Like many observers of the broadcast technology sector, and loyal readers of the Devoncroft blog, I have followed the recent announcements at Harris Corporation with great interest. The merits of Harris Corporation's decision to divest its Broadcast Division are well established. This post is a perspective on the anticipated transaction – timing, type, and price.
Harris in its public messaging has established a few key data points:
Harris Broadcast Division – Fiscal Year (Ends June 30)
Source: SEC filings, Harris Corporation Investor Presentation, Silverwood Partners Estimates
As the chart above suggests, the sale process will not have the benefit of meaningful revenue growth or a meaningful level of profitability in the Broadcast Division. That is not to suggest the Broadcast Division is not a valuable asset. The sale process will have the benefit of an end-to-end suite of products (several are category-leading), a great brand (as confirmed by Devoncroft's Big Broadcast Survey), a well-regarded management team, and substantial size, presence, and revenue level in the media technology industry. The caveat to those qualitative points is a portfolio that is much more hardware than software, and Harris Corporation's self-admission that there is still operational work to do in streamlining the division's operations (Q2 Earnings Call).
Source: 2007 Harris Corporation Investor Presentation
Harris will also have the benefit of a highly accommodating M&A environment, as illustrated in the below slide from our 2012 NAB Industry Analysis.
Source: Silverwood Partners NAB 2012 – Industry Analysis
POSSIBLE TRANSACTION TYPES:
Public Spinout to Harris Shareholders
One possible alternative for Harris is to spin out the Broadcast Division to its shareholders in the form of a stock dividend. There is precedent for Harris taking this action with a subsidiary. In January 2007, Harris Microwave Communications Division and Stratex Networks Inc. combined to create a new company having annual revenues of approximately $650 million. On December 8, 2008 Harris announced it was evaluating strategic alternatives related to this majority-owned subsidiary, Harris Stratex Networks (now Aviat Networks). On March 31, 2009, the Board of Directors of Harris Corporation approved the spin-off to its shareholders of all the shares of Harris Stratex Networks owned by Harris Corporation. Harris Corporation shareholders received approximately .24 of a share of Harris Stratex Networks for every share of Harris Corporation common stock owned.
This approach allowed the Harris Microwave Communication Division to gain scale, and find a public market with shareholders that were focused on small cap commercial communications growth investments rather than large cap, military communications investments. A similar logical underpinning would apply in the case of the Broadcast Division. However, the business would need more scale and much more growth for such a strategy to be successful and attract public investors. This approach would also be time consuming and there may be substantial uncertainty over the upside potential if the business continues to post modest or negative levels of growth and effectively break-even operating results. In sharp contrast, a straightforward sale of the Broadcast Division business for cash allows Harris Corporation to eliminate the distraction and redeploy capital into its core business.
Trade Sale to an Industry Participant
You can count on a single hand the number of industry participants capable of financing a greater than $200M cash purchase price. In each case, it would represent a transformative deal and would require immediate rationalization of the combined organization and cost structure – product overlap would be almost unavoidable. If such a transaction were successfully executed, the resulting business would have a dominant market position.
Trade Sale to a Broader Technology Vendor
Harris is certainly large enough to attract the attention of the comparably much larger IT vendors adjacent to the media technology sector. For some time, IT vendors have lauded the growth opportunities in video as talking points to Wall Street, and in many instances these same vendors have occupied large booths at NAB and IBC. However, head of digital media at these vendors is a difficult job to hold through an entire business cycle.
In this circumstance, the biggest question is whether a broader technology vendor views the Broadcast Division's portfolio as too hardware-centric and too specialized to the broadcast industry. Conceivably any IT vendor interested in moving into the broadcast sector had the opportunity to make such a decision in connection with the sale process at Grass Valley in 2010, the ongoing sale process at Miranda, or in connection with the evolving situation at other large vendors in the sector.
Purchase by a Private Equity Firm
A CapitalIQ screen of private equity firms with a focus in North America, technology, corporate divestitures, and investment criteria in the suggested range yields approximately 2,000 firms – that is not a typo.
There is a tremendous amount of private equity interest in the media technology sector. The single biggest obstacle these firms have in finding investment opportunities in the sector is a dearth of businesses large enough to support the amount of money these groups are looking to invest.
Unambiguously there is a private equity buyer for the Broadcast Division. The challenge is price. Without the benefit of existing, meaningful historical cash flow or near-term expected cash flows, there is little ability to borrow money to support the purchase price. Therefore, private equity firms will value the division based on the expectation of near-term efficiencies that can be brought and the expected value of the ultimate exit (generally in a 3-5 year time horizon). Recall that on a net cash basis, Technicolor provided cash to Francisco Partners at closing in connection with the purchase of Grass Valley.
Since 2004, Harris has spent just under $1 billion dollars on acquisitions for the Broadcast Division. But the market has no memory.
Triangulating between the recent write-downs and the last publicly available balance sheet for the division, it is estimated there is approximately $600 million of assets associated with the division, and more important, the annual revenue is estimated at approximately $530 million. In the context of those numbers, the level of profitability is insignificant, but critically it is not negative.
The public comparable companies suggest a revenue multiple of 0.5x to 1.0x. Recent M&A transactions might suggest a revenue multiple of 1.0 to 1.5. In the case of the Broadcast Division, the multiples ignore the specifics of the situation; all but a select few industry participants can finance a transaction of the size expected. Private equity firms may have an interest, but they are inescapably bound to pay a price supported by the immediate prospects of cash flow, which price would imply the low end of the suggested multiples.
In the context of an IT vendor's balance sheet, a valuation "substantially higher" than $200 million is not a significant amount of money. For that group of buyers, it is a binary question of interest, more than of price. In the past 16 months, by my count, vendors accounting for almost one third of the industry's revenue have been sold or have actively sought a sale. With only a few exceptions, the broader technology vendor universe has not participated in those transactions. The Harris Broadcast Division will make for a great litmus test of the interest in the broadcast technology sector by broader technology vendors: it is big enough to matter to them, spans just about the entire workflow, and comes with a quality and level of video expertise in both the management and engineering ranks that broader IT vendors can not replicate internally.
It will take several months to work through the sale process. The end result will be a signature event in the industry and will reframe exit expectations for vendors in the sector.