ARRS

[David Randolph]

Friday's close was the highest since 2000. My Thursday update says it all:

Well, ARRS had revenues of $891.6 M and net income of $142.3 M.

Tandberg TV had revenues of $350.3 M and net income of $55.6 M (as you can check here: http://www.tandbergtv.com/NewsView.ink?Newsid=1138)

So, the combined company had 2006 revenues of $1.242 B and net income of $197.9 M.

The current market cap, including 14.5 million newly issued shares to buy Tandberg TV, is 122.32 million*$15.26 = $1.867 B. So, the trailing earnings multiple of the combined company is $1.867 B/$197.9 M = 9.43.

Cheap my all means. ARRS should at least double from current levels.

I'll continue holding ARRS.

[webby67]

David, I assume you are aware by now of this piece of negative news for Arris:

"Ericsson bids $1.4 billion cash for Tandberg
Trumps Arris Group's January offer; interest in Net-based TV grows

Last Update: 9:19 AM ET Feb 26, 2007

LONDON (MarketWatch) -- Ericsson AB, the world's largest maker of wireless network gear, on Monday offered 9.8 billion Swedish krona ($1.4 billion) in cash for Norway's Tandberg Television, topping Arris Group's earlier bid.
The Swedish company, eager to position itself for the convergence of telecommunications and television, is hoping an acquisition of Tandberg will help it capitalize on increased demand and investment in TV delivered over the Internet. A large part of the traffic growth generated in the world's mobile and fixed networks is expected to be generated by TV services in the years to come.

Ericsson, which already owns an 11.7% stake in Tandberg, is bidding 106 Norwegian kroner for each Tandberg share.

Suwanee, Ga.-based Arris (ARRS) on Jan. 15 offered 96 kroner a share. Tandberg, whose directors previously approved the Arris bid, said its board will review the new offer and later issue a recommendation.
Traded in Oslo, Tandberg's shares rose 11% in afternoon trading.
Ericsson's shares rose 0.6% in Stockholm.

At stake for the rival suitors is about a quarter of the global market for video processing. Tandberg had net income of $12.1 million in the fourth quarter on sales of $85.3 million.

Tandberg has seen rising demand for its products and services as telecom operators such as the Netherlands' Royal KPN (KPN) have started to invest in broadcasting equipment, and as digital technology has displaced analog networks.

J.P. Morgan analysts said they that while they like the strategic rationale behind Ericsson's offer, they see risk of a counterbid. Echoing this, Dresdner Kleinwort told clients that Arris or Motorola Inc. could come back with a higher offer.

[David Randolph]

Thanks for posting the news webby67, my news service didn't have that news, but I saw the stock down a lot over the pre-market so I checked other websites and saw that Erickson $1.4 B offer for Tandberg.

ARRS was very attractive on its own and it will receive compensation for this, so I see the current 11% fall as a buying opportunity.

I'll write a deeper analysis on the subject over the next update.

[David Randolph]

The news out yesterday was:

• Ericsson trumps Arris' bid for Tandberg with $1.4 bln offer
at MarketWatch (Mon 4:28am)

This offer is $200 M more than ARRS's, and it is an all cash offer, whereas the ARRS offer had a component of shares.

I believe ARRS should walk away from Tandberg and let Ericsson have it. This fight is way out of its league. However, yesterday the market priced in the risk of an Arris counter-offer, because the company said the following:

• Arris 'evaluating' Ericsson offer for Tandberg Television
at MarketWatch (Mon 1:05pm)

I think ARRS will settle this and get its $18 M as a termination fee:



Without Tandberg ARRS is a $1.5 B market cap company with $142 M in net income in 2006, that is, a trailing earnings multiple of 10.56. The balance sheet was and will continue to be extremely strong.

I love ARRS without Tandberg. I just hope they don't enter a bidding war with ERIC.

I'll continue holding ARRS.

[David Randolph]

ARRS had the most horrible two days sell off. Still, I'm losing just 1.66% on the stock. I believe a worldwide recession will curb demand for its products. It was good that Erickson made that counter bid for Tandberg.

I'll sell ARRS today.

