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CommScope/Arris Combo: Sway of MSOs

October, 2018

Assuming the report of negotiations in Reuters is true, and if CommScope decides to purchase Arris International, despite dealing with some difficulties, it would likely result in a highly diversified juggernaut in combining powerful positions on both the passive and active sides of the telecom infrastructure business. In particular, given that fibeReality is bullish on the long-term viability of the networking of the MSOs, the statuses of the suppliers in this space would become even more dominant in that sector with a marriage. Yet, we also think that it may be reasonable to conclude that the major cable operators have not been totally happy with Arris, its major hybrid fiber/coaxial system vendor. At least on optics-related gear, we agree with the characterization of it being kind of a weak sister to comparable access players in the overall telecom market. Arris became the leading force in the cable TV space (still over half of its business) through several acquisitions, leaving remaining players in that market segment, such as Cisco Systems, in the dust. However, in our opinion, the vendor does not excel at managing new technology, and we do not know whether it has had implications in the shift from analog to digital solutions in that sector. Maybe the biggest complaint of these customers has been that it has taken on too much of the mentality of Motorola, which has resulted in undesirable changes. While Arris arguably benefited from the purchase in terms of scale and product portfolio breadth, in absorbing a firm, 2½ times its size, there was an inevitability that it would bring on characteristics of Motorola in the process. So, it would be hardly a stretch to contemplate that these buyers have put some pressure on the company to which they originally enabled its existence, CommScope, to see if a deal with Arris can be worked out.

While CommScope has made it clear that M&A is an important part of its business strategy moving forward (from the CommScope Investor Day in June 2018, “will redouble our efforts to find attractive, strategic acquisitions”) there were a couple of qualifications given at that meeting, which would not make Arris a good fit. Given the current financial situation with the former, it was supposedly looking for opportunities with a valuation of under a billion dollars, as well as those that were not “transformational” in nature.

On the other hand, at that conference, CommScope’s management at least opened the door to the possibility “to broaden the aperture slightly and think about what are these adjacencies that makes sense as long as there's connective tissue back to the core,” “to think a bit differently about the markets that perhaps aren't directly in our wheelhouse” “and [to be] extremely successful around extracting cost synergies.” One of the greatest benefits from a possible collaboration between CommScope and Arris would be in offering a fuller package of solutions.

For example, at one point, Arris was in the enclosures business, but eventually it was divested. Of course, CommScope is a leading vendor in that space.

In fact, at the Raymond James Institutional Investors Conference in March, Arris pointed out the desire of the cable and DSL service providers to offer as much of an end-to-end solution as possible. It explained why the company continued to offer set-top boxes, despite the declining margins.

Nevertheless, although there are apt to be some cost synergies to be gained with a hypothetical CommScope-Arris merger, perhaps somewhat ironically in that it would otherwise be looking for a “highly skilled management team (quoted from the Conference Day),” the abilities gained by the former over the years in really concentrating on just making the acquired company itself more efficient may be the most critical. CommScope’s efforts at cost reduction, enabling greater margin generation, appear to be comprehensive and constant.

At least in the recent past, with the exception of the tariff situation in China, Arris’ approach of a hybrid supply chain for all of its products, with a blend of its own factories, including in Mexico and Brazil, as well as extensive relationships with ODMs/contract manufacturers, such as Foxconn and Asus, was evaluated only on a periodic basis. Arris has had category competitions every two to three years, in which there has been a bakeoff pitting the entire field against one another.

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]

 

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