Skip to main content

S3's Spinoff Plans Could Give Investors Peace of Mind

The graphics-chip maker has suffered since losing its market lead in 1996 and is hoping its spinoff plans give a clearer picture of its business.

SAN FRANCISCO -- You might call graphics-chip maker S3 (SIII) "Spinoff 3."

In his yearlong tenure at the company, CEO Ken Potashner has drawn up plans to split S3 into four divisions and spin off three of them.

Potashner has already spun out one, an e-commerce site for downloadable music called

that's slated for an IPO by next summer. He's considering similar moves for other divisions -- one that makes the graphics chips for high-end business computers, and another making chips for set-top boxes and cable and DSL modems.

At Monday's closing price of 8 11/16, S3 has a market cap of nearly $500 million, but the sum of its parts could be worth a lot more. Broken up into four companies, S3 will give investors more peace of mind because they will have a clearer view of each of the four businesses. There will also be less worry that one chunk of S3's current structure will be a drag on another more promising area.

That difference may be more significant for S3 than it would be for others: Some of the spinoffs are in hot areas such as digital music and networking. And S3's core business, the graphics-chip market, has historically been a volatile one where fortunes can turn on a dime. That mix has so far kept Wall Street from getting too excited about some of S3's nongraphics initiatives.

But that could change soon. Digital music is an industry on the verge of going mainstream. The growth of the modem and set-top box market, meanwhile, has shares of modem chipmaker



trading at 324 times trailing earnings. And the professional-graphics division holds an exclusive contract to provide high-end graphics chips for all


(IBM) - Get International Business Machines Corporation Report

NT workstations.

Best of all, S3 will hold big stakes in its spinoffs. The company won't say how much its 43% stake in is worth, but

Fahnestock & Co.

Scroll to Continue

TheStreet Recommends

chip analyst Dan Scovel says one only has to look at S3's investment in contract manufacturer

United Microelectronics

for a precedent. In 1995, S3 invested $100 million for a 25% stake in the company. This year, it sold 36% of its shares and some manufacturing patent rights back to UMC for about $72 million in cash. Its remaining shares are now estimated to be worth more than $500 million. Scovel, whose firm does no underwriting for S3, rates the stock buy.

Breaking up S3 could entice investors to take a second look at a company that's been a dog ever since it lost its leadership of the graphics-chip market in 1996. Institutional investors tend to avoid graphics-chip stocks because their charts often resemble

Bart Simpson's hair, and they may see S3 now more as a potential mess than as a company on the way up.

S3's Choppy Ride
S3's stock price over five years.

Design cycles in this business are so short, a company can dominate the market one day and crash six months later. Such a fate is befalling



. Its Voodoo product, considered the graphics card of choice for hard-core gamers, led the retail market. Design problems have forced it to delay its launch of its new Rampage card past the crucial Christmas season.

S3 controlled 60% of the overall graphics-chip market in 1996, but that share fell to 15% by 1998, according to


analyst George Iwanyc.

Spinoffs are becoming popular in the semiconductor industry because chip investors have shown that they like highly focused companies. Take

Rockwell International

(ROK) - Get Rockwell Automation Inc. Report

, whose huge communications-chip division was all but invisible until it was

spun out in December as the now-hot


(CNXT) - Get VanEck ChiNext ETF Report

. And

Fairchild Semiconductor


was the forgotten stepchild of

National Semiconductor


until it was spun off Aug. 4. Its 20 million shares were offered to the public at 18 1/2 but have since risen 50% to close at 28 on Tuesday.

But spinning off three divisions in high-growth areas would leave S3 with its core business in graphics chips, where it is still struggling. Graphics cards and boards still make up 80% of the business at S3, which lost 20 cents a share in the quarter ended Sept. 30. "It's a graphics company that's losing money," says Scovel, "and there isn't anything worse."