SRSL Srs Labs, Inc. (MM)

A leading provider of high definition (HD) audio technology, DTS Inc. (DTSI) recently announced that it has entered into a definitive agreement to take over SRS Labs (SRSL) in a 50:50 cash-and-stock deal totaling about $148.0 million. DTS expects the acquisition to be completed by the end of the third quarter of fiscal 2012.

Under the terms of the agreement, SRS shareholders have the option of choosing from either $9.50 in cash or 0.31127 DTS shares for each SRS share they hold. DTS expects to pay the cash portion from its existing cash balances, which stood at $50.8 million at the end of December 31, 2011. The offer price reflects a premium of 38.0% per share over the share price of SRS on April 16, 2012.

SRS is a leading provider of audio processing and enhancing technologies and boasts of a strong clientele, including some of the most well known brands of the electronic industry such as Samsung, LG and Sharp. However, its vast audio patent and trademark portfolio remains the most important asset.

Post acquisition, DTS is expected to have more than 1000 audio patents and trademark in its kitty, which will help the company to expand its services in the rapidly growing mobile industry and other network-connected devices. Since SRS technology is widely used in televisions (particularly home entertainment), smartphones, and virtual audio applications (PCs), we believe that the acquisition will boost DTS’ product portfolio, thereby expanding its customer base going forward.

Moreover, the acquisition will help the company to meet the growing consumer demand for high-quality audio regardless of the platform used. Apart from patents, the acquisition will also generate significant cost and operating synergies going forward. DTS expects the acquisition to generate at least $8.0 million in estimated annual cost savings starting from 2013. DTS expects the transaction to be accretive on a GAAP basis by 2013.

We believe that DTS will continue to gain market share riding on its strong product portfolio, robust growth from the Blu-ray market and increasing penetration into network connected devices. However, we believe that the volatile macro environment and sluggish consumer spending will remain headwinds for Blu-ray sales going forward.

Moreover, we believe that the strong growth of network connected devices will eventually cannibalize the sales of DVD-based products and Blu-ray sales. This in turn will hurt DTS’ growth over the long term. Further, the company faces significant competition from Dolby Laboratories Inc. (DLB), Sony Corp. (SNE) and privately-held THX Limited, which will hurt its profitability going forward.

Thus, we remain Neutral over the long term (6-12 months). Currently, DTS Inc. has a Zacks #4 Rank, which implies a Hold rating in the near term.

 
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