In trying to sort out a two-year-old lawsuit, Genesis Microchip Inc. may have negotiated itself into a jam that could complicate its pending merger with Pixelworks and saddle the display IC supplier with significant licensing fees.
In a July 15 ruling, Genesis was ordered by a Virginia court to honor a memorandum of understanding (MoU) with Silicon Image, a company that owns patents to part of a new display interface that has won support from many of the industry's leading consumer electronics manufacturers.
The MoU dictates that Genesis pay Silicon Image for access to transmitter and receiver technology that meet the Digital Visual Interface (DVI) standard and its successor, the High-Definition Multimedia Interface (HDMI). HDMI in particular promises a simpler and secure transmission between display devices and consumer entertainment products such as VCRs, hard-disk recorders, and cable and satellite boxes.
The decision resulted in the ouster of Genesis chairman and chief executive James Donegan, who, according to court testimony, had verbally agreed to the MoU, allegedly without the approval of company directors, in an effort to resolve a patent lawsuit filed by Silicon Image.
Terms of the licensing agreement were not disclosed. Still, with little choice but to pay up for rights to a display interface that many feel will come to dominate the media industry, Genesis' financial position appears to be headed for a material change, according to analysts, even as it prepares for its marriage to Pixelworks.
"Both Pixelworks and Genesis Microchip stocks have sold off since trading began on July 21, and the merger spread widened out, which can be interpreted as the market having less faith that the merger will go through at the current deal conditions--or at all," said Noel Atkinson, an analyst at Emerging Growth Equities Ltd., King of Prussia, Pa., in a report.
The saga began in 1999 with the Digital Display Working Group, which issued a specification for DVI, a technology related to "an-all digital interface between a computer and a digital display." Genesis signed an agreement that allowed it to develop the DVI receiver technology and gave it the right to use the process, but only for computer displays, according to Silicon Image.
In 2001, Silicon Image sued Genesis, alleging the company violated the intent of the agreement by extending the use of DVI technology into the consumer electronics market. The two companies were locked in court until December 2002 when Donegan and Silicon Image chief executive David Lee met, under court advice, to resolve the dispute.
The July Virginia court ruling was issued to establish exactly what the two executives agreed upon and whether that agreement also extended to the newer HDMI interface.
Genesis said that it agreed to pay costs and royalties only on certain products; however, Silicon Image said the agreement covered all Genesis DVI and HDMI products, with the royalty for HDMI being higher. The court sided with Silicon Image's interpretation after determining that Donegan demonstrated "generally low" credibility during testimony.
Following the court's decision, Genesis' board of directors asked Donegan to resign and has replaced him on an interim basis with chief financial officer Eric Erdman.
In addition to adjusting to the fiscal constraints imposed by the HDMI licensing enforcement, Genesis still must address the issue of the pending merger with Pixelworks. None of the parties involved in the dispute returned calls for comment last week, but court documents and analysts' expectations indicate the merger could go either way.
Emerging Growth's Atkinson said he believes the merger would be concluded since "Pixelworks was aware of the potential costs associated with the signed memorandum of understanding."
But was Pixelworks really informed of what it would inherit upon consummation of the union, which is expected in the second half of 2003?
The U.S. District Court for the Eastern District of Virginia in Richmond has its doubts that Donegan provided enough information to Pixelworks to enable the company to determine the likely impact of the Silicon Image MoU on its merger with Genesis.
"If, as Donegan testified at the evidentiary hearing, the MoU's royalty provisions would indeed be devastating to Genesis, that was certainly a fact material to the Genesis-Pixelworks merger," the court stated in its ruling. "Thus, Donegan either failed to disclose a material fact to Pixelworks, thereby jeopardizing a merger that is of great importance to Genesis and exposing himself and Genesis to an action for fraud, or what Donegan told the court was untrue."
And what of the HDMI standard? Atkinson said the technology, jointly developed by Silicon Image and consumer OEMs, including Hitachi, Matsushita, Philips, Sony, Thomson, and Toshiba, should open new market opportunities for display IC suppliers.
"Content providers, such as the movie studios, have been unwilling to provide HDTV content as they are concerned about pirating of very-high-quality signals," Atkinson said. "HDMI is being put forward by a relatively broad array of consumer electronics companies as a secure link between output devices and display devices.
"If HDMI becomes the industry standard, and integration of the technology is a competitive advantage or competitive requirement, the combined Genesis and Pixelworks could have some margin compression beyond what perhaps would be otherwise attainable."