Video services

What Does Comcast Want From Arris?

A curious press release circulated recently highlighting a new warrant agreement between Arris and Comcast. Under the terms of the agreement, Arris is offering Comcast up to 8 million shares of its company if the US cable operator reaches certain spending thresholds in 2016 and 2017. The share price offered is based on an "average volume-weighted price" of $22.19, which was calculated using the ten-day trading period before the agreement was executed.

The two companies gave very little explanation as to why the warrant agreement was developed other than to offer the standard platitudes about the importance of their strategic partnership, and the opportunity to "further grow our relationship." (Note: Light Reading did discuss the deal with both companies.)

There is an awful lot I don't know about finance, but the deal between Arris Group Inc. (Nasdaq: ARRS) and Comcast Corp. (Nasdaq: CMCSA, CMCSK) still sets off some alarm bells - even acknowledging that 8 million shares is less than 5% of Arris' value. This is the largest cable provider and the largest set-top vendor in the industry. If nothing else, the equity deal will tie the two of them even more closely together, and thus inherently push competitors for the same business further toward the margins.

In other words, if Comcast has such incentive to buy from Arris, won't it be likely to spend more with that company than with another vendor? And if Arris finds itself further under the influence of Comcast, won't it be likely to prioritize technology and product development that Comcast wants over the wants of other customers?

There's important further background to the story. First, Comcast had equity previously in Arris. When Arris bought Motorola Home back in 2013, the transaction was partially funded through Comcast's purchase of 10.6 million shares of the company. That amounted to a $150 million payout. However, Arris says that Comcast no longer owns equity in Arris.*

Second, Comcast is already one of, if not the largest customer for Arris today, meaning the two companies are financially linked even beyond any equity deal.

Of note, the warrant agreement is also not unprecedented for Comcast. The cable company entered into a similar agreement with Universal Electronics Inc. earlier this year, and back in 2001 it earned the option to purchase shares of SeaChange International Inc. (Nasdaq: SEAC) in exchange for spending a certain amount on that vendor's video-on-demand products.

So the question is: Why do both Arris and Comcast want this particular equity deal?

Want to know more about video market trends? Check out our dedicated video services content channel here on Light Reading.

On Arris's part, I can speculate that the company wants to drive business for its network and cloud group. The warrant agreement specifically states that "a set percentage of the purchases must be for products and services included in ARRIS' Network & Cloud segment." Today, that division contributes less than half of what the company earns from its customer premises equipment (CPE) business, and Arris would no doubt like to diversify its income. The warrant agreement is, in effect, a grand loyalty scheme designed to help boost newer product and service lines. (See Set-Tops Are Cash Cow in Arris/Pace Deal.)

On Comcast's part, I can only guess that the company has further interest in locking down the cable vendor ecosystem. The more of an ownership stake it has in Arris, the more influence it can exert over the company's technology agenda. (Although how much more influence does it need?) And Comcast has made it very clear that it wants to be in the driver's seat of cable technology development. Example number one: the company's creation of and contribution to the Reference Design Kit (RDK) set-top software initiative and its corollary, RDK-B for broadband CPE. Example number two: Comcast's development and licensing of the X1 cloud-based video platform.

Comcast isn't the only cable company to invest in one of its vendors. Far from it. Charter Communications Inc. bought a stake in ActiveVideo last year alongside, coincidentally, Arris. (See Arris, Charter Nab ActiveVideo for $135M.)

But I still reflexively find the Comcast/Arris deal more troubling. ActiveVideo is a relatively small player. In this case, we're talking about two giants of the cable industry; two giants that now have the potential to further dominate the cable landscape.

*UPDATE: An earlier version of this article did not report that Comcast had already divested of its previous ownership stake in Arris.

Also, Arris has responded to this story with further comment:

"As a shareholder, Comcast Cable will not influence ARRIS's strategic direction, product roadmap, or operational decisions. We've publicly stated that a key benefit of this agreement is that it enables ARRIS to expand our business with Comcast while further strengthening our financial foundation to continue investing in global growth. This speaks to ARRIS's focus on our entire portfolio of global customers.

Also, to provide some additional context, even if Comcast ultimately would earn the full 8 million shares, its ownership position would still be below 5%."

— Mari Silbey, Senior Editor, Cable/Video, Light Reading

msilbey 7/12/2016 | 1:15:13 PM
Re: Genealogy Comment Thanks, Fwagoner. There's some inevitability here. As the whole industry consolidates, it seems natural for Comcast and Arris to grow closer. My wonder is whether there's enough external competitive pressure from non-traditional video providers and streaming hardware companies - Facebook, Google, Amazon, Apple - to keep the market dynamic.
Fwagoner 7/12/2016 | 3:29:24 AM
Genealogy Comment Excellent analysis by Mari Silbey. Numbers aside, and in my opinion, this announcement of a newer capital linked relationship is really just a step towards a hybrid version of vertical integration without the associated risks. Meaning, Comcast will carry a higher degree of leverage into any future product development discussions with Arris - which will ultimately equate to an accelerated path towards commodity level pricing. In the end, Comcast will rule the day, even at a <5% equity position and any associated product purchasing commitments.
Sign In