CommScope/Arris, in $7.4 Billion Deal, May Have Smooth Regulatory Sailing

Telecom equipment provider CommScope's purchase of consumer electronics company Arris for about $7.4 billion is expected to face smooth regulatory sailing. CommScope is getting a $1 billion minority ownership investment assist from the Carlyle Group, which used to own a stake, the equipment maker announced Thursday. CommScope CEO Eddie Edwards said the deal would position the two companies to take advantage of the rise of 5G and the IoT. Edwards will remain chief of the combined company (see the personals section).

Investors sold CommScope stock amid financial concerns. Standard & Poor's may cut its credit rating on the acquirer as it takes on debt in the deal. It will have "higher leverage than similarly rated peers and the risk that a macroeconomic downturn could preclude the company from reducing leverage below 5x [annual cash flow] in 2020,” S&P emailed investors. Another analyst said Arris isn't getting as much money as it might. The company's set-top box arm has had many corporate incarnations, including ownership by Google and Motorola, since it was named General Instruments in the 1990s.

CommScope and Arris executives were asked several times on a Thursday call about the deal’s debt load. Edwards and others insisted the company isn’t taking on too much. CommScope Chief Financial Officer Alexander Pease said the debt is manageable due to large amounts of cash the combination is expected to generate.

Those we asked saw little reason for concern that regulatory reviews will scotch the deal or lead to major conditions. The combining companies have “no overlaps that would increase any of the concentration issues,” said BTIG analyst Walter Piecyk, who follows the financials of both firms. “I don’t think there should be any regulatory issues with this deal. These are a complementary set of products that should not trigger any type of material regulatory review.”

The companies also told us they see little overlap between their operations. The “highly complementary companies” have “minimal, if any, overlap,” said a CommScope spokesperson: That’s “expected to help in the regulatory process.” Regulators in U.S., EU, Russia and South Africa must approve the deal, an Arris representative said. Though the companies are looking to relocate manufacturing operations from China due to tariff concerns, they don’t need approval from China for the combination, Edwards told analysts.

The combined company would have “approximately $11.3 billion in revenue,” it said. The deal is projected to close in the first half of 2019.

The purchase is designed to let the larger company take advantage of the coming of 5G and predicted growth of the IoT and connected homes, executives and analysts said. The prevalence of connected devices will create “a competitive battleground for wireless and wireline players” that the combination “will be best positioned to win,” Edwards said. CommScope has a history of being in the right place to take advantage of “the beginning stages of disruptive events,” such as the rise of the internet and increase of mobile devices, Edwards said. Fifth-generation is a similar shift, he said.

Executives noted there has been less growth in capital expenditures as carriers ready for the 5G rollout. That might take some time, an analyst said. Simon Leopold of Raymond James doubts capex "experiences a cycle in 2019 linked to 5G" and he and colleagues "expect improvement in 2020." The core CommScope "faces a challenging environment now," Leopold wrote investors. Following an "ugly" Q3 financial report and forecast, he upgraded his rating on the acquirer to outperform. The $31.75-per-share takeover price for Arris is "a bit of a bargain," but investors in that company might "rather take the money than endure a tough" first half, Leopold said.

CommScope closed down 20 percent at $19.56, while Arris rose 10 percent to $30.68.