The merger of SOLA International and Carl Zeiss' eyeglass business, which is due to be completed sometime during the 1st quarter of 2005, is expected to boost their growth in sales and earnings in the long term, thanks to the complementary nature of their operations and to the greater proximity to customers in the major markets that will result from their combination.

Among other factors, Zeiss' officials feel that the company's strong know-how in lens coating, demonstrated by the success of its recently introduced LotuTec anti-stain technology, will make a major contribution to the service capabilities of SOLA's expanding network of prescription laboratories around the world, creating more added value.

The boards of directors of Carl Zeiss and SOLA unanimously approved the merger on Dec. 5, but the two companies have not yet released much information about the future shape of their combined business pending final approval of the deal by SOLA's shareholders at a general meeting due to be held in January or February. There is no indication yet on the future management structure, the positioning of the various brands or the future manufacturing and distribution apparatus, but Zeiss has budgeted €24.6 million for post-merger integration costs.

The price of $28.00 a share offered for SOLA represents a premium of about 30 percent as compared to the company's latest quotation on the New York stock exchange on Dec. 3, which capitalized it at $712 million. Credit Suisse First Boston and Deutsche Bank are ready to provide the required financing. UBS Securities served as financial advisor to SOLA in negotiating the deal, which caught many investors by surprise. Cahill Gordon & Reindel and Gardner Carton & Douglas acted as legal advisors.

With sales projected to reach €275 million this year, Zeiss' eyeglass business is only about half the size of that of SOLA, whose revenues will be equivalent to about €524 million. To help finance the acquisition, Zeiss has decided to team up with EQT III, one of six equity funds that are indirectly controlled by the Swedish Wallenberg Group, with total investments of about $5.7 billion in 22 companies including Leybold Optics. They have gotten out of 13 other investments, and it cannot be excluded that EQT III will do the same at some point with this new one, perhaps cashing out through a public offering.

Technically, Zeiss' eyeglass subsidiary will form a 50-50 joint venture with EQT III that will take over SOLA and its subsidiaries for a total price of $1.1 billion, including the assumption of $285 million in debt. The new holding company, whose name has not yet been chosen, will likely be based at the main office of Zeiss' eyeglass division in Aalen, Germany. It will separately own Zeiss' German eyeglass operations, a new company in the USA that will control SOLA's US activities, and the foreign subsidiaries of Zeiss and SOLA, including its American Optical offices in various countries.

As it turns out, executives of the two groups had their first discussions on a possible merger in 2002, but nothing came out of it. Last July 29, Zeiss indicated that it was interested in making an offer, but SOLA's management said the company was not for sale. Nevertheless, on Aug. 16 SOLA's board of directors allowed Zeiss to carry out preliminary due diligence proceedings and on Sept. 7 Zeiss came up with an initial takeover offer at $26.00 a share, plus or minus $2.00. After more discussions and after reviewing other possible strategic alternatives, the board agreed to a final round of due diligence proceedings and on Nov. 20 Zeiss made its final proposal, asking for approval by Dec. 5.

Zeiss, which had previously changed its status from a foundation to a regular limited liability corporation under German law for greater financial flexibility, decided in November to turn its eyeglass operations into an independent subsidiary, called Carl Zeiss Eyeglass GmbH, in order to facilitate acquisitions and strategic alliances. Aside from the deal with SOLA, the new subsidiary is taking a shareholding in GKB Hi-Tech Lenses, an Indian company based in Goa, to offer Zeiss lenses with advanced coatings on that promising market.

In recommending the takeover in proxy statement, SOLA's directors cites in particular the prospect of increased competition from manufacturers of commodity products, particularly from Asia. Zeiss' management describes the merger as a perfect fit, considering that there is no significant overlap between the two companies in terms of product range and market presence. While Zeiss specializes in high-end premium branded products, SOLA offers a much wider product spectrum. SOLA is a specialist in mass production, covering also semi-finished products, whereas Zeiss boasts expertise in vision correction and prides itself on offering high-quality coatings.

Directly represented in 16 different countries, Zeiss Eyeglass enjoys a strong market position in Germany and in several other European countries. Headquartered in San Diego, California, SOLA is represented in 28 countries and is stronger than Zeiss in North America and in the Asia-Pacific region. While Zeiss targets mainly the traditional eye care professionals, SOLA is strengthening its relations with the multiple chains.

Zeiss Eyeglass and SOLA employ 2,680 and 6,634 persons around the world, respectively. With annual sales of more than €800 million, the new company that will stem out of the merger will be the 2nd or 3rd largest global player in the sector. It will be similar in size to Hoya's vision care business, but much smaller than the global leader, Essilor International, which will post sales of more than €2.3 billion for this year. It will employ about 9,000 people around the world and it will be represented in most of the major markets.

Both companies have shifted a large portion of their manufacturing facilities from Germany and the USA to lower-cost locations over the last few years. SOLA has undergone by far the largest reorganization. Between 1999 and 2001, it has transferred much of its production from the USA to Mexico and other low-cost countries, which now represent about 90 percent of its total output. It has recently embarked on a wave of acquisitions of prescription labs in the USA, following in the wake of Essilor and Hoya.

Based on the merger agreement, SOLA will have to pay a termination fee of $22.2 million to Zeiss and EQT III if it doesn't go ahead with the merger by Apr. 30 for certain reasons, including acceptance of another party's offer to acquire its control. SOLA cannot solicit a counter-proposal but it may respond to it. The members of SOLA's board together own only 0.9 percent of the company's equity. The largest known shareholder of SOLA is Barclays, with a stake of 10.62 percent. Its president and CEO, Jeremy Bishop, owns 10,000 shares and holds 389,800 options. Mark Ashcroft, executive vice president and general manager of European operations, has no shares but he can exercise 120,000 options.

Zeiss previously shed its spectacle frame business, licensing it out to Menrad. The remaining eyewear operations improved their results in the financial year ended last Sept. 30 in spite of a 4 percent decline in total sales to €332 million, largely due to a 30 percent sales drop in the first months of the current calendar year, following the new German health reform. The division's sales, of which about 50 percent are generated in Germany, include the so-called sports optics segment, which consists mainly of binoculars and similar equipment and which would not be involved in the merger with SOLA.

The 158-year-old Carl Zeiss group, which is involved in many other high-tech activities that have a wider geographical scope, raised its total revenues by 5 percent to €2,135 million during the financial year, with an 8 percent increase in local currencies. The pre-tax profit more than doubled to €130 million from the year-earlier level of €64 million. The group again invested about 10 percent of sales on R&D and the number of its patent applications rose by 8 percent.

Interestingly, Zeiss is the third major German supplier of eyeglass lenses to change equity since the German government decided to reduce drastically its subsidies for corrective lenses. Another international equity fund, Permira, acquired in mid-2003 a 49 percent stake in Zeiss' direct competitor, Rodenstock, and according to a German press report, it quietly raised its stake in the former family-owned company last summer to 85 percent. The third-largest German supplier, Rupp + Hubrach, was acquired by Essilor last year, turning the French giant into the largest player on the German market.