[David Randolph]

Since I sold ARRS a lot has changed. I'm no longer expecting a worldwide recession, far from it, as you can read on my latest update to the "Correction or Bear Market?" thread: Re: Correction or Bear Market? (latest update)

Back then investors were worried that ARRS could enter a bidding war with Ericsson for Tandberg TV, but that didn't happen:

• ARRIS Will Not Extend or Increase Offer for Tandberg Television
PR Newswire (Thu, Mar 8 )

Instead it's using its enormous pile of cash ($548 M) to expand organically:

• ARRIS Announces Opening of Major Research & Development Center in Shenzhen, China
PR Newswire (Mon, Mar 19)

ARRS grew revenues at a 31% pace in 2006 from 2005. Excluding special items, net profit margin in 2006 was 12.3%. If these numbers continue for the next 10 years, in 2017 ARRS will have revenues of $13.26 B and net income of $1.63 B. Apply an average 16 times earnings and get a $26 B market cap.

That means an average annual share price increase of:

$1.46 B*(X^10) = $26 B <=> X = 33.4%

The trading plan is:

Buy ARRS, 6.66% of capital as always.

[David Randolph]

ARRS didn't react well to the 50 days SMA resistance level, but that's just a technical short term problem. Longer term fundamentals reign supreme, and I see the stock as an undervalued growth play.

We have a lot to cover as the news keeps rolling in, but let's start by closing the issue of the Tandberg TV acquisition:

• ARRIS Will Not Extend or Increase Offer for Tandberg Television
PR Newswire (Thu, Mar

They ended up making about $20 M from the termination of the deal. Now they'll pursuit organic growth and look for other strategic acquisitions, as they couldn't possibly compete with Ericsson for Tandberg TV.

The following looks like a nice move:

• ARRIS Announces Opening of Major Research & Development Center in Shenzhen, China
PR Newswire (Mon, Mar 19)

I believe there's a huge opportunity in China to deliver consumer goods and services, like cable TV, for example. ARRS is there now to help companies develop in this field.

Financially ARRS had pre-tax income of $107 M in 2006, which was its best year ever. Including tax benefits, EPS was $1.30, so the stock is trading at 10.3 times trailing earnings, which doesn't seem fair to me.

I'll continue holding ARRS.

[David Randolph]

When I look over the following table, comparing ARRS with its industry, I believe it looks clear how this stock is undervalued, even considering its low earnings multiple comes from a $37.37 M tax benefit in 2006:



I believe ARRS is positioning itself for maintaining a 30% average annual revenue growth, so I don't understand the low EPS estimates for 2007 and 2008:



Perhaps this has to do with tax charges or something like that, I'll have to dig further on the reasons why analysts are so pessimistic going forward (I say this because the company made $1.34 in 2006 EPS and analysts are estimating only $0.81 EPS for 2007, since if we exclude the tax benefit it would have still made $1.01 EPS in 2006. Why lower profits per share expected for 07 and 08?)

I'll keep holding ARRS.

[jos]

>That means an average annual share price increase of:

>$1.46 B*(X^10) = $26 B <=> X = 33.4%

David,
   I know you have mentioned the above formula for average share price increase. Could you please elaborate the formula and the factor and calculation goes into.

regards

[David Randolph]

David,
   I know you have mentioned the above formula for average share price increase. Could you please elaborate the formula and the factor and calculation goes into.

regards

Sure, good question jos

Ok, the equation we have is:

$1.46 B*(X^10) = $26 B

(oops, I'm not sure the American math symbols are the same as in Europe, I guess they are since math is an universal language)

a) $1.46 B is the initial market cap
b) X is what we want to find out, the average annual rate of increase
c) 10 is the number of years of the estimate
d) $26 B is the final market cap, if the following assumptions are met:
  d1) Revenue grows 31% a year for the next 10 years, as it grew in 2006
  d2) Net profit margin remains at 12.3%
  d3) The stock has a 16 times earnings multiple in 2017

Going back to the original equation and solving it step by step:

$1.46 B*(X^10) = $26 B <=> X^10 = ($26 B/$1.46 B) <=> X^10 = 17.81

<=> (X^10)^(1/10) = (17.81)^(1/10) <=> X = (17.81)^(0.1)

<=> X = 33.37%

Now, what we can discuss, probably with merit, is if these estimates aren't too optimistic. Because 31% average annual growth can be a long shot, just because it happened in 2006 it doesn't mean it will happen going forward. And maybe 12.6% net profit margin is too rich for ARRS's business.

You're right, I need to elaborate more on these assumptions, since other analysts are calling for lower numbers in 07 and 08 than in 06, I need to find out why.

In the meantime I'll keep holding ARRS, let me know if you have any further doubts. 

