Earlier this week, ARRIS Group (ARRS) acquired BigBand Networks (BBND) in a $172 million deal that values BigBand at a 76% premium to the closing price on Oct 10, 2011.
Net of cash on hand at BigBand Networks, this deal is worth $53 million.
The acquisition is expected to close later this year and ARRIS anticipates it to be mildly accretive by the middle of 2012.
BigBand Networks is a video networking technology provider based in Redwood City, California.
Before the acquisition, the company was trading at a market value of $93 million.
With zero long term debt and $127 million in cash and marketable securities as of June 30, 2011, the company was one of the rare net-net stocks in the market.
The company though has been raking up losses, partly due to its large R&D expense that was regularly around 50% of its revenues. ARRIS cites BigBandís patent portfolio as a key asset that it is acquiring.
Book Valuation In Line with the Industry
Looking at the book valuation, ARRIS is now valuing BBND at 1.45 times its book value. This is roughly in line with the industry. ARRIS itself is being valued at 1.37 times book value in the market.
BigBand though clocks in a 60% gross margin compared to ARRIS 38%, which means once the acquisition is integrated and the R&D expenses are synergized with ARRISí own R&D, there is a significant potential to enhance the net profit margins. SGA, manufacturing and other synergies will add further to the bottom line.
Cost Cutting and Synergies Show the Real Value
A rough back of the envelope calculation shows that if ARRIS is able to reduce the R&D and SGA costs by 50% at BigBand, which is quite possible given that ARRIS is 10 times the size of BigBand, than we may expect around 9 cents/share profit in the next year.
Which gives a rough P/E of BigBand going forward at around 26 based on the acquisition price of $2.24/share. Removing the excess cash of $1.36/share, the P/E of the continuing operations drops to 10.
This still undevalues BigBand a bit and is a great acquisition price to pay for ARRIS, despite a 76% premium to the market value of the stock.
Further, ARRIS will also benefit from the $3.2 million in as yet unrecognised tax losses that BigBand carries on its books.
ARRIS is getting itself a deal and paying a good premium to the BigBand shareholders. It is a win win transaction for all, except perhaps for long time shareholders or BigBand who have seen the stock decline from a high of $20 in early 2007.