How the CommScope/Arris Merger Could Bring 50% Upside on High 5G Hopes
CommScope Holding Co. Inc. (NASDAQ: COMM) had a very rough fourth quarter of 2018, and after shares gapped down from $24 in November to $20, the shares slid to under $16 at the peak of the selling pressure into year-end. They say that rising tides lift all ships, and CommScope has managed to recover almost all of its losses from November, but its shares are still handily down from the $30 level at the start of October due to the company leveraging up to make a big acquisition.
That downside is all about to end. At least that’s the message from Credit Suisse. The communications infrastructure solutions provider has been raised to Outperform from Neutral based on material accretion ahead from the pending merger with Arris International PLC (NASDAQ: ARRS). Credit Suisse named CommScope the new Top Pick and Highest Conviction Outperform name in the group, raising its target price to $34 from $20.
Tuesday’s big analyst call is ahead of the acquisition deal closure date between CommScope and Arris, with an expected closure in April. Arris shareholders already have approved the merger, and the company’s latest forecast was that its acquisition would close in the first half of 2019.
Note that the merger press release issued five months earlier confirmed that the Carlyle Group was reestablishing an ownership position in CommScope with a $1 billion minority equity investment as part of CommScope’s financing of the transaction. The $7.4 billion deal was an offer of $31.75 per Arris share, valued at $5.69 billion, excluding the debt repayment.
The report even calls itself out as having material upside from its conservatively updated merger model. Sami Badri, the analyst covering the technology sector and the stocks, noted that the company will have well-positioned data center products, as well as 5G opportunities and finalized telecom pricing. Channel checks are also said to indicate that CommScope will be better positioned for 2019 and 2020. Badri said:
In our model, we are being very conservative by keeping revenue growth flat, modeling gross margins well below consensus, only incorporating company guided cost synergies, and factor no incremental debt repayment of the combined COMM-ARRS company through 2020… Based on our data center supply chain channel checks, we have learned that COMM has successfully transitioned its data center product portfolio to compete more effectively going forward against data center component vendors when compared to prior years.
Badri also sees CommScope as being a key victor from 5G capex and buildouts in the years ahead. The report said:
We believe CommScope is one of the early beneficiaries of 5G spending, with Global Telecom Capex growing 4%/4% in 2019/2020, respectively, but we conservatively project our CommScope revenue growth flat during this period. Additionally, issues with telco customer product pricing have been locked in through 2019, giving us visibility into the company’s 2019 revenue guidance.
CommScope previously closed at $22.23, in a 52-week range of $15.09 to $41.60. The Refinitiv consensus analyst target price was last seen at $26.88, and the street-high analyst target is $37.00.
CommScope shares were up 3% at $22.90 on Tuesday after the strong research note. Arris shares are quite near the takeout price, with its stock last seen at $31.66.
It is not common at all to see a firm call for upside of about 50% and say that its combined outlook model is very conservative. The growth opportunity of 5G also has been used to prop up long-term prospects for Ericsson and Nokia.