[dnickers]

Hi David -

Sorry to be nitpicky, but 17.81^0.1 is 1.3337, not .3337.  To be correct here, the formula is 1.46 B*((X+1)^10) = 26 B.

Since X is the percentage increase per period (a year in this case) we need to add the 1 in there to add that percentage to for each of the periods we're considering...10.

What you've got down is this:
X = (17.81)^(0.1)
X = 1.3337, or 133.37%

Technically, it should be like this, 1.46 B*((X+1)^10) = 26 B, gives you
((X+1)^10) = 17.81
((X+1)^10)^(1/10) = 17.81^(1/10)
X+1 = 1.3337
X = .3337, or 33.37%

.derek 

[David Randolph]

Hi David -

Sorry to be nitpicky, but 17.81^0.1 is 1.3337, not .3337.  To be correct here, the formula is 1.46 B*((X+1)^10) = 26 B.

Since X is the percentage increase per period (a year in this case) we need to add the 1 in there to add that percentage to for each of the periods we're considering...10.

What you've got down is this:
X = (17.81)^(0.1)
X = 1.3337, or 133.37%

Technically, it should be like this, 1.46 B*((X+1)^10) = 26 B, gives you
((X+1)^10) = 17.81
((X+1)^10)^(1/10) = 17.81^(1/10)
X+1 = 1.3337
X = .3337, or 33.37%

.derek 

Good point Derek, thanks for the correction

I missed that "1" but gave the same results using a "mental trick". Will use the correct math formula from now on.

[David Randolph]

Yesterday ARRS said when will it release Q1 results:

• ARRIS Announces First Quarter 2007 Earnings Release Date and Teleconference Details
Business Wire (Tue 1:20pm)

Analysts estimates call for $0.18 EPS on $235.13 M in revenues. We have time to study ARRS estimates for this quarter and beyond, I'll keep holding the stock.

[BigSully1]

I'm going to keep holding also, David. Stock is behaving very nicely through the market turmoil. Still appears to be a real bargain.

Telephony is the fastest growing cable provider service, my only concern is the heavily concentrated customer base- 4 largest cable cos. account for 68% of revs, with Comcast alone @ 39%.

[David Randolph]

I'm going to keep holding also, David. Stock is behaving very nicely through the market turmoil. Still appears to be a real bargain.

Telephony is the fastest growing cable provider service, my only concern is the heavily concentrated customer base- 4 largest cable cos. account for 68% of revs, with Comcast alone @ 39%.

Thanks for the valuable information BigSully1, I'll investigate it further for the next updates. Perhaps that costumer concentration is what is keeping the valuation low.

Yesterday's rise was due to changes in the S&P indices, so probably it won't last ...

«Standard & Poor's Announces Changes to U.S. Indices
Mar 27, 2007 6:57:00 PM

NEW YORK, March 27 /PRNewswire-FirstCall/ -- Standard & Poor's will make the following changes to the S&P 500, S&P MidCap 400, S&P SmallCap 600, and S&P REIT Composite indices:

    --  S&P MidCap 400 constituent Abercrombie & Fitch Co. (NYSE: ANF) will
        replace Univision Communications Inc. (NYSE: UVN) in the S&P 500, S&P
        SmallCap 600 constituent Phillips-Van Heusen Corp. (NYSE: PVH) will
        replace Abercrombie & Fitch in the S&P MidCap 400, and Blackbaud Inc.
        (Nasdaq: BLKB) will replace Phillips-Van Heusen in the S&P SmallCap
        600 after the close of trading on Wednesday, March 28.  Univision is
        being acquired by an investor group including Madison Dearborn
        Partners, Providence Equity Partners, Texas Pacific Group, Thomas H.
        Lee Partners and Saban Capital Group in a deal expected to close on or
        about that date, pending final approvals.

    --  S&P SmallCap 600 constituent NVR Inc. (Amex: NVR) will replace New
        Plan Excel Realty Trust Inc. (NYSE: NXL) in the S&P MidCap 400, Arris
        Group Inc. (Nasdaq: ARRS) will replace NVR Inc. in the S&P SmallCap
        600, and One Liberty Properties Inc. (NYSE: OLP) will replace New Plan
        Excel Realty Trust in the S&P REIT Composite after the close of
        trading on Wednesday, April 4.  New Plan Excel Realty Trust is being
        acquired by S&P Global 1200 constituent Centro Properties Group in a
        deal expected to close on or about that date, pending final approvals.»

... but I hope it does

I'll keep holding ARRS.