Arris Group, Inc. (NASDAQ:ARRS)

CAPS Rating: 4 out of 5

A global communications technology company develops, manufactures and supplies cable telephony, video and high-speed data equipment, as well as outside plant construction and maintenance equipment for MSOs.

Recs

8
Player Avatar paperpump (96.92) Submitted: 2/24/2011 11:08:20 PM : Underperform Start Price: $13.22 ARRS Score: +8.64

After the gulf oil spill this past summer, Mr. Market priced in draconian outcomes for BP and their potential liabilities. However, when looking at Arris Group (ARRS) at present, he is overly optimistic.

Arris Group's main business is the manufacture and distribution of cable boxes, modems and other gear to tv broadcast networks. This, as you know, is old media. The company has a 26 multiple with shrinking revenues and earnings over the past 3 years. Management and executives have dumped stock in the past couple months (more than $14MM this February alone) and the company is trading just off their 52 week high. Short interest stands at 6% of the float, up from 5% last month. 16% of assets are intangibles, comprised mostly of customer relationships to be amortized over 5 years. The company received letters from the SEC throughout 2010 regarding the large amount of intangibles relative to assets, aggressive revenue recognition assumptions, and requested that the company more accurately state events that could have an impact on its future. I think it is interesting when noting the SEC's involvement that the CEO is also the CAO and the CFO.

Additionally, the company has legal/product viability issues. Comcast and Time Warner are being sued for patent infringement in regards to products that ARRS has sold them. In aggregate those two companies comprise over 50% of ARRS' sales. If either company is found liable ARRS may be required to indemnify the defendants, pay royalties and/or cease using certain technology. Compensatory and Punitive damages can extend back as far as 6 years from the filing of the suit.
In addition to Comcast and Time Warner there are 20 other lawsuits regarding patent infringement...

A patentee, whose patent was infringed is entitled to-
1.an award of lost profits from sales the patentee would have made "but for" the infringement
2. a reasonable royalty on the infringing sales
3.a combination of (1) and (2).
Note: A reasonable royalty award provides the floor below which damages cannot fall

Looking at only Time Warner, revenues for network subscription made up $7.6B of their 26.8B in revenue for 2010. Keep in mind ARRS has a market cap of 1.6B. What if ARRS was asked to indemnify a 5% royalty to the patentee amounting to 1/5 of TWX's sales over 6 years. TWX's network subscription sales in 2008 were $6.7B and assuming a 5 billion yearly network sales number we get..

5B (conservative estimate of network subscription sales) x 6 (years) x .2 (guess of ARRS' exposure to TWX's network sales) x .05 (royalties) = $300MM

This is only one lawsuit out of the more than 20 that are pending in which ARRS would be required to indemnify the defendants.

We can guess the potential liabilities resulting from these lawsuits..

50%- 100MM loss
30%- 500MM loss
15%- 1B loss
5%- 1.5B loss

Now let's construct a decision tree, pairing the potential outcomes with the probabilities.

100MM damages x .5 = 50MM
500MM damages x .3 = 150MM
1B damages x .15 = 150MM
1.5B damges x .05 = 75MM

so our weighted average outcome is -425MM

Therefore, there is a good chance this company could realize $425 MM in losses. If we stretched these damages out over 10 years they would amount to 42MM a year or roughly 39% of ARRS’ 109MM operating earnings in 2010.

With massing looming downside, should this company be trading at a PE of 26 compared to an industry average of 22? I don't think so.

Report this Post 3 Replies
Member Avatar oldman144 (< 20) Submitted: 5/20/2011 11:15:19 AM
Recs: 0

I would not like to argue with your well laid out facts- not fiction.. In the current downward direction, looks like this company is going, going, GONE.

Member Avatar paperpump (96.92) Submitted: 6/2/2011 11:48:02 AM
Recs: 0

"the CEO is also the CAO and the CFO." This was incorrect, however the corporate governance power structure is concentrated, and the CEO is also the chairman. Fraudulent companies often have these issues.

Robert J. Stanzione- CEO/Chairman of the Board/Director
David B. Potts- CFO/Chief Accounting Officer/Chief Information Officer/Executive VP

Member Avatar whaddpa (< 20) Submitted: 9/9/2011 12:35:50 PM
Recs: 0

Thanks for the well reshearched info. Very helpful.

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