Blu-Ray's triumph over HD-DVD expected to pay big dividends

Vector Capital Corp.'s latest bid for Corel Corp. undervalues the software developer and comes just before Corel realizes the benefits of its InterVideo acquisition, says one analyst.

The US$11 per share offer, made late last month through Vector affiliate Corel Holdings LP, is 6.9 times Corel's forecasted $1.60 non-GAAP earnings per share, a "shockingly low multiple," said Jeffrey Jacobowitz, an analyst at Robotti and Co. who also owns Corel shares in a partnership he manages.

"This is not by any means at all a distressed company ... It's unimaginable to me that any profitable software company has ever sold at anything remotely close to seven times earnings," he said.

Mr. Jacobowitz said Vector's offer follows Corel's integration of WinDVD maker InterVideo, acquired in 2006, but comes before the payoff materializes. He added the company's WinDVD player will benefit in the second half of 2008 from Blu-Ray's format war victory over HD-DVD that has made Blu-Ray the standard for high-definition DVD.

"I think as a shareholder, we have only good things to look forward to and therefore no reason to sell," he said.

Another analyst, Steve Frankel at Canaccord Adams, agrees Vector's bid doesn't accurately reflect Corel's value.

"If they are going to be successful in getting the rest of the shares, there is going to need to be an adjustment," said the Boston-based analyst.

Vector's bid for the 31 per cent of Corel's outstanding common shares it doesn't already own came days before Corel reported a first quarter loss of $30,000, or break even on a per-share basis, on $65.5 million of revenues earlier this month.

Its revenues are more than double what the

company posted in its first-quarter results five years ago, when Vector launched its first bid to take Corel private.

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At the time of that $1.05 per share offer, Corel's revenues had shrunk to $28.3 million in the first fiscal quarter of 2003 and the software company had lost $574,000, or a penny a share.

Vector had concluded Corel's losses masked the growth and profit potential of Corel's core product portfolio and felt its share price, hovering around 74 cents, was a deep discount, according to a case study published on Vector's website.

(A Vector Capital official declined an interview request for this story.)

After Vector took Corel private in September 2003, it scrapped speculative R&D projects and divested non-core businesses so Corel could refocus as a packaged software company.

Once private, Corel scaled back its products from more than 20 to just five: CorelDRAW, WordPerfect, Office, Painter, Designer and iGrafx.

"These were very high quality products and we really focused all the assets of the company on those products," Corel CEO David Dobson told the OBJ last year.

"Many times, it has been proved that someone from the outside who has experience with similar situations, like Vector Capital has been, are able to identify the value in a company that has not been tapped ...We are seeing this reoccur around the world today, and what usually emerges is a stronger, more focused and much healthier company. That's clearly been the case with Corel," he added at the time.

In 2006 Corel went public again, offering 6.5 million common shares at US$16 each. Vector retained majority control of the company. Since the initial public offering two years ago, the company's shares have never returned to that level and closed as low as $7.32 on Feb. 1, 2008.

Mr. Jacobowitz said he believed Vector had hoped the share price would rise to between $25 and $30 a share, prompting a secondary offering that would allow Vector to sell its remaining stock and exit the investment.

Instead, Corel's low share price led Vector Capital's founder and managing partner to declare less than two years ago that the private equity firm had no intention of selling its stake, which today stands at 69 per cent of Corel's outstanding common shares.

"At current values of Corel, Vector is emphatically not a seller," Alex Slusky told Reuters in October 2006. "Today, I certainly think the public market is not fully appreciating the Corel story."

Mr. Jacobowitz said he thinks Vector is looking at a second opportunity to buy Corel at a low price and flip it in another two years. He added Mr. Slusky's 2006 remarks are another reason shareholders should reject Vector's offer and suggested it is incumbent on Corel's independent directors to find a higher bidder, possibly an industry buyer.

In the meantime, Corel has formed a special three-member committee of independent board members to assist it in evaluating and responding to the proposal. Like Vector, Corel has remained tightlipped about the offer. During a conference call a couple of weeks ago to discuss its first-quarter results, Corel management declined to comment, other than to say it was still "business as usual."

Mr. Frankel said he did not expect the offer to be quickly accepted or rejected.

"This is going to be a fairly drawn-out process to determine the fate of Corel," he said. N

COREL/VECTOR TIMELINE

March 11, 2003:

Microsoft Corp. announces it is selling 22.9 million preferred shares of Corel to Vector Capital for US$12.9 million. The deal gives Vector a 20 per cent stake in Corel.

March 24, 2003:

Corel announced a deal with Vector.

Aug. 22, 2003:

An Ontario judge approves Vector's takeover bid. The San Francisco private equity firm offered US$1.05 a share, or $97.6 million, for the 80 per cent of Corel common stock that it didn't already own.

May 2, 2006:

Corel closes its initial public offering of 6.5 million common shares at US$16, raising US$69 million in new capital.

Feb. 1, 2008:

Corel Corp. shares sink to US$7.32 on the Nasdaq.

March 28, 2008:

Corel announces the US$11 per share offer from Vector affiliate Corel Holdings LP for the 31 per cent of Corel's outstanding shares it doesn't already own. The company's share price briefly jumps to $11.42 in a flurry of trading following the announcement before settling around $10.95 in early April.