Can Gemstar Keep Rising?

Henry Yuen has a PhD in applied mathematics, but on the eve of a 1988 Boston Red Sox baseball playoff game he found himself facing an all-too-common problem.

He couldn’t program his VCR.

From that moment of frustration was born VCR Plus--a one-step system that has simplified VCR programming for tens of millions of consumers and brought financial success to Yuen and his Pasadena-based company, Gemstar International Group.

Now the little-known company is on the verge of an even bigger product launch: an on-screen, interactive TV programming guide that could be used by hundreds of millions of consumers worldwide.

But the same aggressive business and legal strategies that Chief Executive Yuen has used to bring the company this far also raise questions about how much farther Gemstar can go.

To its credit, Gemstar’s technology has attracted the attention of such media heavyweights as Microsoft Corp. and NBC-TV.

Another media company--United Video Satellite Group, controlled by cable giant Tele-Communications Inc.--liked Gemstar so much it launched a hostile takeover bid in early July.

Yuen managed to make United go away, but his tactics irritated some Gemstar shareholders.

At the same time, Yuen’s new pay package--including stock options worth more than $60 million--has raised eyebrows not only for its size, but for the way it was approved: on short notice at a special shareholders meeting in Tokyo.

By the stock market’s judgment, Gemstar now is worth $1.6 billion. But by Yuen’s account, the company’s potential for growth is measured in multiples of 10.

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Yuen, who was working as a mathematician and lawyer at the time, didn’t intend to be in the consumer electronics business when he co-founded Gemstar in 1986 as a real estate holding company.

Yuen was tinkering with an idea for a phone with a keyboard to let users leave text and voice messages when his VCR epiphany gave Gemstar a new direction.

“We wanted to make technology consumer-friendly,” said Yuen, who was born in China and immigrated to the United States in 1966.

VCR Plus, introduced in 1990, assigns a numerical code to every TV program. Users look up the codes in TV listings and punch them into remote controls of specially equipped VCRs, which convert the codes into recording instructions.

Today VCR Plus codes are printed in 1,800 publications and used by 80 million people in 40 countries, Yuen said.

Gemstar also owns Index Plus, which tracks programs stored on tape, and the forthcoming V-Chip Plus, which will allow parents to program their TVs to keep children from watching certain shows.

Gemstar’s products aren’t sold directly to the public in the usual sense. Gemstar licenses its technology to electronics manufacturers. Consumers pay when they buy specially equipped TVs or VCRs, typically at premiums of $50 to $100.

The company’s revenue, $127 million last year, consists mostly of royalties from the electronics manufacturers that have adopted its technology. The company earns between $2 and $3 from each VCR built with VCR Plus, for example.

As Yuen himself acknowledges, the technology Gemstar developed isn’t terribly complicated. But Yuen, whose PhD is from Caltech and who also has a law degree from Loyola University, has overseen Gemstar’s accumulation of more than 60 patents covering about 1,200 claims over the last decade, and the company also has 120 patents pending.

To augment what Gemstar developed in terms of technology, Yuen made strategic purchases of rival companies.

By waging some carefully chosen legal battles, Yuen, 50, has adeptly used Gemstar’s patents to both beat back direct foes and persuade potential rivals to become allies. Indeed, Yuen believes his “greatest contribution” to Gemstar has been negotiating favorable terms in its many deals with other firms.

That skill may face its greatest test with the Gemstar product Yuen is most excited about: Guide Plus Gold, an on-screen TV program listing that is navigated with a remote control. The system, scheduled for release later this year, is designed to allow users to highlight a program, see a detailed description, then set their VCRs to record the show with a single button click.

As the number of TV channels marches toward the ballyhooed 500 mark, electronic program guides that will let viewers sift quickly through the daunting array of choices are expected to become a critical part of TV-watching.

They could even become as important as World Wide Web search engines such as Yahoo, which have become indispensable tools for efficiently surfing the vast Internet.

