship with NDS was not a surprise. The media giant had let it be known it was looking at various options since late last year. But the US$60 per share deal price seemed low to some analysts and to minority shareholders, especially as NDS's stock price had been as high as US$63 as recently as December 2007. An analyst note from RBC Capital Markets underlined a sense of frustration with the low price with the headline "Let the bidding begin".

By early August the price had been sweetened to US$63 per share, a price that was arrived at by independent members of the NDS board. But in the evident absence of bids from other private-equity players or strategic investors, how do investors really know that even the revised take-out price includes a large enough premium? The Wall Street Journal pointed out in a recent article that the entire buyout deal can be seen as a way for News Corp to get access to NDS's cash (some US$735m is on the balance sheet). News Corp will also receive US$1.8bn from Permira (US$1.52bn in cash and a US$242m vendor note) in exchange for a third of its stake.

NDS has a strong market position and is doing very nicely. According to RBC Capital, it is on track to reach US$1bn in revenues by 2010. In fact NDS has beaten the City's financial estimates for four quarters in a row. It set its 2008 fiscal year mid-point target at US$810m in revenue and US$2.58 per share but ended up beating that quite nicely by US$40m and 14 cents respectively.

Despite NDS's impressive track record (and plaudits to management), in its most recent investor call in August, the company scaled back its financial guidance saying that it is lowering its three-to-five-year outlook to 15-20% growth in operating income, down from 20-25% growth. One reason cited by CEO Abe Peled for this caution is pricing pressure or what he called "discounts" for larger clients. He said that extending the life of large contracts was "critical" to NDS and added: "We want to have a relationship with customers, not a take-it-or-leave-it." It is true that a recession could affect sales of pay TV-related products, but NDS has few serious rivals in the premium smartcard space.

Beyond how the deal is being priced, the big question is why take the company private now? Peled said in a statement that "with the convergence of broadband and broadcast technology, new frontiers lie ahead for NDS" and that the current ownership structure posed "certain limitations". He said that NDS needed "strategic agility and flexibility to enter into any type of value enhancing transactions" and that the change would enable it to "capitalise on these new opportunities with a more independent structure and the expertise of Permira".

If the proposed deal does go through (and in all likelihood it will, given that the minority shareholders may think that this deal is good enough in the current climate) then Permira will own 51% and News Corp 49% of NDS. This is all very nice for News Corp, particularly as it will help it improve its balance sheet and allow it certain tax benefits. But who will really control the company? News Corp-related companies like BSkyB and Tata Sky accounted for 37% of NDS's revenue last year, so will Permira really be in charge?

For NDS, going private could allow it to partner with other companies and perhaps offer them equity as part of the deal. It could also allow them to act as an industry consolidator. It is certainly true that the pay-TV business is attracting all kinds of new players. NDS will have to cope with this and perhaps the new structure will help. For example, in August, Intel and Yahoo! announced a deal to marry the internet with the TV by providing software tools and a new Intel chip that will enable interactive features on TVs, set-top boxes and other gadgets.

In my opinion, at US$63 a share, the deal looks good for News Corp, neutral for NDS and not as good as it could be for independent investors in NDS. The point is this: despite management's cautious outlook, the company looks strong enough to grow to US$1bn in revenues and to consolidate its strong position in smartcards and its newer convergence products. If you believe that, and if equity markets recover in two years, a new IPO of NDS could be priced at US$80 a share, according to RBC Capital Markets. That is all money that will flow to News Corp and Permira.