Arris (NASDAQ:ARRS) provides cable operators with communication systems that make it possible for users to consume bandwidth. When customers demand faster internet speeds and more bandwidth to watch movies or upload pictures, the internet providers have to upgrade their infrastructure. This is where ARRS comes in, because it provides the hardware and software needed for expanding network capacity.
We initially invested in Arris in November 2010, and we more than doubled our investment in 2013 after they acquired Motorola Home from Google. This acquisition transformed ARRS into one of the market leaders in all aspects of the cable infrastructure market, with No. 1 market share in cable modem termination systems, No. 1 in cable modem shipments, and a close No. 2 to Cisco in set-top boxes. We thought ARRS got a good deal by buying from a motivated seller, and we had great confidence in the management team’s ability to integrate this very large acquisition. This thesis largely played out, and the stock price tripled from November 2010 to March 2014.
We started buying again at a time when four of the company’s five largest customers—Time Warner, Comcast, Charter and AT&T—were involved in M&A talks. The uncertainty over consolidation forced those companies to rein in big spending, slowing orders at ARRS. We consider this a short-term issue because the level of competition is stronger than ever, between both the traditional players and newcomers such as Amazon and Netflix. In addition, Arris’s products help these companies differentiate themselves, and there is a major replacement cycle around the corner. We believe the future is bright for Arris.
Arris sells a great number of products to a global customer base of corporate giants, and we believe there is tremendous growth ahead for Arris in the foreseeable future. Arris’s largest customers are running out of network capacity, so their CapEx plans should remain elevated.
In April 2015, Arris announced another big acquisition—Pace plc. In our opinion, the deal is very attractive financially because there are large synergy opportunities. Moreover, this purchase cements the company’s size advantage over competitors and further diversifies its client base. At the time of the announcement, the company said it expected 45 to 55 cents of non-GAAP6 accretion in the first year. It has already increased that forecast to 65 to 75 cents.
Once the synergies start kicking in, the company could generate as much as $700 million to $800 million of owner earnings. Arris is trading at about 6x owner earnings to pro-forma enterprise value.
From FPA Capital Fund (Trades, Portfolio)'s first quarter 2016 commentary.
