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Is Arris the Answer to CommScope's Pain?

Jeff Baumgartner
11/8/2018
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CommScope's leadership and a team of independent advisors have been evaluating and analyzing how to turn around the financial performance of the company and reach into new or adjacent markets, and here's the answer they came up with: splashing out $7.4 billion for Arris.

The acquisition of Arris Group Inc. (Nasdaq: ARRS) offered the "best path... to drive growth and shareholder value over the near- and long-term," CommScope CEO Eddie Edwards said Thursday in a call in which he spent most of the time justifying the deal. "We believe with this transaction we can achieve growth and success that neither company could achieve on its own." (See CommScope Puts Up $7.4B for Arris.)

Billing the CommScope Inc. and Arris product lines as "extremely complementary," he said a big focus is to create a portfolio of wired and wireless technologies and products that will play a major role in the world's move to 5G. He also talked up how CommScope's work in the licensed spectrum arena will fit well with Arris's expertise in the area of WiFi/unlicensed spectrum.

Both Arris and CommScope have developed products for the shared CBRS band. Edwards said CommScope's Spectrum Access System (SAS), used to keep new users in the CBRS spectrum from interfering with incumbent users, has the potential to carry over to WiFi as the FCC considers allocating some spectrum in the 5.9GHz band for unlicensed use. (See Who's Doing What in the CBRS Band?, AT&T Picks Samsung, CommScope for CBRS Rollout, Cable Makes Play for 5.9GHz Band and FCC Tests Show WiFi Can Operate Safely in 5.9GHz Band .)

However, CommScope investors don't appear to be completely sold on the basic alignment early on, as shares closed down 20.13% Thursday in the wake of CommScope's premium-priced play for Arris alongside Q3 results that missed the mark and reduced Q4 guidance. Shares in Arris, which has been dealing with headwinds of its own, closed the day up 10.4%. (See Arris Financials Clipped by Component Shortages.)

With respect to CommScope's Q3 earnings and revised Q4 forecast, Edwards said some customers are taking a "more conservative approach" with near-term capital spending affected by industry consolidation and a shift in the timing of certain large projects. Still, he's confident that the long-term prospects look good, but noted that part of the issue today comes as the 4G cycle winds down ahead of future, accelerated spending on 5G.

Bruce McClelland, the Arris CEO who will stay with the combined company, went to bat on the deal, noting on the call that the merger will give CommScope's business more customer and geographic diversity. Of note, about 40% of Arris's revenue comes from outside the US.

CommScope appears to have a lukewarm attitude about Arris's overall consumer premises equipment (CPE) business, recognizing that the video set-top box business is in decline while sales of broadband modems and gateways remain strong. CPE represents a large part of Arris's revenue, but it will likewise represent a small portion of the combined company's pro forma EBIDTA, Edwards said.

The broadband side of the CPE business is a "strategic weapon" as the home becomes an important part of the 5G battleground, CommScope CFO Alex Pease said. But CommScope didn't share a similarly glowing view of the video set-top box biz.

Given the struggles on the video end, BTIG Research analyst Walter Piecyk speculated last month that CommScope might be willing to sell Arris's set-top box business, which largely has been built through Arris's acquisitions of Motorola Home and Pace plc.

China concerns
Though there's not much overlap in CommScope's and Arris's product portfolio, both are figuring out how to reduce their financial exposure to the US tariffs on certain Chinese goods, which are at 10% today and set to rise to 25% in 2019.

For its part, Arris is attempting to mitigate the impact by moving production of affected products outside of China. That activity is "well underway" and Arris expects to complete it in the first half of 2019, McClelland said. (See Arris: Tariffs Add $200M in Broadband Gear Costs, Threaten US 5G Plans and Arris: We're Tackling the Tariffs .)

CommScope has likewise taken "aggressive action" to mitigate 75% of the original costs associated with the tariffs, and implement surcharges, as needed, to bridge the rest of the gap. CommScope is also moving some manufacturing to other parts of the world not affected by the tariffs.

"We are not, on the face of it, moving out of China," Edwards said, noting that CommScope has "significant manufacturing capacity" in China as well as India. "We are going to redirect what we make and where it goes."

CommScope, he added, has been "well advised" that it won't need China's blessing on the proposed merger with Arris.

In a note today, BTIG' Piecyk downgraded Arris to "Neutral" from "Buy," but stressed that he doesn't see any material regulatory or financing risk on the deal nor anticipates a competitive bid emerging.

Back to the future
For industry history buffs, the CommScope-Arris merger is a full-circle move in some ways. The deal enters play more than 20 years after General Instrument split itself into three publicly traded companies -- NextLevel Systems (the set-top and modem business that was also an early player in the telco TV/IPTV market), CommScope, and General Semiconductor. NextLevel took over the General Instrument name in early 1998 and GI was sold to Motorola about two years later. Arris acquired Motorola Home, which included much of what used to be GI, from Google (Nasdaq: GOOG) in 2014. (See Arris Secures Motorola Home.)

And CommScope's move for Arris will seemingly replace some cable-focused products it recently got rid of. It was only about two years ago when CommScope sold some of its fiber-access products, including its RF over Glass (RFoG) systems and EPON gear with DOCSIS-style provisioning elements, to Adtran Inc. (Nasdaq: ADTN). Arris has products in both of those categories. (See Adtran Seeks Cable Stardom With EPON Deal.)

— Jeff Baumgartner, Senior Editor, Light Reading

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bosco_pcs
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bosco_pcs,
User Rank: Light Sabre
11/9/2018 | 3:10:36 PM
Re: Necessary mistake?
Not if you view this as a private equity special. ARRS got some valuable assets. It got Ruckus at a discount from AVGO when the latter bought BRCD. Carlyle, with its convertible and probably some debt in COMM could instigate selling off of some of its assets. If the combined company works out, Carlyle could hold/sell the equity. If not, it is going private again!
komatineni
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komatineni,
User Rank: Lightning
11/8/2018 | 8:24:17 PM
Necessary mistake?
The traditional models are dying fast while the hype cycle of 5G is probably at the very early stages. Commscope do know that buying Arris is not going to help them in mid to long-term. Probably this is what CXO can do unless they transform totally into artificial intelligence based, using deep neural networks ASIC to support IoT and AR/VR experience from Cloud-based solution (/S - all hyped stuff).
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