Financial hurdles for ADC/Andrew?

The merger that equipment vendors ADC and Andrew Corporation announced earlier this week is drawing its share of concern from financial analysts following those companies.

Merrill Lynch lowered its earnings-per-share estimate for ADC's 2006 fiscal year by one cent to $1.10 EPS. "While this acquisition is strategically sound, it could depress ADC's profitability for a prolonged period, in our view," wrote analyst Tal Liani in a Merrill Lynch research report this week. Still, Liani added, "Despite our concerns [regarding] near-term profitability, we favor this bold move by ADC. The combined company will be a large and diverse supplier of cable/connectivity products for broadband, wireless and converged triple play deployments..."

Morgan Keenan analyst Simon Leopold voiced similar concern. "ADC is well positioned to benefit from long-term spending trends; however, the acquisition may lead to higher risk and a longer time frame to reap the rewards," Leopold wrote in his own research note. "ADC's connectivity business provides a technology agnostic means to invest in favorable areas (e.g., wireless and fiber optic access upgrades). ADC has improved its own operations, improving its operating margin by eliminating non-core businesses, and improving efficiency and scale. The same strategy could work with Andrew, but it likely takes many quarters to complete. Management maintained its 3-year goal of reaching 14% operating margin, which we considered achievable for ADC alone, and more challenging, yet still achievable with Andrew."

ADC Andrew announced the $2 billion stock-for-stock deal earlier this week. Westchester, Ill.-based Andrew, which has holdings in wireless antennas and components, satellite and other markets, will become a subsidiary of ADC, under the terms of the companies' definitive agreement, with ADC president and CEO Bob Switz remaining in charge of the combined firm.

Based on most recent financial reports, the companies have combined sales of about $3.3 billion. Shareholders of Eden Prairie, Minn.-based ADC will own about 56% of the merged entity, with Andrew shareholders keeping the remaining 44%.

“Together, we’re better positioned to assist our customers worldwide and capture growth opportunities that result from the convergence of our customers’ next-generation wireless, broadband, video, data and voice services," Switz said in a statement.

Ralph E. Faison, president and CEO of Andrew, added, “As we join ADC’s leadership position in wireline connectivity solutions and Andrew’s leadership position in wireless infrastructure solutions, ADC and Andrew will have a substantially greater global presence, customer base, economies of scale, product breadth, innovation ability and financial strength. The synergies that we expect to create will enable us to better serve our converging customer base worldwide as their wireline and wireless networks deliver high-speed, any-content, anywhere communications services.” Faison will serve as a consultant to the combined company to facilitate an efficient transition.

The combined company will have a range of solutions for both wireline and wireless connectivity, including systems for copper, coaxial, fiber, radio frequency, broadcast and enterprise networks, as well as antennas, cable products, base station subsystems, in-building and distributed coverage, geolocation systems and satellite communications. About 23% of the combined sales will be to wireline customers, 44% to wireless customers, 6% to enterprise customers, 24% to original equipment manufacturers (OEM) and 3% to other customers.