February 27, 1996

Wall Street Jitters Over Deal for Cray


Edward R. McCracken, the chairman of Silicon Graphics Inc., said yesterday that his company's planned acquisition of Cray Research, the supercomputer maker, would create "the No. 1 high-performance computer company in the world and a real national asset for America."

But investors registered their concerns about the financial value of that asset, as the shares of Silicon Graphics slid $2.125, or about 7.7 percent, to close at $25.375 on the New York Stock Exchange.

Some Wall Street analysts lowered their investment ratings on Silicon Graphics stock. By acquiring Cray Research Inc., they said, Silicon Graphics seems to be taking on a new management challenge and a business that is less profitable and growing more slowly than is its own.

And Silicon Graphics, they said, is taking on this additional challenge at a time when the company has had trouble maintaining strong earnings growth and getting new products onto the market quickly.

"The strategic value is somewhat fuzzy, and acquiring Cray seems to add another new risk," said Steven Milunovich, an analyst for Morgan Stanley & Company.

Mr. Milunovich lowered his rating on Silicon Graphics yesterday to "outperform" from "strong outperform," a move that suggests he remained optimistic about the prospects for Silicon Graphics but less optimistic than he was before the announcement. A few other Wall Street firms, including Prudential Securities and Alex. Brown & Sons, lowered their recommendations to "hold" or "neutral" from "buy."

The Silicon Graphics bid is a two-stage deal with a value estimated at $783 million. In the first stage, which began yesterday, Silicon Graphics is offering $30 a share in cash for up to 75 percent of Cray's shares. In the second stage, it plans to complete the purchase by exchanging one Silicon Graphics share for each remaining share of Cray.

Cray shares rose $3.625 yesterday, to $28.875, on the Big Board.

Thomas A. Jermoluk, president and chief operating officer of Silicon Graphics, which is based in Mountain View, Calif., said the deal had been put together to try to minimize the dilutive effect on earnings of issuing new stock. The company, he said, would be adding 3 percent to its total shares outstanding to buy a business that would increase its revenues by more than 20 percent.

"That's a very inexpensive way to acquire revenues and a growth opportunity," Mr. Jermoluk said. He added that Silicon Graphics was likely to take a charge of $50 million to $100 million in the quarter ending in June as a result of the merger.

Executives for both companies stressed what they viewed as the strategic benefits of the combination. Silicon Graphics, a leader in 3-D work stations, has been pushing aggressively into the supercomputer business and is strongest in machines that are priced from $100,000 to $1 million.

By contrast, Cray is the leader in the biggest supercomputers, which can cost $30 million or more and are used by government agencies and large corporations for everything from weather prediction to hunting for oilfields.

Roughly half of Cray's sales of $676 million last year were to government agencies. Mr. McCracken said that in the last few months, after being approached by Cray, he quietly discussed the notion of a merger with senior officials in the Department of Defense, intelligence agencies and even the White House. "I discussed this with all of them, and they were very encouraging," Mr. McCracken said.

J. Phillip Samper, the chairman of Cray, said that after a difficult overhaul resulting in a $226 million loss last year, the company was poised to become profitable once again. It ended last year with a $450 million backlog of orders, a record, he said.

Mr. Samper said he sought the deal partly to reassure Cray's big customers that the company's business would survive and thrive.

Despite the challenge of absorbing Cray, some investors said Silicon Graphics should benefit from the merger. With increasingly powerful personal computers moving into the work station business, they said, Silicon Graphics needs to continue moving into high-performance computing and spreading that technology throughout its product lines.

"With Cray, Silicon Graphics saw an opportunity to quickly strengthen its position in the high end of computing," said Conrad Leifur, an analyst for the American Express Financial Corporation, an investment concern with a large holding of Silicon Graphics shares. "So I think the move makes financial sense."

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