Multi-Dimensional Audio Plans for DTS and SRS Hang in Balance Following Announcement of Buyout

DTS’ proposed $148 million acquisition of SRS Labs would expand DTS’ portfolio of audio-based intellectual property to more than 1,000 registered and pending patents and trademarks, as the company looks to expand in mobile and connected technologies, DTS CEO Jon Kirchner said Tuesday on a webcast. Bringing on board SRS and its audio processing technologies will enable DTS to offer customers a “comprehensive integrated suite of audio solutions ranging from voice processing to audio rendering and from low bit-rate applications to high-quality lossless audio delivery,” he said. The complete package will cover pre-processing, codec delivery and post-processing “in an integrated intelligent suite,” he said.

The acquisition of SRS will accelerate DTS’ expansion in mobile and other network-connected device markets, where shipments are expected to reach 2 billion units annually by 2016, Kirchner said. DTS has been working to get more of its content onto cloud platforms, expanding relationships with semiconductor companies and offering more audio solutions for the connected market, he said. The company saw more than 60 percent growth in the fledgling connected market in 2011 with customers releasing 4,000 smartphones, digital media players, PCs and TVs incorporating DTS technology, he said.

It remains to be seen how the proposed buyout would affect both companies’ plans for 3D audio. Last month, SRS said it had completed development of its Multi-Dimensional Audio (MDA) platform specification 1.0 and that it was available to members of the 3D Audio Alliance. SRS is a founding member of the 3D Audio Alliance along with AMD, but Dolby and DTS are not members. The 3DAA is an industry alliance “completely independent of SRS Labs,” according to the organization’s website. SRS said it “encouraged the creation of the 3DAA with the mission to develop, standardize and promote open and royalty-free specifications for the transmission of 3D audio information."

When asked about MDA during the webcast, Kirchner said the two companies have been approaching multi-dimensional audio from “slightly different angles” and that combined, “we'll be a much stronger player in some of the next-generation developments.” Multi-dimensional audio is “certainly something of interest to both of us” in terms of “defining the future of audio delivery in a more innovative and advanced way,” Kirchner said. Next-gen audio “remains very much on our collective roadmaps,” he said, “and the combination will allow us to accelerate some of the work that’s already ongoing and exists in both respective companies.” Additional plans will be revealed once the deal is complete, he said.

A “substantial portion” of SRS Labs’ $33 million in revenue in 2011 came from the networked connected space where the technology is incorporated in a “broad range of silicon platforms” that will help DTS expand its footprint, Kirchner said. SRS technology is found in HTC and ZTE smartphones, where DTS is not, and in PCs from Hewlett-Packard, Dell and Toshiba, he said. In addition to benefits deriving from combined R&D efforts from the two companies, DTS expects customer synergies to create cost efficiencies resulting from “streamlined sales and licensing activities,” he said. Through consolidation in overhead, marketing and R&D, DTS will achieve scale benefits and cost efficiencies “across the board,” he said. Increased scale in licensing will enable the company to “cost effectively monetize” the combined portfolio, he said. The acquisition will be “accretive” in 2013, supported by at least $8 million in estimated annual combined cost synergies, he said.

Regarding relationships SRS has with brands that are not DTS customers, including ZTE and HTC, Kirchner said “the depth and breadth of the relationships between us will allow us to more effectively service customers and deliver more compelling offerings.” Regarding its plans for the SRS brand, DTS expects to “capitalize” on it, Kirchner said, and DTS sees value “in both the technology and the brand.” DTS gives SRS the larger platform it needs “to fully realize its strategic objectives,” said Thomas Yuen, CEO of SRS Labs. Its customers will benefit from worldwide support through DTS’ network, and consumers will benefit from the companies’ ability to “drive faster innovation” and push audio technologies to the next level on “hundreds of millions of electronics products worldwide,” Yuen said.

Regarding the look of the new company, DTS is working on integration planning that will play out over the next few months, but Kirchner said there are certain “overhead” and “cost of business” synergies that are obvious. From the R&D side, SRS does work in Asia, China and in California, while DTS doesn’t currently have an R&D team in China, Kirchner said. “As we look at key markets like China, having a broader footprint in a geography like that is certainly a good thing for our business."

Under the deal, which was drawn up as a 50-50 split of cash and stock, SRS shareholders can elect to receive either $9.50 per share in cash or a fixed ratio of 0.31127 shares of DTS common stock for every share of SRS common stock they own, subject to proration and adjustment as described in the definitive agreement, said Mel Flanigan, DTS chief financial officer. DTS was valued at $30.52 per share for purposes of the calculation, he said. That valuation was 38 percent per share higher than DTS’s stock price as of the close of trading Monday, he said.

Following the announcement of the proposed buyout, securities litigation firm Powers Taylor said it was investigating the deal for SRS shareholders based on the $9.50 valuation, which it said was “well below the 52-week high of $10.14 per share.” The investigation targets whether SRS shareholders are receiving “adequate compensation” for their shares, whether the transaction “undervalues SRS’s stock” and “whether SRS’s board attempted to obtain the highest share price for all shareholders prior to agreeing to the deal,” the firm said, citing an analyst opinion that SRS’ inherent value “may be as high as $10 per share, far higher than the current price being offered to shareholders.” The proposed shareholder lawsuit seeks to obtain “additional value for shareholders than what is proposed in the current buyout offer."

Commenting on SRS’ statement that the proposed buyout was the result of a comprehensive process of seeking alternative bids and other alternatives, Yuen said the board conducted a thorough and careful review that included seeking and considering competing offers and the option to stay independent. He didn’t comment further on the process or other bidders. Yuen is expected to join the SRS board of directors following completion of the deal, which is expected in Q3. SRS stock closed up $2.53 for the day to $9.39, and DTS rose $0.49 to $30.24.