Sun's Encore acquisition threatened

Shareholders threaten to nix deal in November 24 vote

By Robert McMillan

November  1997
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San Francisco (November 8, 1997) -- Sun Microsystems, Inc.'s planned acquisition of Encore Computer Corp.'s storage products division is in danger of being scuttled by Encore shareholders unhappy with the terms of the agreement.

Sources close to Encore say shareholders are upset that the bulk of the proceeds from the acquisition would be used to repay loans from Encore's largest shareholder, Gould Electronics, Inc. of Ohio. According to documents filed with the SEC (Securities and Exchange Commission), once debts and restructuring costs are paid, Encore expects to realize $7.1 million in net proceeds from the $185 million transaction.

Industry observers see Sun's attempt to acquire Encore's storage business, including its line of Infinity SP storage products, as an important component of Sun's plan to sell its products into mainframe accounts -- and as a buttress against encroachment into its own accounts from third-party vendors like EMC Corp. and Hitachi America Ltd.

Data on Infinity SP storage arrays can be shared by both mainframe and open systems like Sun's Solaris.

Tom Mancino, an industry analyst with Pacific Growth Equities, notes that the deal is of strategic importance to Sun. "I think Sun has needed the mainframe part of Encore just to be able to represent itself as a legitimate horizontal mainframe and open systems vendor in the storage arena," he says.

On July 17, 1997 Sun Microsystems Computer Company vice president Ed Zander proclaimed that Sun's acquisition of Encore was "just a matter of going through the regulations" and predicted that the deal would be finalized within 60-90 days. Encore shareholders were to vote on the agreement sometime in September, but the vote is now scheduled to take place on November 24th, according to SEC documents.

One industry observer following the deal estimates that dissenting stockholders control between 15 to 18 percent of Encore's 67 million voting shares. He predicts, "there is a strong likelihood that the proposition will fail." SEC filings show that Gould Electronics and Encore management in favor of the deal control 55.9 percent of voting shares, but the filings note that a vote of at least 75 percent of the shares of common stock represented at the shareholder meeting is required for the transaction to be approved. According to the observer, this means that it is unlikely "that there are enough [votes] on either side of the equation right now to definitively decide the vote's outcome." But, the observer notes, even if the transaction is approved "it's almost irrelevant because there's likely to be litigation from disgruntled stockholders" -- and that could further delay the acquisition.

Gould Electronics, which is a wholly owned subsidiary of the Japan Energy Corporation, actually owns 83 percent of Encore, including a large quantity of preferred (non-voting) stock. It stands to recoup 81 percent ($150 million) of Sun's payment, should the transaction go through. But because Encore does business with the Federal government, Gould, a foreign-owned company, is prohibited from holding more than 49.9 percent of Encore's common (voting) stock.

If the deal is rejected, Encore is threatened with bankruptcy. Encore's SEC filings say that "under such circumstances, the Company [Encore] believes that it would not be able to continue as a going concern." The filings also say, "Sun has indicated to the Company that if the vote of the Company's stockholders required to approve the Sun Transaction is not obtained, Sun will explore alternative business strategies...and will not engage in any further negotiations with the Company concerning the purchase...of the Storage Products Business.

Dataquest analyst Tom LaHive notes that some delay in closing the deal will not significantly impact Sun's plans. Referring to Sun and Encore, he says, "Realistically speaking, they're probably already rolling some of the R&D together now." He predicts, "it's going to require over a year to roll the Encore product line into the Sun storage line."

A source close to the shareholders would not say specifically what changes would be required to ensure the deal passes except that "there could be a number of different alternatives." The bottom line, the source says, is that the shareholders are seeking "a better split of the money between Gould and Encore."

Though it seems certain that shareholders will not recoup their investments if they vote against the deal, some apparently see their chances of recouping after the transaction as equally unlikely. Gould has agreed to keep Encore solvent for one year after the Sun transaction closes, but Encore will be left with a dwindling real-time software business and a small amount of capital.

Pacific Growth's Mancino believes that Sun will somehow find a way of making the deal go through. "I think it's going to happen," he says, adding, "I believe it's going to happen because Sun needs the technology."

Sun, Encore and Gould all declined to comment on this story.


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