CARMELO SANTORO : Behind the Scenes at a Merger : Silicon Systems Sees Deal as Leading to $1 Billion in Sales

When Carmelo Santoro joined Silicon Systems Inc. in 1982, the Tustin company was a rather unspectacular maker of custom computer chips with annual sales of about $13 million.

Santoro, Silicon Systems’ president and a veteran of computer chip manufacturers such as Motorola, RCA and IBM, soon realized that the Tustin firm would have to devise a new strategy if it was to grow into a major company. That new strategy, he decided, would be to go after speciality markets that large chip producers ignore.

By focusing on the market for custom chips for the telecommunications and computer disk drive industries, Silicon Systems’ revenues spurted to $56 million in 1984 and $120 million by 1988.

Silicon Systems’ strategy was successful enough to attract the attention of Japan-based TDK Corp., which in April announced that it was acquiring the Tustin firm for $224 million, or $20 a share. TDK is a $3.4-billion public company that is best known as a producer of audiotapes, videotapes and computer disks.

With TDK’s backing, Santoro believes the Tustin company could top $1 billion in sales by 1998.

Santoro, 48, graduated from Manhattan College in Riverdale, N.Y., and received a doctorate in physics from Rensselaer Polytechnic Institute in Troy, N.Y. He joined Silicon Systems as president and chief operating officer in 1982, and was named chairman and chief executive officer in 1984.

He and his wife, Nancy, live in Laguna Hills.

In this recent interview with Times Staff Writer David Olmos, Santoro discussed how and why the merger came to pass.

Q. Why did you decide to sell the company?

A. It goes back to the whole problem of capital formation for small and medium-size companies. And, particularly, for companies that are in capital-intensive industries. The semiconductor industry is a lot like the oil-drilling industry. The cost of the facilities and equipment, which allows you to design, manufacture and be competitive in producing semiconductors, is extremely high. And the return on that investment comes from being able to use that equipment to make the huge volume of product. It used to be that American companies could form capital in the public market relatively easily. You can form capital in two ways, either with debt or with equity. Making a debt offering was out of the question for Silicon Systems. And making an equity offering also was unattractive. Silicon Systems was a company that had struggled in the public marketplace for eight years. We had a good story to tell and great earnings relative to our industry. But we were recognizing the need for cash. When someone came after us with a very lucrative offer to allay that concern, we listened.

Q. How did the merger with TDK get started?

A. I’ve been contacted repeatedly in the last eight years as to whether I was interested in merging or being acquired. Nearly all the time my answer was no. Once in 1983, I believe, there was a big rumor going around that The Plessey Co. was going to acquire us. There haven’t been any more serious rumors since that time. But after the (stock market) crash in 1987, I was approached by a consultant who asked me if I thought I might want to entertain being acquired. I said, ‘You’re asking me exactly at the wrong time. I mean, our stock is at a very low point.’ Anyway the consultant went away, then came back in January, 1988, and asked me again. Now our stock had risen to the $12 range. We had just finished a year where we had sales of $82 million and earnings of 42 cents a share coming off of an industry recession in 1985 and 1986. We were really comfortable. I told the consultant that I wasn’t sure I wanted to discuss an acquisition because I thought we were going to have a great year in 1988, break $100 million in sales and earn $1 per share, and that we’d have a $20 stock.

Q. So what did you tell the consultant next?

A. I said there’s no sense in me talking to anybody who’s not willing to look at a multiple of near 150%. So, the consultant went away and then came back late January or early February to say that the company that wanted to acquire us was TDK.

Q. So you met with TDK’s representatives, and what happened?

A. TDK and its bankers came here for two meetings. Afterwards, (TDK’s representatives) said I was very American, which meant I didn’t have a lot of time to talk, and the first question that came out of my mouth was: ‘How much?’ Anyway, the negotiations broke down. We said, ‘Let’s stop talking because we’re miles apart.’ And we stopped.

Q. And the company did pretty well after that, right?

A. Yes, our fiscal year ended in October, 1988. We didn’t do $100 million; we did $121 million; We didn’t make $1 per share; we made $1.67. And we didn’t have a $20 stock; it went down to $12! So then we went to the (annual) American Electronics Assn. conference in Monterey, where Wall Street analysts are invited to hear presentations from promising high-tech companies). We told our story in Monterey, and by the time we left, our stock had dropped to $9.875. We were really frustrated! We didn’t know what was going on. We were trying to map out a strategy for getting people comfortable with the company. Every time we turned around, we heard a new excuse (for the lack of interest on Wall Street).

Q. What happened next?

A. In November, I get a call from our investment banker at Robertson, Colman & Stephens. He said they had had a call from TDK. TDK had asked Robertson, Colman to do a survey of possible acquisition candidates in the semiconductor industry and our name was one that was recommended to them. The investment banker hadn’t realized that we had talked to TDK a year earlier. He said the guys at TDK had said the earlier meetings hadn’t gone very well, and they didn’t know whether you wanted to talk to them.

Q. What did you say this time?

A. I gave them a very different response. It was a lot more humble. I not only said that I was interested in talking to TDK, but one of their complaints had been that I had refused to go to Tokyo for talks. Every meeting we ever had was right here in Orange County because I didn’t have time to go there. I said I will go to Tokyo for the first meeting, and I promised--because of that earlier remark--that I wouldn’t act “very American.” So, the first set of discussions took place in Tokyo and lasted four days.

