An industry observer is expected to believe that CommScope, which was on the record at Investor Day, several months before the announcement of the merger with Arris Group, that it would only consider a relatively modest acquisition (and highlighted its previous buyout: “a very small connectivity company called, Cable Exchange,”) would so quickly change its mind, ostensibly because of future market opportunities, especially 5G (while commenting last month at the Barclays Global Technology, Media and Telecommunications Conference, “[W]e’re really in the infancy of all of this, trying to figure out where it’s going….”). Such an individual is also supposed to be persuaded that “[a] primarily…passive product infrastructure provider,” which around a couple of years ago divested its RFoG and EPON businesses, suddenly decided to change its corporate ethos radically by becoming entrenched in active devices, mainly based on the advantages resulting from diversification and synergies (not to mention getting back into the satellite game, after exiting about a decade ago). Most incredibly, that spectator has to buy into the notion that conservative-minded CommScope would work out a deal in which it was a billion dollars short – and after winning complete independence from the Carlyle Group after a total of six years, that the player would be “thrilled” (3Q report) to potentially give up a piece of its corporation again to the same VC. As with other recent M&A activity related to optical/broadband transport, the power of large buyers of equipment in influencing the behavior of vendors to act in unanticipated or abnormal ways can never be underestimated. It has been recently seen with Cisco/Luxtera with the system house engaging in a quid pro quo, with II-VI/Finisar, as big customers, in general, wanting to reverse the destructive steps taken by the latter, and with Lumentum/Oclaro in responding to the unprecedented methods of particular users driving down pricing to an intolerable level.
fibeReality is stating its position even more strongly than in our November 2018 article that the only explanation that makes sense for CommScope’s unusual action is that the situation at the MSOs have compelled it to fix up the mess at Arris because the future success of the Hickory, NC-based firm itself is substantially based on timely delivery of evolutionary developments to the existing HFC network architecture. Apparently, the MSOs need a greater amount of assurance that what is coming right behind DOCSIS 3.1, gigabit symmetric capability, will not be delayed. While Arris is the only major transport system company in the US, which is primarily devoted to the cable TV operators, in our opinion, the supplier has not excelled at managing new technology.
It seems that the large CATV providers want CommScope to “really improve [Arris’] profitability and cash flow,” because they have insufficient confidence that the latter can accomplish these goals alone. One problem is that Arris has struggled to adequately incorporate all of its acquisitions.
While at least on that initial conference call involving the pending contract, there was a good amount of focus on “fiber optic and RF access transmission technology,” afterwards, the narrative understandably shifted more to sexier subject matter, such as future IoT possibilities, to appease the financial community. Although there is discussion concerning the requirement for “deploy[ing] fiber deep and densify[ing] the wired networks in support of the 5G buildout,” such as at the Bank of America Merrill Lynch Leveraged Finance Conference in December, too much emphasis on comparatively mundane subject matter would not have a chance in getting institutional investors to be enthusiastic.
In addition, there is no dispute that Arris’ Ruckus group would “be a critical and highly complementary addition.” (Q3 report). We also agree with the statement that “[t]he ultimate edge of the data center world is the central office.” (Barclays conference). Yet, at that same investment meeting, “the cultures” of the two combined entities are actually very “[dis]similar”, and if it were not, arguably, a matter of survival for CommScope, because of the necessity to repair a heavily weakened monster of a supplier, it is hard to imagine that negotiations with Arris would have been otherwise initiated.
As always, fibeReality does not recommend any securities, and this writer does not invest in any companies being analyzed by us.
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[written by Mark Lutkowitz]