Nortel alliance comes back to bite Arris shareholders
bayarea.com
Posted on Sun, Jun. 16, 2002
By Gretchen Morgenson
New York Times
NEW YORK - During the fast times at Wall Street High, investors paid little notice to companies' balance sheets and capital structures. Since the world would be ever awash in capital, why worry whether your company had planned for a drought?
Well, the drought has arrived in the form of a bear market and slack demand for technology gear. Investors are learning the hard way how crucial a solid financial structure can be.
Exhibit A is the Arris Group, a company that generated about $730 million in revenue during the last 12 months selling equipment to operators of cable systems. Although the company has lost money in each of the last six quarters, analysts expect it to eke out a profit in the current quarter and earn 20 cents a share this year.
But, like those of many technology companies, Arris' shares have lost more than half their value in the last year. They are now at $5.03, giving Arris a market capitalization of $411 million.
Several analysts rate Arris' depressed shares a buy. But these optimists are ignoring fissures in the company's capital structure that could cause further declines in the stock. Those cracks involve various financial stakes in Arris held by Nortel Networks, the beleaguered telecommunications concern.
Arris began life as Antec; last August, Nortel and Antec reformulated their joint venture and renamed it the Arris Group. At the time of the combination, Arris had a market value of $1 billion, and Nortel's 37 million Arris shares accounted for 45 percent of the company's stock. Nortel also holds a so-called membership interest in Arris that is effectively a loan to the company of $80 million to $100 million at 10 percent interest. In addition, Arris has roughly $100 million in convertible debt coming due in May 2003.
Several problems lie in this capital structure for Arris' public shareholders. First, Nortel, in need of cash, has filed to sell 21 million Arris shares, putting pressure on a stock that trades, on average, 500,000 shares a day. But even after these shares are sold, the registration documents show, the further Arris shares fall, the greater the stake Nortel could receive when its membership interest is repaid. That puts the interests of Nortel opposite those of Arris' public shareholders. And as for the $100 million in convertible debt due next year, Arris needs a strong stock price if it wants to convert those notes into common shares.
There appears to be one bright spot in this cloudy scene: the remaining 16 million Arris shares owned by Nortel are subject to a lockup of one year. But this lockup, unlike most, is full of holes. Typical lockups forbid shareholders from transferring shares either directly or indirectly by selling, selling short, loaning or granting any options for the purchase of the shares. Yet Nortel's agreement has no such specifications.
As a result, these shares could find their way into the market as well. If Nortel were not desperate for cash, Arris shareholders might not need to fret. But Nortel's free cash flow in the first quarter of 2002 would have been negative $1 billion had it not received a $500 million tax refund.
A spokesman for Arris referred a reporter to regulatory filings, saying that he could not comment further, given the pending share sale.
It is an unfortunate paradox that even as Arris is facing these difficulties, it is improving its cash flow and working capital. Arris is also reducing its reliance on big customers like AT&T Broadband and increasing its business overseas. |
