Mergers & acquisitions

Will Harmonic Keep Singing Solo?

Which way will Harmonic Inc. (Nasdaq: HLIT) go?

That's one of the hot questions that cable tech industry analysts are debating now that Arris Group Inc. (Nasdaq: ARRS) has made its $1.2 billion bid for Tandberg Television and a bidding war has broken out for Terayon Communication Systems Inc. . With a dwindling number of mid-sized digital video equipment and software vendors left standing on their own, sources say Harmonic must either get bigger to survive or find itself a larger suitor.

"It's like musical chairs right now," says one industry source. "You don't want to be left without a seat."

Harmonic, a digital video encoding and edge QAM specialist, generated $257.4 million in revenue in 2005, earning itself a scant $500,000 profit. Analysts estimate that the company will report about $242 million in sales and a heftier profit for 2006.

Unlike Tandberg TV or Terayon, Harmonic seems quite determined to get bigger quickly rather than succumb to takeover fever. Industry sources say the company, which just completed the purchase of Entone Inc. 's video networking software business for $45 million, has emerged as one of the two or three most active bidders for Terayon.

Sources say the other likely bidders for Terayon include Motorola Inc. (NYSE: MOT) and Cisco Systems Inc. (Nasdaq: CSCO)'s Scientific Atlanta . A fourth possible suitor, Arris, has apparently dropped out of the hunt after swinging its deal for the somewhat larger Tandberg TV. (See Terayon Preps for Likely Auction.)

Harmonic appears to be scouting acquisition targets as well. With its stock value pumped up by takeover speculation over the past few months, analysts say the company could now afford to buy properties that it couldn't touch before.

Questioned about its strategy, Harmonic officials are not shy about their hunger for acquisitions. Like their Arris counterparts, they talk freely about their desire to grow "inorganically" through buyouts as well as through internal expansion.

"We continue to keep our eyes open for opportunities," says David Price, VP of product marketing and communication for Harmonic. "The time for growth is now. We're set to do that."

Price says Harmonic, a major player in the European telco TV business, is particularly looking to grow in the IPTV encoder space. He says the company is seeking to expand both "horizontally" into new IPTV products and "vertically" into "higher levels of control" of video streaming.

"The market is being driven by IPTV," he says. "You'd expect us to move into more IP parts of the puzzle."

The big problem for Harmonic is that there are increasingly fewer companies for it to buy to achieve much greater scale. Even if it succeeds in acquiring Terayon, for instance, Harmonic will only boost its annual revenues by about $75 million to $80 million.

"There's not another Tandberg TV out there for somebody to buy," says Brian Coyne, a senior analyst for Friedman, Billings, Ramsey & Co. "I think it's going to be hard for Harmonic to build itself into a fourth key competitor."

Another headache for Harmonic is that Tandberg TV, a key rival in the digital video encoding business, is poised get a lot bigger through its merger with Arris. (See Arris Pounces on Tandberg TV.) Although a relatively new player in the market, Tandberg TV jolted Harmonic last month by capturing a major MPEG-4 high-definition (HD) encoder order from DirecTV Group Inc. (NYSE: DTV). Analysts estimate that the order, worth $8 million initially, could end up generating at least $40 million for Tandberg TV over the next two years.

Harmonic rebounded somewhat earlier this month by winning a similar MPEG-4 HD encoder award from EchoStar Satellite LLC , a long-time customer. But financial analysts, anticipating that award, are mixed in their assessment of its impact.

"The opportunity is a positive, but not a gold mine," Coyne wrote in his latest analysis of the company. Labeling the company's stock an "underperformer" because of unusually bullish investor expectations that have driven up the share price, he argued that the impact of the EchoStar order has been "overestimated."

Harmonic executives, however, are trying to portray Arris's proposed takeover of Tandberg TV as a positive development for their firm. Relieved that their rival hasn't fallen into the hands of Motorola or Cisco, they contend that Arris and Tandberg TV officials will be so busy integrating their two firms on both sides of the Atlantic that they will be distracted from focusing on customers.

"I do expect to see Tandberg TV and Arris have a fair amount of settling time," Price says. "Of all the possible outcomes for us, the Arris-Tandberg combination is the best."

— Alan Breznick, Site Editor, Cable Digital News

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