Update: Seagram Stumbles After Merger Deal Is Finalized

Updated from 7:09 a.m. EDT

Although the deal was no surprise, investors still reacted nervously Tuesday after Seagram (VO Quote), the entertainment and spirits company, agreed to be acquired by Vivendi SA of France for stock valued at $34 billion.

Vivendi will also acquire the 51% of the French pay television company Canal Plus that it doesn't already own for stock valued at $12 billion. The merger of the three will complete Vivendi's transformation from a French water utility into the world's second-largest media and entertainment company, behind the planned union between America Online (AOL Quote) and Time Warner (TWX Quote).

When the deal was announced, it valued Seagram at $77.35 a share, or a 46% premium over last Tuesday's close at 53, when the speculation about a possible merger first emerged. Seagram confirmed Wednesday that it was in talks with Vivendi.

But that valuation quickly changed.

Seagram shares ended down 5 15/16, or 9%, at 58 1/16. Vivendi, meanwhile, was down about 6% in trading on the Paris Stock Exchange at 90.15 euros, or $86.45. Based on the structure of the stock swap, the number of Vivendi shares to be exchanged for Seagram shares will be subject to a collar -- a financial device which limits how much the deal price can vary -- under which the exchange will be fixed at 0.8 if Vivendi's stock trades below $96.69 and fixed at 0.622 if Vivendi's stock trades above $124.30. Thus, at recent prices, Seagram shares are worth about $69 in Vivendi stock, nearly $10 more than its current price.

The $9.75 gap, according to one analyst, reflects investors' uncertainty about how far Vivendi shares will fall. "I share the wariness," said Tom Graves, an analyst at Standard and Poors Equity Group, who covers Seagram. Graves downgraded Seagram Tuesday from a hold to an avoid rating. Still, he said, "I am surprised there is as big a gap" between the trading price of Seagram and its value in Vivendi shares.

Graves also offered another explanation for the selling pressure on Seagram: Since Seagram is included in the Standard & Poor's 500 stock index, investors are worried that S&P index funds will be unable to hold shares in the new company, he said, since there is a question of whether the France-based company will be included in the index.

"This is a situation where people have to keep constantly reevaluating," he said. "Right now, I'm telling people to steer clear of Seagram shares."

David Williamson, an analyst with Swiss American Securities, kept his buy rating on Seagram. He said the deal represents a fair price for Seagram shareholders, but investors naturally get skittish when stock -- rather than cash -- is the currency used to complete a merger. "In all stock deals, there is risk associated with it," he said.Neither firms represented by Graves and Williamson have performed underwriting on behalf of Seagram.

The new company will be called Vivendi Universal and will be headquartered in Paris with an additional "corporate center" in New York, the companies said. It will initially have combined revenues of $55 billion, and be listed on the Paris, New York and Toronto stock exchanges.

The combined company will be heavily focused on the Internet, according to a statement released by the three companies. The merger will combine Vivendi's telecommunications assets -- which include high-speed wireless transmission, fixed and wireless communications networks, Internet access providers and both cable and satellite networks -- with Seagram's extensive music, film and television libraries, as well as its production and distribution capabilities through Universal Music Group, Universal Studios, its stake in USA Networks, and Canal Plus' film and broadcast assets.

The Bronfman family, which owns 24% of Seagram, signed a binding commitment to vote in favor of the transaction. The deal is still subject to shareholder approval and regulatory reviews in the European Union, the U.S. and Canada.

Jean-Marie Messier, Vivendi's chairman and chief executive, will head the new company. Edgar Bronfman Jr., president and chief executive of Seagram, will be vice chairman and in charge of music and Internet activities.

"The formation of Vivendi Universal is both the beginning of a new era of opportunity and the culmination of Seagram's transformation into a leading force in the global media and entertainment industry," Bronfman said in a statement.

Seagram is expected to shed many of its liquor assets, as the new company focuses on becoming a global media company.