“By the year 2006, we will have nearly 1 billion TV households that are going to be ripe for some form of electronic program guide,” said Cynthia Brumfield, a senior analyst with Paul Kagan & Associates, a media research firm in Carmel.

In a vote of confidence for Guide Plus Gold’s technology, Microsoft agreed last month to pay $45 million to Gemstar for access to its related patents, plus an additional fee for every electronic program guide Microsoft builds into devices such as set-top boxes and WebTV units.

But Yuen has his eye on something even bigger: advertising revenue from Guide Plus Gold, which will run ads alongside its listings.

“I think we have very much just started,” Yuen says of Gemstar.

Some analysts agree. One is Shaun Andrikopoulos, who follows Gemstar for broker BT Alex. Brown, which brought Gemstar public in 1995. He said in a recent report that he expects the company’s earnings--81 cents a share last year--to grow 30% to 35% a year long-term because of Gemstar’s “de facto monopoly” in electronic program guide technology and, potentially, “some of the most valuable advertising real estate in 21st century television.”

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United Video Satellite also saw great possibilities in Gemstar.

The Tulsa, Okla.-based company, creator of the scrolling “Prevue” TV listing guide for cable, was embroiled in a patent rights lawsuit with StarSight Telecast before StarSight--whose technology is key to Gemstar’s Guide Plus Gold--was acquired by Gemstar in 1996.

Hoping to end their differences, Gemstar and United last year began discussing ways to work together, and it appeared that a pact was near in January, when the companies announced plans for a joint venture. But the accord unraveled in March.

At the time, with Gemstar’s stock in the $30 range, United made a secret offer to buy Gemstar for $40 a share. That offer was later raised to $45 a share, or $2.8 billion.

Yuen, however, had no interest in a deal. Stymied, United went public with what it portrayed as a generous offer on July 6. The maneuver, known on Wall Street as a “bear hug,” was intended to encourage Gemstar investors to pressure Yuen to accept the deal.

United President Peter Boylan went so far as to assert that Gemstar Chairman Thomas Lau--a Hong Kong investor whose 24% stake makes him the company’s largest shareholder--would “support” the buyout, as would entertainment giant Viacom Inc. and Thomson Consumer Electronics, two other big Gemstar holders.

But Gemstar’s board voted 7 to 0, with three abstentions, to reject United’s bid. The company also adopted a so-called poison pill, making a takeover too expensive.

Lau did not respond to requests for an interview. Yuen said Lau never told him directly that he was in favor of United’s offer. “I don’t know if Thomas supports it,” Yuen said, “but I do know he wants to sell his shares.”

Boylan insists that United’s $45 cash bid--which was a 16% premium to Gemstar’s share price before the announcement--was a generous offer. To Boylan, merging the two companies would make more sense than continuing to fight over patents in the courtroom.

It appears some Gemstar shareholders agree. A lawsuit seeking class-action status filed last month against Yuen and other directors alleges that it was “inherently unfair for them to reject any proposed transaction in order to entrench themselves in their positions.”

Yuen, however, contends that in addition to offering too low a price, United’s proposal, since withdrawn, had a range of “real structural problems,” including financing and antitrust concerns.

Gemstar also could have lost clients by appearing to be a cable industry rival instead of just a supplier, Yuen said. “The company’s potential can only be realized if we can continue to keep a very neutral, evenhanded and open-minded licensing policy,” he said.

But some observers wonder if Gemstar shot itself in the foot by rejecting United--and, by extension, Tele-Communications CEO John Malone, who is regarded as the industry’s most powerful executive.

Gemstar risks possibly alienating Malone as well as his many cable allies upon whose good graces Gemstar may have to depend as it rolls out Guide Plus Gold. Moreover, Rupert Murdoch’s News Corp. is about to become a big investor in United as well.

