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8 November 2018

What becomes of Arris CPE biz under CommScope wing?

CommScope and Arris have agreed a $7.4 billion takeover deal. The most pressing issue for us is how CommScope, as a network infrastructure supplier, is likely to accelerate the unraveling of Arris’ focus on set tops, while the Arris network product line will be geared towards complementing CommScope’s existing portfolio, rather than opening up a whole new world of prospects for the world’s largest set top business.

On the other hand, there is a slim chance the merger could give Arris scale for a remarkable CPE turnaround to better compete with Samsung, Humax and Huawei.

When M&A rumors first swirled a couple of weeks ago, the two firms were similar in size, Arris with a market cap of a little over $4.3 billion and CommScope valued at $4.7 billion. Today, they have traded places with Arris shooting up to a $5 billion valuation, while CommScope’s is flat as of writing. The deal coincided nicely with the latest set of quarterly results from Arris, showing that the $7.4 billion purchase offer (including repayment of debt) is some 4.5 x quarterly Arris revenue as of Q3, down slightly by 4.5% from the previous quarter to $1.65 billion, while revenue for the first nine months came in just shy of $5 billion.

So, let’s break out its segmented earnings from the quarter and dissect what CommScope sees. As mentioned, Arris’ CPE business is in trouble, with gross margin falling by 27.5% from the previous quarter to $62.1 million, while the Network and Cloud division also incurred a surprise gross margin slip of 1% to $199.1 million – albeit on net sales of around half the size that of CPE.

Arris decided not to break out revenues for individual business sectors this quarter, but in Q2, CPE revenue was down 12.8% to just over $1 billion, contributing to a total revenue dive of $327.6 million year on year to $1.9 billion for the first six months of 2018. On that run rate, the CPE sector could be on course for a full year revenue drop of over $600 million.  The $7.4 billion acquisition offer from CommScope suddenly looks even more appealing from the Arris point of view.

Meanwhile, Arris’ smaller Network and Cloud division is enjoying healthy growth and this is where CommScope sees real value, with revenue up 15.5% to $1.1 billion for the period ended June 2018. For the 12 months ended September 2018, the CPE sector accounted for $3.9 billion in revenue from Arris’ total $6.7 billion, while Network and Cloud contributed $2.2 billion.

Net income for the third quarter suffered, falling to $47 million from $88.3 million in Q3 last year.

CommScope is no spring chicken itself mind you. Founded 42 years ago, the company is enduring a recovery process after its share price plummeted aggressively earlier this year when it decided to talk openly about a turbulent market outlook.

We mustn’t leave a stone unturned, so it could even be feasible for CommScope to initiate a bargain sale of the flailing CPE business to a set top rival or private equity firm if it successfully completes a takeover of Arris.

We at Faultline Online Reporter will take half credit for predicting the outcome, having previously suggested Arris may sell off parts of its CPE business judging by recent figures, but never went as far as foreseeing a full sale. What remains clear though is that Arris selling up to another network equipment major is an ominous sign for the set top industry in the long-term, while more immediate ramifications could see set top opportunities open up for other players, namely TiVo and Technicolor, allowing vendors and operators to squeeze every last penny from legacy hardware before cloud DVRs take much of the market.

As our sister publication Wireless Watch brought up last week, from the cellular perspective a merged Arris and CommScope entity would form an interesting portfolio to address indoor wireless deployers, whether traditional operators or new entrants such as cablecos.

It will bring together a carrier WiFi platform heavily geared to the cable sector, but also implemented in the home; antennas from outdoor base stations to indoor Distributed Antenna Systems (DAS); virtualized and conventional 4G small cells for home and enterprise; and a wide range of cable equipment including set tops, modems and other units. Arris’ E6000 edge router has been widely deployed globally and is one of the leading devices for cable’s Converged Cable Access Platform (CCAP.) All of this with a growing dose of cloud management to help bring all the elements together in an indoor HetNet (heterogenous network).

It’s worth noting that Arris expanded from its cable equipment base into carrier WiFi when it acquired Ruckus Wireless (itself offloaded when its former parent, Brocade, was acquired by Broadcom). And CommScope – best known for base station antennas and DAS – added small cells, including an indoor enterprise virtualized RAN solution, when it acquired specialist supplier Airvana in 2015. Other similar deals have taken place, such as DAS provider Corning’s purchase of enterprise small cell vendor Spidercloud.

The sale will have also been influenced by the import tariffs being imposed by President Trump, meaning a critical period for the electronics industry with Arris and Technicolor two companies directly in the crosshairs. Complete set tops are currently exempt from tariffs so the dangers are not quite so immediate, yet tariffs levied on electronic components will certainly impact the value of the set top industry globally.

A further caveat for consolidation in the legacy set top industry are the rumored plans for an Amazon-made streaming DVR dedicated to interoperating with smartphones, much like Chromecast, as well as its own Fire tablets. TiVo shares immediately slumped 10% back in late August but the long-term target is really Roku, the frontrunner in the dongle streaming space with 50% compared to Chromecast’s 22%, while Amazon Fire has 15% and Apple TV 12%.