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. 

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[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.

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David Dines
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Cisco Leads in SP Video Infrastructure Hardware and Software Markets

Cisco continues to hold its commanding leadership position in the SPVI market (ACG Research’s Service Provider Video Infrastructure 4Q 2102 Worldwide Market report). Not surprisingly, Cisco has held a leadership position for many quarters based on it strengths in CMTS and packet infrastructure. It is notable that Cisco has been solidifying its position in STBs by taking share from Motorola in IPTV STBs and developing cable STBs (second place in market share).

In aggregate, the SP Video infrastructure market shrunk 2 percent to $13B in 2012. CMTS revenues dropped in the high single digits in 2012 though it remains a $1+ billion industry. CMTS build out is starting to level off as MSOs are completing their DOCSIS 3.0 build out and as port densities are doubling and reducing ASP. Cable STBs have been essentially flat, based on declining video subscribers; however, a mix of HD and DTAs has helped buoy the market. IPTV STBs were also down, driven by price pressures and demand for low-end devices in emerging markets.  Packet Core and BRAS saw double-digit declines in annual revenues; Carrier Ethernet gained modestly.

ACG also published its Video Infrastructure Software and Services Market 4Q 2102 report, which tracks conditional access systems (CAS), digital rights management (DRM), middleware, subscriber software and infrastructure software (head end, workflow, advertising). In the aggregate, Cisco leads this market, based on its strength in CAS. 

When combined, the hardware and software markets are approximately $16 billion in annual revenue. While we have seen a flattening of growth, this sector remains very strategic to SPs. The market is undergoing a transition as SPs deal with 1) competition from over-the-top video competition, 2) how to deliver video to multiple smart devices within the home, and 3) upgrading infrastructure to handle increasing bandwidth demand of consumers.

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David Dines
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www.acgresearch.net

Arris' Aqcuisition of Motorola Home Division: Verdict, Please

Arris recently purchased Motorola Home Division. The jury is still out as to whether or not it is a wise purchase.

It was not surprising to see that Google sold the Motorola Home Division. It was clear from the outset that it was a bad fit for Google. As you may recall in previous blogs, I had suggested that Google had no expertise in running a hardware business (http://acgresearch.blogspot.com/2012/10/google-motorola-can-this-marriage-be.html), and it probably had little interest in legacy-type technology.  Although official statements to the contrary, the latest announcement and reports in the press essentially confirm my initial assessment.

On balance, I am positive about this deal. The pros: 

• Strategically, this acquisition makes sense for Arris because it greatly diversifies its product portfolio and solidifies its presence in Tier 1 MSOs in the Americas.
• There is some product overlap, (for example, CMTS and QAMs), but it is not that significant, especially given that the majority of Motorola’s revenues are derived from STBs.
• Arris has technical expertise and credibility within the industry and has experience with the design, manufacturing and selling of cable hardware.
• Arris diversifies its customer base substantially and reduces its reliance on Comcast and TWC, which are about 50 percent of total revenues.
• Arris’ management has a good track record and has delivered consistent growth over the last few years.
• The combined company is sufficiently large to compete effectively with Cisco

The concerns to watch are: 

• Execution risk: Can Arris effectively swallow a company twice its size? Will it be able to integrate the two companies fast enough to minimize loss of momentum? Will the cultures assimilate?
• Market risk: Will the combine product strategy/portfolio/roadmap meet the market transitions? Will the economic uncertainty continue to put downward pressure on SPs’ CapEx? 
• Financial Risk: Will Arris be able to increase Motorola’s historically low margins? Was the price too high?

Personally, I was glad to see Motorola end up in competent hands (the other bidder, Pace, is also a competent player in the space and would have been a good match as well). It was hard to watch the division suffer under the lack of attention, strategic vision and direction provided by Google. While we see this as a positive development, we will not know how it turns out for several years.

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David Dines
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Google-Motorola: Can This Marriage Be Saved?

Stock plunge, premature earnings release, Motorola's losses, what more could go wrong for Google?

To say that yesterday was not a good day for Google would be a gross understatement. RR Donnelly, its financial printer, released Google’s Q3 results in the middle of the day (East Standard Time), rather than after the markets closed. In addition to the embarrassing snafu, Google’s profits were well below expectations. Since Wall St. hates surprises, the double whammy caused the company’s stock price to decline 8% on 6 times the normal volume. 

Much of the media attention is focused on the weakness in advertising revenue. Total activity is up, but the cost per click is declining, in part driven by the move to mobile, which commands a lower price and potential competition from Facebook. Only a few analysts and reporters focused on the more than half a billion dollar GAAP loss from Motorola this quarter. 

I have been consistently (since its announcement) saying that the Google-Motorola wedding was not a match made in heaven (read the original blog here). My analysis focused on how Google’s poor track record with hardware, its potential conflict with its customers and how the cultures did not fit. (Yes, I may be wrong in the long term if Google can successfully expand its Kansas City gigabit fiber experiment nationwide and have a captive market for its CPE, but that is a big if). 

