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Google's (GOOG) $12.5B purchase of Motorola has been covered extensively by the media for the past year, however, one less well-known aspect of the deal was Google's $2.35B sale of Motorola Home--a division of Motorola that makes network infrastructure for cable companies and home devices such as set-top boxes, among other things--to Arris (ARRS), another cable equipment company.

Arris paid for the acquisition with $2.2B cash and 10.6M shares of its common stock, which gave Google an ~8% stake in the company. This suggested to me that Google was not necessarily unloading the company due to poor business prospects, but simply because Motorola Home was unrelated to Google's core business and not part of the reason Google decided to acquire Motorola.

Since 2001, Google has acquired 127 companies and before the Motorola Home deal had only divested three: Frommers, SketchUp, and Google Radio Automation.

There were several other aspects of the acquisition that piqued my interest when I started following Arris in June:

  • Before the acquisition Arris had only 2,100 employees while Motorola Home had over 5,000
  • Arris's 2012 revenues were $1.3B while Motorola Home had revenues of $3.4B
  • Arris's Q2 report on August 7th, 2013 would be the first report to include the combined financial figures for both companies
  • Arris's stock price had not moved substantially from $15 since the deal was announced in December 2012

To finance the acquisition, Arris took on two loans: A $1.1B loan at LIBOR + 2.25%, and a $0.8B loan at LIBOR + 2.75%. Together, these loans will generate about $60M of interest per year, which seemed quite manageable given Arris's combined pro forma annual revenue estimate of $4.8B to $5.1B.

While researching the acquisition, I discovered on page 58 of Arris's 2013 Q1 10-Q that Motorola Home had $2.5B of total assets. This meant that Arris actually paid less for Motorola Home than it had received (assuming Arris didn't inherit any large liabilities). This also allowed me to calculate what Arris's new price per share would be if its price-to-book value were to remain constant after the acquisition, using the following formula:

(share price)(number of shares)/equity = price-to-book value

Before the acquisition, Arris had $1.47B of assets and $0.514B of liabilities. After the acquisition, Arris would have an equity of $1.556B, with 137M shares outstanding. Since Arris's PBV was 1.81 before the acquisition, I used these numbers to solve for the share price, and found that the new share price should be around $20.60, meaning that if Arris's market value were to remain constant compared to its book value, its share price would have to increase 37%. It seemed to me that there was a nice upside and limited potential downside for buying Arris and waiting a few weeks to see how everything played out.

As it turned out, the stock went up ~10% between August 6th and August 12th. At Arris's earnings conference call, however, Arris's management disclosed that their set-box top sales had declined 8-10% over the past year. In addition, Arris's combined revenues were $800M short of their lower estimated pro forma revenues (PDF) for 2012, so at that point I sold. In fact, it looks like my estimates were also not quite right, because Arris's current PBV is around 1.79. This illustrates the importance of having a good safety margin. However, things still worked out pretty well.

The reason I wrote this article, other than to brag about my trades, is to bring attention to the fact that similar analyses might be successfully applied to other acquisitions as well. For instance, another recent example would be of Standard Register's (SR) acquisition of the private company WorkFlowOne on August 1st. WorkFlowOne was a major competitor of Standard Register, and the two companies shared many of the same customers. However, on the day Standard Register announced the acquisition, its stock shot up 350%. Standard Register made ~$600M in revenue last year, and acquired WorkFlowOne for $218M. Standard Register hopes to achieve sales of $1B when the integration is complete--however, does that justify a tripling of the share price?

Source: A Post-Acquisition Analysis Of Arris And Motorola Home