Yuen counters that his alliances with all of the major TV networks, satellite TV services and electronics manufacturers will ensure that Gemstar can distribute its products. New Federal Communications Commission regulations also will make it politically difficult for cable companies to strip Gemstar’s data from TV signals, he said.

“We don’t need access to the cable box,” he said.

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Given the growth that Yuen--and some analysts--believe Gemstar can achieve long-term, many shareholders may be happy with Yuen’s rejection of United’s bid.

But as Gemstar’s CEO, it would appear Yuen also has a major interest in keeping Gemstar independent: a spectacular pay package.

At a meeting in mid-March, Gemstar’s board approved a new compensation package for Yuen that experts say looks exceptionally lucrative. Yuen was granted 4.16 million stock options that vest in annual installments over five years.

With Gemstar stock now at $36.75 a share on Nasdaq, and an exercise price of $22 each for the options, their value on paper now tops $60 million. In addition, Yuen owns about 3 million shares outright, plus 2.6 million previous options.

The new pay package also allows Yuen to earn as much as $4 million in annual salary and bonuses in the current pay period. That rises to $22 million in six years.

In fiscal 1997, Yuen earned nearly $1.2 million in salary and bonuses.

Yuen’s potential earnings place him well beyond the 90th percentile of salaries and bonuses paid to top executives at other high-tech companies, according to a survey of 500 firms by the Radford division of Aon Consulting in San Jose.

Also, the options granted to Yuen could significantly “dilute” the ownership of existing shareholders, according to George Paulin, a pay expert who examined Yuen’s package at The Times’ request.

Specifically, Yuen’s options, and those of other officers, could boost Gemstar’s 48.4 million outstanding shares to nearly 76 million, Paulin contends--spreading Gemstar’s future earnings over a larger base of stock and thus diluting other investors’ stakes in the company.

“People might say, ‘OK, it’s a lot, but at least it’s options, it’s pay for performance,’ ” said Paulin, who is president of Frederic W. Cook & Co. in Los Angeles. “But when you take this level of options and combine it with the type of cash incentives [Yuen] has been granted, the package, in my opinion, is excessive.”

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Yuen disagrees with Paulin’s analysis. He defended the package, saying his pay is tied to criteria such as Gemstar’s earnings growth, and also that he did not receive options in previous years because of legal limitations tied to Gemstar’s acquisitions of other companies.

Still, at least one of Gemstar’s former institutional investors objects to the size of Yuen’s pay package and the way it was approved.

The shareholder vote on Yuen’s new pay deal occurred March 12 in Tokyo, close to some of Gemstar’s big investors. What irked some U.S. investors was that the proxy for the meeting was sent out less than three weeks earlier--very short notice for shareholders, by usual standards.

Furthermore, Yuen’s options were priced as of Jan. 7, just six days before Gemstar announced its first licensing pact with Microsoft. Gemstar stock soared 19% on the news.

Yuen said he asked for the options package last fall and that it simply wasn’t completed until January.

In any case, a majority of shares represented at the meeting were voted in favor of the package.

But the institutional investor, who requested anonymity and who has since sold his Gemstar shares, says, “We think it’s a great franchise and Henry is a brilliant guy, but he’s lining his pocket too much.”

The pay agreement, this investor argued, is one of the most lucrative “we’ve ever seen short of Walt Disney Co . . . and [Yuen] hasn’t created the value that Disney has for its shareholders.”

Yuen, however, notes that for his stock options to pay off, Gemstar shares--now priced at a lofty 32 times the company’s most recent four quarters’ earnings per share--must remain strong.

“For me to be a rich man,” he argues, “the investors would be extremely rich.”

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Red Ink to Black

Gemstar’s revenue has soared in recent years as royalties from its technology systems have jumped and as it has acquired related businesses. Losses in recent years have been attributable to acquisitions. Results for fiscal years ended March 31, in millions:

1998 Revenue

$126.6

1998 Net Income

$38.7

Source: Company reports