By offering to acquire Tandberg TV this week, Arris will challenge Cisco Systems and Motorola for the residential video and triple-play equipment market.

In a research note issued this morning, Think Equity Partners analysts called it a “gutsy move to create the standout ‘third force’ in cable TV and video technology.”

Arris is offering a combination of cash and stock worth roughly $1.2 billion for Tandberg, whose market capitalization is near $800 million and whose estimated 2006 revenue approaches $350 million. The combined company would claim about $1.25 billion in revenue for 2006.

Arris had publicly announced its intentions to make an acquisition roughly a year ago, and among its likely choices, Tandberg was one of the largest. Arris executives say the combination doesn’t offer much in the way of cost synergies, but the strategic value of the combination drove the deal.

"We've been anticipating this deal for some time as Arris really needed to make a splash in the video space and to keep pace with Cisco and Motorola in the cable MSO market, where operators are beginning to look at switched digital video and video-over-DOCSIS,” Jeff Heynen, Infonetics Research analyst said in an e-mail to Telephony. “Arris is strong in voice and data, but until now, they've had no video play whatsoever. Tandberg is strong in cable head-end, satellite, and telco IPTV, and this acquisition will allow Arris to build on its strength in the CMTS and EMTA markets for cable VoIP and to sell complementary video solutions from the head-end all the way to the home."

“The attraction between Tandberg TV and Arris is mutual, as the product lines are almost perfectly complementary,” Think Equity analysts added.

With Tandberg, Arris will challenge Cisco and Motorola in the market for cable modems (especially those with phone jacks included) and for cable modem termination systems, where it will be in a close third place. It will also challenge Cisco in the digital video encoder market, in particular leading the market for high-definition MPEG-4 encoders. And in perhaps its most direct challenge, Arris can also use Tandberg’s acquisition of video-on-demand (VOD) software vendor N2 Broadband to counter Cisco’s acquisition of Arroyo and Motorola’s acquisition of Broadbus.

“This merger is an outright declaration of war against Cisco and Motorola, so we fear [it] could greatly damage the prospects [for Tandberg’s VOD software], unless other opportunities make up for the difference,” Think Equity analysts said.

The two vendors have some customer overlap but will also offer expansions in geography and customer segments. While about 75% of Arris’ revenue comes from the U.S., Tandberg’s revenue is more evenly distributed, with Europe and North America each contributing roughly 45%.

“ARRIS will maintain its focus on MSOs, but Tandberg brings some exposure to telcos and satellite [providers] with its MPEG-4 encoders, which are not generally used by MSOs,” Morgan Keegan analyst Simon Leopold wrote in a note this morning.

Other vendors could still conceivably outbid Arris for Tandberg. But the only two with enough money to spend are Cisco and Motorola, Think Equity analysts said, and neither is likely to make a move. “Each would like to shut Arris out of emerging as a ‘third force’ across cable and video,” the analysts said. “On the other hand, the wide range of customers--in particular, cable--would likely bark loudly, followed even by potential government intervention, if any such attempt were actually made.”

In addition, the deal includes an $18-million breakup fee for the party that backs out.

Some analysts questioned the timing of the deal, as it comes four months after Tandberg warned of a temporary drop in profits. But on this morning’s conference call, Tandberg chief executive Eric Cooney dismissed any notion that it brokered the deal in a position of weakness. “There are, to be blunt, no signs of weakness at all,” he said.

One analyst questioned the premium Arris was paying, estimating it at more than twice the 20% premium Cisco Systems paid to acquire Scientific Atlanta. However, Arris chairman and chief executive officer Bob Stanzione cautioned that the volatility of the stock makes premiums hard to calculate precisely. For the purposes of the deal, Arris stock will assume its average value over the ten days immediately preceding the deal’s closing.

“Premium is in the eye of the beholder,” Stanzione said. “There’s so much volatility that premium turns out to be not a real good metric to look at in terms of the valuation on this deal.”

Arris expects the deal to close by the middle of this year and be accretive in 2008.