The company’s results to date have been validating my position. The Home segment was down over 3% Y-Y, which will likely reinforce its market share losses. Interestingly, my comments about the Home segment were more pronounced for the mobile segment, which was down 27% Y-Y this quarter. Since I do not focus on mobile handsets directly, I did not write much about the mobile segment. In hindsight, this is not a surprising outcome given how competitive the handset space is and how aggressive Samsung has been in its battle with Apple. 

Year-to-Year Change	3Q11	4Q11	1Q12	2Q12	3Q12
Home	-9.5%	-10.3%	-2.2%	-8.4%	-3.4%
Mobile	19.7%	4.7%	3.1%	-24.7%	-27.0%

Google is facing serious issues in its main business and the distractions of a half a billion loss from Motorola, weakness in the handset business, and the slow decline in the home segment are not helping it financially or strategically. Maybe it is time for a divorce? 

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David Dines
ddines@acgresearch.net
www.acgresearch.net

Developing Economies Driving Broadband Market

The Broadband CPE and Infrastructure market was nearly 2.4B in Q2 2012, .4% increase sequentially and 6% Y-Y. The infrastructure market was nearly $1.4M (down 13% Y-Y) and the CPE market was approximately $1B (up 7% y-Y).

The BB market is driven significantly by the number of broadband lines: more than 16M new broadband lines were added in Q1 2012 for a total of 612 M lines worldwide. This growth is driven by the developing economies in Latin America, Eastern Europe, and South/East Asia. DSL continues to be the majority of the market, followed by Cable, FTTx (fiber to the node with copper to the premise) and FTTH, although fiber is growing faster.

The market is in the midst of several technology transitions. The growth of fiber to the node or to the premise is changing the landscape. The biggest issue is the return on investment/payback time on the investment. Most of the FTTH growth is occurring in markets where governments are subsidizing fiber. VDSL and vectoring are growing as companies are starting their first commercial deployments.

In CPE, the trend toward commoditization and high volumes is favoring consumer electronics manufacturers over companies that traditionally sold through service providers players, such as Motorola, Alcatel-Lucent and Technicolor (Cisco’s purchase of Linksys places it in both camps). The Infrastructure segment (CMTS, QAMs, DSLAMs, video processing equipment and video on-demand servers) was down 13% Y-Y. The annual decline was across all segments, although DSLAMs, QAMs and servers suffered the largest declines.

For more information about ACG Research's Broadband CPE contact sales@acgresearch.net.

David Dines
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Motorola Mobility Licenses Comcast’s RDK

Motorola Mobility just announced that it is licensing the Reference Design Kit (RDK) from Comcast to enhance the development of applications for set top boxes (STBs) and other consumer devices, such as tablets, smart TVs, and game consoles.

The two major reasons given by Motorola: 1) to support Comcast’s key technical initiatives and 2) to provide a tool for Motorola to drive the shift to an all IP infrastructure. Since RDK is a middleware layer, Motorola will also reap the benefit of reducing development time and support effort by eliminating the need to write code for each individual device (device layer abstraction).

My first reaction was that this is a smart move at multiple levels. There are the obvious reasons: partnering with Comcast at a deep level, increasing efficiency/speed of the development team and the ability to support new architectures and devices with minimal effort. Furthermore, on a deeper level, this move signals a potential shift in attitude and suggests receptiveness to more open approaches. That being said, Motorola made it clear they see RDK as an expansion to their portfolio and is committed to having broad platform software solutions.

Given the uncertainty surrounding Home Division since the Google acquisition announcement, it is good to see that the company is moving ahead.

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David Dines
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Google Acquiring Motorola: Mash-up or Crash-up?

(Note: This post was originally posted in August 2011.) The big news rocking the wireless, handset, tablet market is Google’s bold bid for Motorola Mobility Inc. This is excellent news for Motorola Mobility’s (MMI) investors and MMI’s shareholders who were faced with the prospects of a long slog of an unprofitable business in an unrelenting competitive environment. However, the long-term prospects for Motorola as a Google company look pretty dim.

It’s about patents

The primary driver of this acquisition is the patent portfolio. It seems that much of the fight over mobile is going to be over patents, and Google needs to shore up this weakness. Google is moving to a vertically integrated business model, which would enable it to increase margins and revenues in the mobile business. Google can now make money on the hardware, the Android ecosystem. Additionally, in-house hardware expertise should result in faster development and more robust software. If it succeeds in taking Apple’s basic business and adding a degree of openness, Google could become the master of the mobile universe, which would enable it to charge premium pricing.

The acquisition will succeed in giving Google a solid patent portfolio for waging both offensive and defensive IP legal battles. However, given the amount of money paid, Google needs to get more than just a patent portfolio. Google also acquired a mobile device manufacturer and a cable TV equipment company (the Home division sells set-top boxes, cable modems, CMTS, optics, QAM and other network gear).

