Consolidation within the pay-TV industry appears imminent. Earlier this year, Comcast (CMCSA 12.90%) announced it agreed to acquire Time Warner Cable (NYSE: TWC). Recently, AT&T (T 1.54%) announced that it proposed to buy DIRECTV (DTV +0.00%).
While there are several reasons behind Comcast's and AT&T's decisions to buy out competitors, the question for ARRIS Group (ARRS +0.00%) investors is how will consolidation affect the equipment suppliers?
What ARRIS has to say about it
In ARRIS's most recent 10-Q, the company notes that consolidation within the industry poses a risk to the company's business:
When consolidations occur, it is possible that the acquirer will not continue using the same suppliers, thereby possibly resulting in an immediate or future elimination of sales opportunities for us or our competitors. Even if sales are not reduced, consolidation can also result in pressure from customers for lower prices, reflecting the increase in the total volume of products purchased or the elimination of a price differential between the acquiring customer and the company acquired.
Comcast, Time Warner Cable, and AT&T represent three of the top-five customers for ARRIS. Last quarter, Comcast accounted for 16.6% of sales, Time Warner accounted for 13%, and AT&T accounted for 11%. Any change in orders or pricing from one or more of those customers could have a significant impact on ARRIS's earnings.
What can investors expect from Comcast-Time Warner?
Shares of ARRIS spiked on the news that Comcast would buy out Time Warner. Comcast owns a 7.85% stake in ARRIS group, which means the interests of both companies are fairly aligned.
Comcast tapped ARRIS to help produce the cable operators X1 set top box, and also uses home gateways from the company to deliver video. Considering Comcast would take over operations, should the merger with Time Warner go through, ARRIS stands to gain from further opportunity to sell the premium XG1 system.
Moreover, both Comcast and Time Warner are following similar technology paths. Internet speeds are increasing at both companies, as both operators move to deliver IP-based video. They are both focused on user experience as a differentiator to competition from the likes of AT&T and other telecom companies, as well as DIRECTV and satellite providers.
ARRIS is well positioned to facilitate both companies while demanding higher ASPs for premium services and equipment. A Time Warner acquisition will only accelerate that trend considering Comcast's leading technology.
What about the AT&T-DirecTV merger?
Although AT&T is a big customer of ARRIS's, DIRECTV gets its most popular equipment, the Genie set-top box, from Pace. Considering the size of DIRECTV's subscriber base, ARRIS may not be able to capitalize on the deal in the same way as the Comcast-Time Warner merger.
DIRECTV ended the first quarter with 20,265,000 subscribers in the U.S. Including international subscribers, the company counts more than 38 million customers. Comparatively, AT&T ended last quarter with 11.3 million U-Verse subscribers, but only half subscribed to its television service.
It wouldn't make sense for AT&T to spend an enormous amount of money moving from DIRECTV's legacy technology to a new supplier in ARRIS. Moreover, AT&T uses the same supplier of DIRECTV's Genie for its low-end home gateway networking equipment.
ARRIS investors shouldn't be worried, though. As AT&T rolls out higher speeds, works to get the most out of its copper infrastructure, and introduces gigabit services, ARRIS is poised to win new sales. ARRIS already supplies the Motorola NVG510 gateway to U-Verse households that subscribe to Internet speeds above 6 Mbps.
AT&T is very good at upselling customers to higher speeds. Over 60% of U-Verse Internet subscribers have a plan delivering speeds above 6 Mpbs. As AT&T rolls out bundled services and more IP-based video features to DIRECTV it should be able to convert more customers to faster broadband connections. That's good for ARRIS.
In the end, the risk of a deal between AT&T and DIRECTV balances out with the upside.
ARRIS is looking good
ARRIS may state that consolidation poses a risk to its business, but the risk seems relatively small considering its position in the broadband and cable industry.
The potential merger of Comcast and Time Warner presents significant upside for ARRIS should the deal go through.
The AT&T-DIRECTV deal presents more risk, but the potential for AT&T to expand its broadband penetration presents some upside as well. Moreover, DIRECTV isn't tied to Pace. It's already moving away from the set-top maker with its next iteration of the Genie, and there's no reason ARRIS couldn't eventually win a design with an AT&T-owned DIRECTV considering its strong ties to the former.