Q. And when was this happening?

A. This is February, 1989. And our stock is in the $10-plus range. We spent four days with TDK executives, and from the very first minute, we decided to listen instead of talk. We got a whole different flavor. For example, they wanted to know if we had thought about the kind of acquisition or merger that we’d like to be involved in. And we told them that we really had intended for management to be kind of a group. They said they were glad to do that because their preference was to have management-sponsored buyout. It was real important for them that the management that achieved this success make some kind of commitment to stay around. They asked me personally if I would want to stay around to do that, and I said, I’m not really sure. One of the things I would like to do is is to run a $1-billion company. They said it was it was conceivable to dream up a way to be a $1-billion company in 10 years. They said they will commit to $100 million in capital for the first five years, and $200 million in the next five years.

Q. So, the situation began to look attractive from your perspective?

A. It became pretty clear that operating in this environment was going to be real different. The more we thought about this operating mentality, the availability of capital, the ability to maintain our independence, the better it looked. We also negotiated the same benefit programs for our employees, the same kind of profit-sharing program. The more we negotiated with them, the more we realized that we could have a really different company, a big company, one in which the burden of cash availability and going out with a public stock offering every three or four years would go away. And it was apparent that here was a $3.5-billion company that had an internal need for our chips that would allow this $1-billion plan to be accomplished even more easily.

Q. How significant is the potential business of selling chips to TDK for use in its own products?

A. We think it can be about $200 million to $250 million of the $1 billion by 1998. Our outside customers would provide the remaining 75% to 80% of our sales.

Q. What products will TDK use your chips in?

A. A variety of products they make for the automotive market. They also make power supplies, magnetic sensor controllers. And they make transformers used in telecommunications equipment. So, TDK has a real vested interest in seeing us succeed.

Q. Did other companies approach you about a possible acquisition?

A. Nobody after TDK. And we weren’t searching for anybody else. When we divulged the terms of the merger, any other party had 30 days to react. No one did so. My only conclusion is that this was a super deal for employees, and nobody wanted to come in and try to better it. Everybody I’ve talked to since the merger--the reaction from other industry executives--has been favorable to the point of them joking: “Gee, how do I get me one of these” deals.

Q. Did you have any concerns, selling to a foreign firm, Japanese or otherwise, as far as selling them access to your technology?

A. I certainly had concerns about selling to a Japanese company before I became seriously involved in finding out what their intentions were with respect to selling technology. We’re not really a technology company; we’re an applications company. We’re about three or four years behind the state-of-the-art semiconductor technology. We have sold some products indirectly into defense-related application in Japan during the past eight or nine years, but none of our major customers are defense suppliers. So we didn’t have any problems with needing approval from the Department of Defense.

Q. Will Silicon Systems benefit from gaining access to technology from TDK?.

A. There’s some advantages in the magnetics area, as you might expect. We’ll be associated with the world leader in magnetics. And the semiconductor work they have done has been mostly in the power area--power devices and power integrated circuits--which we don’t do at all. But we have had a need in some of our market areas to have power technology. So we’ve gained a lot of technology that ought to help us be better in the markets we serve.

The merger will help us accelerate our presence in the automobile industry, and will allow us to participate in Japan’s auto market. I believe you will see us make our presence felt in power supplies, integrated circuits and in motor-controlled integrated circuits in areas other than computer disk drives. I think you will also see our products in the consumer area, where we have had no presence before. I’m specifically referring to integrated circuits in VCRs, in high-definition television, and in some other areas.

Q. Because Silicon Systems’ stock price was low before the TDK offer, did the threat of a possible hostile takeover have any impact on your decision to sell the company?

A. I never worried, nor do I think any other semiconductor executive worries much, about the threat of an unfriendly takeover. It’s real simple. You don’t buy buildings, products and equipment as much as you’re buying people’s expertise. If you bought this company and the management team walked out, you’d be set back eight years. The first person TDK came to was me. They asked me what it would take for them to get a commitment from me to stay. And I told them. Now, I do not have a contract with TDK; I could write my letter of resignation and walk out of here this afternoon. But I will also tell you that if I did that, somebody ought to have me committed, because there is no way that I can make out as well financially by leaving here as by staying. As long as they treat me like that, and I suspect they will, and as long as I perform, we’re going to have a great relationship.

Q. Did you talk to TDK’s people about the issue of whether they would bring in management from Japan to help run Silicon Systems?

A. I not only talked about it, I went to them and told them that was an important ingredient for me. I am not only the president of Silicon Systems, they also have made me the general manager of TDK’s semiconductor division worldwide. I function as a division general manager, reporting directly to the president of a Japanese company. The ability for me as an English-speaking American to effectively integrate in the company is very difficult. So I went to TDK’s president and I asked him to assign to me someone who can work for me and whose job it will be to help me integrate into the company. I not only got one guy, I got two of his best guys, one from research and development, and one from corporate planning.

Q. What changes are in store for the company because of the merger?

A. The biggest and most positive ones are that we’ll have the availability of more capital for capacity expansion than we would have had, and we’ll have a bigger budget for product development. The profit objectives that I have to live with are substantially lower than I would have had to maintain a reasonable stock price as a publicly held company. Now I can focus on reinvesting profits for growth as opposed to putting profit into the bottom line for stock price.