Clipping Android’s wings

As a mobility play, this acquisition makes as much sense as Microsoft buying Dell. There is a very high risk of alienating the other vendors, because the temptation to play favorites will be too great. Even if there is no actual favoritism, the appearance of preferential treatment will be enough to create issues. Google just gave all the Android ecosystem partners a compelling reason to execute plan B and start evaluating overtures from Microsoft. Do not expect to see any company shift strategies in the short term, but the long-term growth trajectory of Android just got clipped.

The mobile handset market is a low-margin business with tremendous risk, especially if a product does not sell as expected and heavy discounting is required to move inventory. MMI’s gross margin in Q2 was less than 26 percent and that includes the approximately one-third of its business from the Home division, which has much higher margin products and for which they pay nothing for Android licensing.

Google also has not been very successful in consumer hardware: the Google Nexus One failed, the Nexus S seems to be lost in a crowded field and Google TV is on the ropes (currently returns are exceeding sales of the Logitech Revue, see WSJ article). With this track record, it will be interesting to see how well Google competes in this market.

Clash, bottlenecks, delays

From a culture and operations perspective we would expect major assimilation issues and major delays in key decision-making. Cultures and bureaucracies will certainly clash, which will contribute to bottlenecks and delays in product development and delivery. It will be interesting to see new hardware designs from the combined companies, as designers try to please two masters.

This acquisition puts more pressure on MMI’s Home division; it is a great opportunity for competitors to take more business from Moto and accelerate its share decline. The Home business seems to get less attention from Moto management than its sexier sibling, and the uncertainty and distraction from the acquisition will exacerbate this situation. The Google name may be great with consumers, but not with service providers. Service providers already distrust Google because of its stance on net neutrality and its 1G FttH project. Furthermore, Google is trying to muscle in on their main source of revenue with OTT (and have a direct relationship with the customer, excluding the SP). If Google can get over these hurdles, it has to sell its vision and fight the perception of putting out half-baked software and putting little effort into customer support.

Regarding business models, there are dangers in trying to chase Apple at a game that it has spent decades perfecting. While imitation is a sincere form of flattery, it is a bad business strategy for most companies. Bottom line, other than getting a decent patent portfolio, this deal is not going to be worthwhile for Google.

David Dines
ddines@acgresearch.net
www.acgresearch.net

Motorola Continues to Slide

I have been watching Motorola’s Home (including STBs) business over the last year or so and been noticing that it has been steadily losing market share across the board. It just seemed to be suffering from malaise and not able to put together compelling story to stem the slide. When Google acquisition was announced, my first reaction was that the uncertainty internally and externally would hurt sales, in the short term for the very least and possibly long term.

Not surprisingly, this has happened. This afternoon they issued a press release announcing an earnings miss. In this PR, they mentioned that the Home business unit will take in $900M in revenue for Q4 2011. While this is up sequentially from $825M in Q3, it is down 10% from the same quarter last year. Q4 is traditionally an up quarter Motorola and most vendors due to end of year budget spending, so a 10% decline is pretty hefty. When we run the market size and share numbers next month, I expect to see market share further erode and would not be surprised if Motorola is knocked out of first place in cable STBs, their strongest market segment. Stay tuned.

David Dines
ddines@acgresearch.net
www.acgresearch.net

Video Infrastructure Market Grows 11% in 2010

The Service Provider Video Infrastructure (SPVI) market grew 8% sequentially in Q4 2010 and grew 6% y-y. Much of the increase in Q4 was the service providers’ “budget flush,” while year-over-year growth was more modest.

STB boxes, overall, were up 7%, though down nearly 2% from last year. Cable set top box (STB) revenues were up 4%, though Q4 was down 4% from Q4 2009. IPTV STBs were up 16% sequentially and 1% y-y. Growth in the Video Packet Infrastructure segment was fueled mostly by the continued deployment of Carrier Ethernet as a replacement for BRAS. CMTS revenues grew approximately 3% sequentially and were flat y-y.

Even though Cisco lost 2.6 points in share, the company remains the leading vendor in the overall SPVI market with 37% share — a result of its dominant (60%) share in Video Packet Infrastructure and second place in STBs. Motorola holds the two spot with a majority share (35%) of STBs, which it grew 3.7 points in Q4.

In Cable STBs Motorola gained over 6 points share in Q4 to widen its lead to nearly 40%. In IPTV STBs, Cisco with approximately a quarter of the market gained 6 points to squeak by Motorola for first place share. In CMTS, Cisco gained over 14 points share from 2009 and now has captured over 60% of the market.

The market is transitioning towards more HD, more broadband options, IP video, multiscreen viewing and Internet/OTT video delivery of content. These factors are game changers for service providers and equipment vendors and will undoubtedly change not only the vendor landscape but force business model changes with the service providers.

For information about ACG Research's video infrastructure syndicated service, contact Karen Grenier at kgrenier@acgresearch.net. To purchase the report go to http://acgresearch.net/store/product.php?id_product=103.

David Dines
ddines@acgresearch.net
www.acgresearch.net