Little Downside For A 4% Gain From ARRIS Acquisition

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About: ARRIS International plc (ARRS), Includes: COMM
by: Michael D. Harris
Summary

Carlyle-backed CommScope is set to acquire ARRIS for $31.75 per share.

That still leaves investors looking to get in on the acquisition a chance for a 4% profit when the deal goes through.

Even in the event the deal is retracted or shelved, investors would still benefit from owning ARRIS due to the secular growth in networking and connectivity that ARRIS will benefit from.

Read time is 5 minutes and 2 seconds.

Abstract

Investors still have an opportunity to realize a nearly 4% profit from the expected acquisition of ARRIS International (ARRS) by Carlyle-backed CommScope (COMM) for $31.75 per share. This opportunity comes with limited downside risk if the deal doesn't go through since the networking technologies and solutions company, ARRIS, will still see long-term growth thanks to the global secular growth in demand for connected devices and technologies as the world continues to exponentially increase internet bandwidth usage and the mirrored growth in devices connected to that internet.

The Acquisition

On November 8th, 2018, Carlyle-backed CommScope Holding Company, Inc. (COMM) announced an intention of acquiring ARRIS International (ARRS) for $31.75 per share. That acquisition price represents nearly a 4% premium on the closing trading price on Friday, January 4th, 2019, and at the time of the announcement, represented a 27% premium on the closing trading price on November 6th, 2018 – the acquisition wasn’t announced formally until November 8th, but the irregular volume and the straight upward move in price action over the next two days suggests it was clear to some parties prior to the 8th.

The price hasn’t closed in fully on the offered acquisition price likely because of some perceived skepticism of the deal, or else it would be trading at the offered price. However, this deal doesn’t pose any anti-trust issues as some of the deals in 2018 did meaning that it is likely to pass that legal hurdle without contest. Additionally, the Board of Directors for ARRIS unanimously agreed to allow the acquisition and has urged investors to do the same.

On the surface, the only issue seems to be from some investors filing investigative claims against the Board on the grounds that they are not holding up their fiduciary duty and are allowing CommScope to underpay for the acquisition. The investigation is being led by the Law Office of Brodsky & Smith, LLC. From a shareholder notice on Yahoo Finance from ACCESSWIRE:

[S]hares of ARRIS have traded at $34.17 and an analyst has set a $39.00 per share price target for the stock. As a result, the transaction would result in a loss for many long-term holders of ARRIS stock."

I immediately had an issue with that statement (which in all fairness is likely from the law office and not ACCESSWIRE) due to the fact that just because a company has traded at a price in the past doesn’t mean that price is reflective of the current value of the company. Also, for the analyst price target issue, I haven’t been able to find that specific price target and one price target doesn’t really mean anything. The Yahoo Finance average one-year analyst price target for the stock is $30.39, which is almost a full percentage point discount to the current price, and a 4.3% discount to the offered price.

In the past, after the announcement of acquisitions, there is almost always some shareholder(s) unhappy with the deal and they more often than not file some sort of investigation into the deal. Of course, as you can see from the lack of M&A scandal on the front pages of the financial news, most of these claims go nowhere and the deal goes off without a hitch.

For me, the largest risk to the acquisition is the possibility of one of the parties trying to walk away. However, the lopsided acquisition terms stipulate a $52 million penalty for ARRIS if they walk away, so leaving the table would do more harm than good to ARRIS even if the price of $31.75 per share is slightly less than they’d like. Truthfully, the only party I’m worried about walking away is CommScope, which is the acquiring party of the transaction. If for some reason the economic situation turns bleak, then CommScope could walk away or at least shelf the deal for now since the contract only penalizes them $250 for leaving.

Because of this highly unlikely, but still present risk, I had to look into the possible downside of the deal being put off that the investors that bought in hopes in arbitraging the current price and the acquisition price would have to face. Looking at the company from a bottom-up perspective I think the company, and the entire industry, are set to benefit from the immense secular growth trend in networking and the increase in connected data points and devices.

It's All Connected

ARRIS international is an entertainment and networking technology and solutions company. They provide technology and infrastructure to a broad range of clients from retail consumers looking for basic home wi-fi, to enterprise clients looking to improve and update their networking architecture in data centers.

This is important because it is expected that by 2021 the world's internet traffic will be over 3,000 exabytes of data. To show you what an exabyte is, imagine a simple one-gigabyte thumb drive. Now, imagine that you have one trillion of those thumb drives, and that’s an exabyte. Or, to put it in a better way, one single exabyte is equal to the total storage capacity of 15,625,000 base model iPhone XS’. Now multiply that by 3,000 and you can see that the total estimated internet traffic by 2021 will be larger than 46.9 trillion iPhones (which is roughly 6 iPhones for every person on Earth).

(Source: Screenshot from The Daily Conversation video on YouTube titled, "The Future of Internet Infrastructure")

I obviously beat that point into the ground but it’s important that you understand the scale of the bandwidth being used by humans. Not only are we exponentially growing the amount of bandwidth we’re using but we’re also exponentially growing the number of devices that are being connected to the internet, and the cloud. Everything from cars, appliances, and even baby clothing are being connected to the internet. Billions of tiny data points that consumers expect to be connected at all times. That means the need for retail and enterprise network solutions are going to continue to break all-time records as the world connects itself in every imaginable – and even unimaginable – way.

(Source: Screenshot from The Daily Conversation video on YouTube titled, "The Future of Internet Infrastructure")

This growth isn’t just from novelty uses and entertainment streaming purposes. This is the new way of life. From a whole-home security system keeping your loved ones safe, to robotic workers in a manufacturing facility, to entire cities being connected to ensure that energy, transportation, healthcare, and everything else are seamlessly integrated and efficient. This isn’t some boom-bust cyclical trend. To not understate the importance of this shift in demand: this is truly the next evolution in human society.

ARRIS is a BUY

ARRIS is positioned perfectly to benefit from this long-term growth. As I said, they work with clients big and small from selling modem-routers for simple home wi-fi to sophisticated video equipment used to stream the next best Netflix show. They even service the data center industry which is the backbone of the new revolution in society and the place where the auspicious “cloud” lives.

Because of this holistic approach by ARRIS to service everyone from family homes, to enterprises, to even the infrastructure that connects the two is why investors, even ones buying now shouldn’t worry about the risk of the deal not falling through. The way I see it is investors buying now will either A) realize a quick 4% profit when the deal closes or B) will be able to see long-term gains from a comprehensive networking player that will benefit from the huge wave of connectivity that is already beginning.

Disclosure: I am/we are long ARRS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.