On Friday, July 30, the Portland Business Journal reported that Carl Icahn has now reached a 14.13% ownership of Mentor Graphics. If you remember, Mentor passed a shareholder rights plan (see http://www.gabeoneda.com/news/mentor-graphics-adopts-shareholder-rights-...) to defend itself against unwanted takeover maneuvers. The plan stipulates that if an unfriendly shareholder accumulates more than 15% of shares in the company, all other shareholders of record as of July 6, 2010 will receive one share for every share held at the discount price of 50%. The purpose is to dilute the percentage of shares held by the unwanted "intruder". Let's do the numbers.

As of this writing Mentor Graphics had 106.83 million shares outstanding. This means that Carl Icahn has 15,095,079 shares in his name. So, the available pool for the 50% distribution would be 91,734,921 shares. This means that Mentor would "sell" 45,867,461 shares. The opening price today was $9.79. Each distribution share would then be priced at $4.895. The total income to Mentor Graphics would be a staggering $224,521,222 (rounded to the nearest dollar). This is cash that cannot immediately be invested in products or development, thus making that pot of money very desirable to a corporate raider.

In addition, the price of the stock will of course adjust itself downward, since there is more of it in circulation and since the income per share will be diluted as well. Mentor operating profits would now have to be divided among 152,697,461 outstanding shares. Carl Icahn will now be forced to purchase more shares, to get back to the 15% ownership. This means that Carl has to own 22,904,620 shares. Thus he has to purchase 7,809,541 shares at the lower price, which I predict to be around $7.30, or an investment of a bit more that $57 million.

I want to say up front that I think it is in Mentor Board's right to defend against unwanted takeover, and that the shareholders poison pill is the most frequently used mechanism in this circumstance. So, they did what they had to do. But will it be enough?

If you really think that you can generate a significant return on the investment, I am talking here about something way over 10%, and you have invested already upward of $60 million in the venture, would you just let go, risk to take a loss and consequent write off, or would you keep investing? If Carl decided that the game was not worth the candle, he could sell the shares, further devaluing the stock price. But with a treasure chest of almost $225 million, practically a quarter of its capitalization, Mentor would become the target for another take over. My prediction is that Carl Icahn will stick to the game, call the bet, and see what else the Mentor Board has up its sleeves.

Wall Street Thinks Mentor Is Worth Splitting Up

If you are looking at Mentor from Wall Street, and not from an EDA point of view, then Mentor is an odd assortment of divisions some of which are ripe for a sale or a spin-off. In the DFM space, Mentor's Calibre product has over three times the market share than any of its competitors. This means that it can demand a license price of 80% above costs, which is quite lucrative. The System Division, whose name hides the fact that it really sell PCB and manufacturing tools, also enjoys the same status, according to Wally Rhines, its Chairman and CEO. But both divisions have to contribute to cover the cost of the entire Mentor operations which includes divisions that are barely breaking even or are, in fact, loosing money. So, setting those two divisions as independent companies would make them very profitable!

And although the Systems Division, lets call it VeriBest II, would not attract the interest of buyers right away, the Calibre division, now a very profitable company, would be a very attractive acquisition target and generate immediate high returns to its shareholders. But what about the rest? It turns out that the ESL and Verification group generates enough revenue to keep the rest of Mentor in business, especially if, for example, the company would exit the emulation and acceleration business, a segment that is becoming very price sensitive while requiring high engineering investments to compete with Cadence and EVE.

I find it difficult to predict whether or not such eventuality would be good for the EDA industry or not. To be sure, our industry is very conservative when it comes to its human side, and the shock of having one of its most sacred cows dismembered would send it into turmoil.

One think is sure: the stock market is not reacting positively to the possibility that Mentor will enact the poison pill. After a brief spurt early Monday August 2, when the stock price surpassed $10, it quickly came down again, partly due to the fact that any purchase after July 6th is not eligible for the defensive stock distribution.

In fact, a curious thing happened on the way to the July 6th deadline. You would think that the opportunity to get a 50% "stock bonus" would be appealing and that investors would want to purchase the stock. After all, if a person invested $1000 in Mentor at say $8.00 a share before July 6th and the poison pill was triggered (a good possibility), the opportunity of purchasing an additional 500 shares at $4 would mean that now the person owns 1500 shares that cost $6.67 per share. Instead, from a high on June 15th of $9.68 the stock price declined to $8.29 on July 6th. And this after Mentor issued its "Shareholders Rights" document on June 24th.