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Thursday, August 8, 2013

Arris: First Earnings Post Positive since Motorola Home Division Acquisition

In the interest of full disclosure here are my biases: When Google first announced its acquisition of Motorola Mobility, from a strategic standpoint I was mostly negative. Other than the patents, I did not see much value or a fit with culture, expertise or products. I also assume that Home Division customers were probably uncomfortable making long-term architectural commitments to Google. If the acquisition was just about patents, then Google paid a premium. During the short tenure, there was little hard information, but anecdotally, it seemed that my assessment was correct and that Motorola Home was losing momentum. When Google announced that it was selling the Moto Home division to Arris, I was mostly bullish. There was a much better fit with Arris’ culture, management expertise, and products. This purchase gave Arris a more diverse customer base.  

As with any large acquisition, assessing the long-term success is tricky especially with a dearth of information. Now, with Arris’ first earnings post acquisition, we have some more insights. Revenues grew a huge (and expected) 186 percent, roundly beating earnings expectations. Arris is moving quickly to integrate Moto, and the company is already starting to see cost savings with supply chain efficiencies. On the product side Arris is seeing significant shipments of the E6000 (mostly to Comcast), with deployments and trials in multiple geographies. The company can boast wins in infrastructure and CPE, for example, Comcast XG1 hybrid QAM IP gateway.

The negative news came primarily from Moto, which lost momentum because of Google ownership[1]. Gross margins were down to 23 percent from nearly 34 percent last year, and the traditional STB business is down 8 to 10 percent from last year. I am most concerned about the gross margin. A back of the envelope calculation reveals that Moto’s gross margins[2] are 17 percent (see the delta column in Table 1).  

The challenges of integrating the two companies, rationalizing products, processes and organizations are more straightforward because the levers of change are mostly under the company’s control, which allows it to find the duplication/inefficiencies, make tough choices and address damage control. Boosting gross margin is a greater challenge, because it takes longer and is more nuanced. External factors, such as technological change, competitive pressures, customers’ needs, and internal factors, such as product design/life cycles, and manufacturing processes, limit degrees of freedom in moving the needle.

While I am still mostly bullish on the Arris/Moto combination, there are significant challenges ahead for its management team. Increasing Moto’s gross margins is one I would put at the top of the list. 

[1] From Robert J. Stanzione in the earnings call on August 7, 2013: “As I mentioned during our call, after the close of the Motorola Home transaction, there was a loss of momentum caused by disruptions and distractions within Motorola, as well as a parent customer reluctance to fully engage our new product initiatives, given some of the uncertainties surrounding the business.
[2] This is not the exact number as it includes some organic growth and excludes the $66M revenue/$6M margins, pre-acquisition results but is a good approximation for analysis purposes.

David Dines

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