What's happening
Shares of Viavi Solutions Inc (VIAV -0.25%) are up 15.5% at 12:30 p.m. EST on Feb. 2, following two announcements after the market close on Feb. 1. First, the company reported its second-quarter earnings results, with its adjusted earnings of $0.09 per share coming in ahead of the $0.07 per share analysts who cover the company were expecting. On a GAAP basis, Viavi reported a loss of $0.02 per share.
Viavi also announced that it was acquiring Cobham plc's test and measurement business unit for $455 million. This is a potentially significant addition to the company, with its $200 million in annual revenue worth more than 25% of Viavi's trailing 12-month sales.
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So what
The Cobham acquisition could be a big deal for Viavi, since it strengthens an important part of its business while also expanding its reach. From the announcement:
The transaction significantly strengthens Viavi's competitive position in 5G deployment and diversifies the company into military, public safety and avionics test markets. Cobham AvComm and Wireless T&M is the leader in comprehensively testing communication service providers' networks from the radio access network through to the network core. It has also served military, public safety and aviation markets for decades with its trusted land-mobile radio and avionics test solutions. The business generated more than $200 million of revenues in calendar year 2017.
The company also said it expects the addition to be "meaningfully accretive to free cash flow and non-GAAP earnings per share" as soon as it closes. At quarter-end, Viavi had $1.22 billion in cash and $802 million in long-term debt, giving it a decent cushion to fund this transaction without significantly weakening its balance sheet.
Now what
Viavi is making a big bet on 5G, which is probably a smart move. The big question interested investors must ask at this stage is how much this acquisition will pay off with profitable growth. Management expects it to be immediately accretive to cash flow and earnings, but there will likely be some growing pains as the company works to integrate this new, fairly substantial operation with its existing enterprise.
Trading for around 25 times 2018 adjusted earnings estimates prior to this acquisition, Viavi hasn't exactly been a cheap stock. The big question is, how much of an earnings boost can investors reasonably expect? If it's a linear gain -- i.e. it will grow earnings the same 25% it will increase revenue -- then the current price is around 20 times forward adjusted earnings, still not exactly cheap for a company whose core business has been declining the past couple of years.
Put it all together, and I think investors would do well to give the company a little more time to explain its expectations and integration plans, and then wait a couple of quarters after the acquisition closes to see how it's working out before buying. There's potential here, but also a lot of uncertainty that creates risk at the current share price and valuation.
