How Comcast, Verizon and the ‘Direct-to-OEM’ Trend Drove Arris – Pace Merger

Arris CEO Bob Stanzione took a question near the end of his company’s fourth-quarter earnings call in February that offered one clue as to why set-top manufacturers need to consolidate in order to survive.

An analyst asked the Arris chief about the “potential risk” Arris faced from major customers “moving toward more of an OEM [original equipment manufacturer] procurement model on the CPE [customer premise equipment] front over time.”

It’s been a challenging few years for Arris, Pace and Cisco, three of largest suppliers of cable set-tops to U.S. pay TV distributors. In addition to facing competition from China’s Huawei, South Korea’s Humax and Samsung and Denver-based Evolution Digital, set-top manufacturers face competition from cable operators and telcos designing their own customer premise equipment, and going directly to OEMs in Asia to build the CPE. They also face competition from streaming video devices ranging from Apple TV and Google Chrome to Roku, which have allowed many consumers to rely less on cable set-tops to watch both live and on-demand programming on TV.

Stanzione downplayed the threat Arris could face from multichannel providers pursuing a direct-to-OEM model. “We’ve seen certainly a trend with some of the larger customers where they’re doing some more of a design work themselves. “I’d say there is a general dynamic of that taking place but none that indicates a mass move towards going direct OEM type model at this point,” Stanzione said.

But recent moves from key Arris customers Comcast and Verizon show how Arris, which agreed to buy Pace this week for $2.1 billion in stock and cash, faces the prospect of one day being eliminated as a middleman between pay TV distributors and OEMs.

Take a look at the label on the bottom of the next-gen XG2 set-top that Pace is building for Comcast. “Designed by Comcast in Philadelphia. Made in Thailand.”

Pace XG2 label.jpg

Verizon is also relying less on Arris and other set-top manufacturers to help it build gear for the over-the-top video and LTE broadcast products that it is developing. It contracted Taiwan-based Quanta Computer to build Ellipsis, the first Verizon-branded tablet computer. And earlier this month, Verizon wrote in a job listing for systems engineer at its San Jose, Calif.-based OnCue division that it was looking for someone who could work directly with OEMs to build new devices.

The candidate would be responsible for “engaging with both internal and external suppliers to support the prototyping and fabrication of accessories.” He or she will also be responsible for researching, specifying, and securing system level components for both prototype and volume-manufactured platforms,” according to the Verizon listing.

The scale that major pay TV distributors such as Comcast, AT&T and Charter Communications will achieve through mergers and acquisitions will give multichannel providers increased leverage to negotiate volume discounts in their deals with Arris, Cisco and other manufacturers.

Arris will gain some leverage with its acquisition of Pace, whose customers include Comcast and DirecTV. Arris investors like the deal. Its stock was trading at $37.06 this afternoon, up more than 21 percent.

 

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