While many investors waited to see how much of a drag Google’s (NASDAQ:GOOG) purchase of Motorola Mobility was continuing to have on its bottom line, a smaller company reaping the benefits of the transaction was quietly celebrating.
The company is Arris Group (NASDAQ:ARRS), and it just finalized a deal with Google to acquire Motorola Home. As part of its $12.5 billion buy of Motorola, Google became the owner of Motorola Home, which was the company’s TV set-top business. It didn’t fit with the search engine giant’s ecosystem, and it immediately began shopping around for interested buyers for it after acquiring Motorola Mobility.
When Google found Arris as a potential buyer of the set-top business, it was ideal for both companies. Google was able to shed the unwanted business and focus on making Motorola’s mobile business profitable for it. In addition to getting a leg up in the hardware business for mobile devices, the acquisition of Motorola Mobility allows Google to get its hands on some highly desired patents. As you know, there is no shortage of litigation in the tech world when it comes to patents, especially over smartphones and tablets. Most notable are the battles between Google and Apple (NASDAQ:AAPL) in which patent infringement lawsuit wars are being waged on just about every continent on the planet.
Buying the set-top business from Google was ideal for Arris because it was able to pick up a business that fits neatly in its efforts to grow in the telecommunications space. Through the purchase of Motorola Home, Arris will have a global presence with more than 500 customers in 70 countries. This will more than triple the company’s pro forma combined revenue to roughly $4.7 billion for the trailing four quarter period ended Sept. 30, 2012.
But not everyone is happy about Arris. Zacks Equity Research last week downgraded Arris based on its high-level of current valuation. In the report, Zacks noted that Arris is currently trading at a significantly higher multiple with respect to several valuation metrics compared with the S&P 500 as the stock’s price has soared more than 50% over the last year and is currently trading within a 52-week high channel.
While we agree that ARRS is at high valuations the potential for growth is like an embedded call option. For example, its forward P/E ratio (calculated based on forward earnings expectations) is much lower than the S&P 500 current or forward average. That is clearly speculative but ultimately traders aren’t making decisions about what they know now but what they anticipate for the future.
Click to Enlarge In our opinion, the biggest concern with ARRS is a potential emerging head and shoulders pattern. The stock has not broken out yet, however, a break below $16 per share would be a sell signal. At this point we recommend opening a long position on the stock on a break above $17.50 or short term resistance. That would ‘break’ the potential reversal pattern and signal further upside potential in the short term.
On Wednesday ARRS reported its fiscal 2013 first quarter earnings. ARRS beat the consensus EPS estimate by one cent, coming in at 25 cents. For the first quarter of 2012, the EPS was 19 cents.
Given all of the positives that Arris will reap from the acquisition of Motorola Home, we disagree with Zacks’ concerns over Arris that prompted the company’s downgrade. Zacks even acknowledged the positives that result for Arris from the Motorola Home acquisition, with one of them being the company gaining a strong foothold in the video offerings market. Also important is that the transaction will reduce Arris’ dependence on Comcast (NASDAQ:CMCSA) and Time Warner Cable (NASDAQ:TWC) which together constitute about half of the company’s total revenue.
Consider going long on Arris. We like buying opportunities above $17.50 per share to reduce the possibility of a completed head and shoulders pattern. The chain sheet for ARRS is a little thin but we still like the August 17.50 Calls for $1.00 or less. A limit order set between the bid and ask prices should be able to be filled if you are patient.
Recommendation:Buy ARRS on a break above $17.50. Set stops underneath the potential head and shoulders pattern to protect capital
Option Alternative: Buy to open the August $17.50 Calls for $1.00 or less with a limit order set between the bid and ask prices.
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Investor Place advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.