Arris Downgraded As DOCSIS 3.0 Seen Tapering Off
Jefferies & Co.'s Notter Says Vendor After Comcast Upgrades Taper Off
Todd Spangler -- Multichannel News, 10/6/2009 3:14:55 PM
While Arris appears to be "executing very well" on the migration to DOCSIS 3.0, the company may not be able to sustain its current profit margins from CMTS upgrades after Comcast's nationwide rollout of the next-generation, cable-modem technology nears completion, a Wall Street analyst wrote in a research report Tuesday.
Jefferies & Co. analyst George Notter downgraded Arris to "underperform," from a previous "hold" rating, citing concerns that the company's margins will "come under pressure" as Comcast wraps up its initial DOCSIS 3.0 rollout in 2010.
"Looking at other operators, it's hard to see how Arris can generate the same amount of DOCSIS 3.0 software upgrade business once Comcast tapers off," he wrote.
Arris' share price was down 9% in trading Tuesday afternoon, to $11.51 per share, from its previous closing price of $12.67. Jefferies lowered its target on the stock price to $9.50, from $12 previously.
According to Notter, Arris' upgrade path to DOCSIS 3.0 for the C4 CMTS allows operators to reuse about 80% of an existing DOCSIS 2.0 investment and that DOCSIS 3.0 software upgrades have largely boosted Arris recent gross margins. However, "the pace of software upgrades should eventually taper off.... The installed base of Arris 2.0 CMTS is finite in number and the 3.0 software upgrade is non-recurring in nature."
For the second quarter of 2009, Arris's revenue dropped 0.9% from a year earlier but both gross margin increased to 42.1% (up from 33.0% in the second quarter of 2008). The company said the improvement reflected strong CMTS sales. "We have a very different margin profile in the company than we did a year ago, and we think we can sustain it," Arris chairman and CEO Bob Stanzione said on the company's earnings call.
But in Notter's analysis, once Comcast completes its initial DOCSIS 3.0 rollout, Arris' mix of business will become "less software intensive and therefore less profitable." The analyst estimates that software upgrades at Comcast alone have been contributing roughly $7 million to $12 million (roughly 20% to 30%) of quarterly operating profit for Arris this year.
Comcast is aiming to deploy DOCSIS 3.0 to 40 million of homes, nearly 80% of those passed in its service areas, by the end of this year, with full coverage by 2010.
Other MSO customers, including Time Warner Cable, even if they were to upgrade as quickly as Comcast has, don't represent as large a footprint as the nation's No. 1 cable operator, Notter said. In addition, Notter said, international cable operators are unlikely to replace Arris's Comcast business either, given that DOCSIS 3.0 adoption will probably be slower overseas in general and that Cisco and Motorola are relatively stronger in international markets.
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