Arris-PACE: Consolidation, Set-top Box Domination and Tax Avoidance

Arris (USA) has agreed to acquire Pace (UK) for $2.1 billion. According to Arris the key benefits of the deal are to accelerate growth and to improve finances. The growth part is driven by the enhanced international presence and the large-scale entry in to the satellite TV market. The finance part is driven by accretive earnings and corporate taxes.

SP video is still a top five CxO top-of-mind but it’s number five; they still need a compelling video offering to complete a competitive bundle. The driving issue is access to content not number of channels. Ask 100 random people what’s the problem with TV and no one will say resolution. Sorry 4K TV manufacturers. IP video, like IP voice, is just packets, albeit a lot of packets. The impact of video delivery to all devices on all networks is much more interesting to ponder.

With the Arris-Pace deal we have the Number 1 and Number 2 global providers of set-top boxes (STB) combining. If this deal goes through the combined company will have almost 60 percent market share in Cable STBs and 44 percent of the IPTV market. The next vendor, Cisco, will have 10 percent and 15 percent of these markets, respectively. It appears Arris is intent of being the dominant provider of STBs globally.

Set-top boxes have been and continue to be a tough market to sell to. The service providers constantly demand price concessions while at the same time demanding new features. No surprise gross margins are challenging. Cisco realized this late after buying Scientific Atlanta and adopted a “high-end” STB only strategy. As I predicted two years ago this was doomed since high volume is required in this type of market. Simply put, there’s not much of a difference in semiconductor content of a low-end and a high-end STB. Those participating in the low-end, high-volume market thus have a substantial price advantage at the high-end lower volume market because they are receiving substantial volume pricing from all silicon vendors.

Beyond challenging margins, the STB market is facing technical and architectural disruptions. The traditional functionality of the STB is being repositioned between the residential gateway and the cloud, TV manufacturers want a piece of this too, and over-the-top services continue to exert pressure on the legacy linear TV functionality as well. Arris will receive some immediate near-term benefit of entry into the satellite market and will increase its international presence. The value in the long term is less clear as the set-top as we know it is in a state of flux.

On the finance side the deal is accretive: “an increase by natural growth or by gradual external addition: growth in size or extent.” According to the press release the new Arris will be based be “incorporated” in the UK but based in Suwanee GA, USA. Transactions of this ilk, where the acquirer reincorporates to the target country, are not new. You can’t fault U.S. companies from wanting to avoid excessive U.S. corporate taxes. The fundamental of micro economics encourage this.

So, I see marginal long-term strategic benefit in the set-top box area that’s outweighed by the broader portfolio synergies and financial tax gains.

 

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Greg Whelan
gwhelan@acgcc.com
acgcc.com

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
ddines@acgresearch.net
www.acgresearch.net