Hayes, Micronics in merger talks

Just as two wrongs don't make a right, one troubled company plus another troubled company does not make a healthy company.

Micronics Computers (MCRN) announced today that it is in talks with modem maker Hayes Microcomputer Products about a potential stock-for-stock merger.

But the combination of these two companies does not paint a healthy financial picture.

Micronics reported a loss of $2.7 million, or 19 cents a share, for its second quarter of 1997, and shrinking revenue of $24.3 million. Hayes, which emerged from a 17-month bankruptcy reorganization last spring, is struggling to gain market share from competitor U.S. Robotics (USRX).

Losses aren't new to system boards maker Micronics. The company saw losses for three of the four quarters in 1996 while revenues continued to fall. However, it did manage a tiny profit in the first quarter of 1997, even though revenue had dropped 40 percent over the same quarter a year earlier.

Modem maker Hayes also has seen its market share shrink because it grabbed onto 56-kbps proprietary modem technology from Rockwell, not USR. Citing Dataquest 1996 numbers, an analyst at Hambrect & Quist, said USR held 26 percent of the revenue market share for 1996 with a wide gap over second-place contender Maxtech/GVC, which holds 5.5 percent, followed by Hayes, which has 4.4 percent of the modem market. Hayes recently started selling 56-kbps modems based on technology from USR through a subsidiary newly created in March in an attempt to catch up.

The H&Q analyst said that USR holds the lead and continues to grow market share because is produces high quality, reliable products. USR also has great distribution and channel control and very aggressive management. The company also is "widely accepted and offers decent perks to retailers."

Analysts also believe it will be difficult for USR competitors, like Hayes, to catch up.

A recent Bear Stearns report said that USR's competition, "which does not own core modem technology and relies on suppliers, like Rockwell (ROK), will again operate in a catch-up mode for several months" before it delivers products with capabilities on par with USR. Moreover, the report added that the "manufacturers will have to absorb at least a portion of the costs for the 56-kbps hardware upgrades to the installed base of Rockwell-based concentrators."

This added financial burden could impede Hayes's ability to remain afloat in the competitive modem pool, as Hayes is no stranger to financial difficulties either.

Hayes has been an innovator in data transmission (inventor of the AT command set) and has cleared some rough waters in recent memory, with founder Dennis C. Hayes pulling out of a merger with competitor Boca Research and then seeking protection from creditors through the U.S. bankruptcy court. Hayes's 17-month bankruptcy reorganization ended last spring, and the company managed two profitable quarters for the year.

So why does Micronics want to do a deal with Hayes? The parties have not entered into any letter of intent or binding agreement.

Micronics CFO Bill Finley said, "This thing could go on for a long time or it could end really quickly...There is still a lot of work to be done." He said that he could not comment on why Micronics may want a piece of the modem market.

Incorporating modems into its motherboards may give Micronics an edge over the growing number of contenders entering the market, said Abner Germanow, an analyst with IDC Research. And that is where Hayes steps into the picture.

Hayes originally had premium brand, but the company's financial and management problems led to declining market share, he said. Another factor is that there are more competitors in the market.

"Many companies just buy chips from Rockwell and package products. They just slap the chips on the board and put them in a box. It seems to be more about marketing and price than technology," he said. Standing out in a crowd is becoming increasingly difficult.

In 1996, USR held the No. 1 spot for revenue generated from analog modems worldwide. Its market share grew to 26 percent from 19.7 percent, while Hayes' share shrank to 4.4 percent from 6.3 percent.

Since the end of May, Micronics' stock has risen about 25 percent.

Micronics said it believes that rumors about the companies' talks are the reason for its unusually high trading volume. Volume has been in the hundreds of thousand for the past five consecutive trading sessions, reaching nearly 640,000 yesterday. That is nearly ten times the usual volume for the company.

Micronics previously announced that it had hired a financial advisor to identify acquisition and strategic partner relationships, including talks with Hayes about a potential stock-for-stock merger.

Micronics' stock ended down 1/8 from yesterday's close of 3-9/16. Hayes is a private company.