Harris Buys Leitch

Combined companies target $2.4B market
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Combined companies target $2.4B market

MELBOURNE, FLA & TORONTO

Harris Corp. announced late last month that it plans to purchase broadcast technology provider Leitch Technology Corp. in a deal worth approximately $450 million. Harris says it expects the transaction will be completed by November.

Harris will pay $14 per share, but doesn't expect the acquisition to affect its 2006 earnings. In fiscal year 2007, the transaction is expected to increase earnings by 6 cents per share. Toronto-based Leitch saw its stock rise over 25 percent after the announcement. Harris stock, which has gained 60 percent over the past year, edged up slightly as well.

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The acquisition represents one of the biggest mergers to date in the broadcast technology industry as manufacturers attempt to consolidate to provide "end to end" solutions in the DTV transition. Harris is traditionally known as a provider of broadcast transmission and automation products, although the company has recently increased its focus on asset management and other software-based technology. Leitch is famous for its master control, server and signal processing and distribution products, but has also been branching out. Over the past year-and-a-half, Leitch has purchased two companies that complement its product line: Pottstown, Penn.-based test and measurement company Videotek in 2004, and fellow Canadian graphics provider Inscriber Corp. earlier this year. Harris acquired broadcast automation provider Encoda for $340 million a year ago.

The Leitch acquisition makes Harris the broadcast behemoth, expanding its market potential from serving a $500 million TV sector to a $2.4 billion market, with 3-4 percent annual growth, according to Brian R. Roub, chief financial officer for Harris Corp. Leitch has approximately 850 employees worldwide and serves more than 3,000 customers in 100 countries. Harris' broadcast division, which has announced recent layoffs and is moving production from the U.K. to establish a single transmitter manufacturing plant in Quincy, Ill., has about 1,700 employees worldwide. Broadcast revenues in its most recent quarter were $114 million, up from $89.1 million for the same quarter a year ago.

The deal comes on the heels of another large industry acquisition, Avid's recently completed purchase of Pinnacle Systems. In contrast to that transaction, which represented the takeover of one video-editing powerhouse over a competitor, the Harris-Leitch merger will result in a combined company with complementary product lines.

"We don't have any product offerings that overlap with Leitch," said Jeremy C. Wensinger, president of Harris Broadcast Communications Division. "We believe this is a very exciting merger between two complementary companies," added Roub.

Wensinger said that Leitch's management team, headed by former Grass Valley chief Tim Thorsteinson, was also an important factor in the deal. Since coming onboard as president and CEO of the company 18 months ago, Thorsteinson has slashed costs and increased the company's focus on new products and acquisitions. The result has sweetened Leitch's bottom line: pro forma operating income excluding restructuring charges increased from a loss of US$14 million in fiscal 2004 to a profit of US$7 million in fiscal 2005, which ended April 30.

"What Tim and his team have been able to do is demonstrate that the products that they have designed and developed are paying off," Wensinger said. "They're seeing good revenue growth, they're seeing good margin expansion and this team is being rewarded in the last year; you saw with their stock price moving, that the market is seeing that."

Thorsteinson, for his part, said that Leitch's size has prevented it from effectively competing in the broadcast marketplace.

"I've believed for a while, and have been pretty public about the fact that it's very difficult to be a $217 million global enterprise attacking the worldwide broadcast market," he said. "Whether we rolled up other companies or somebody acquired us was probably inevitable to hit the operating model we're talking about and invest in the R&D and service and support we have. Although we weren't looking for this to happen, once we started talking, it became pretty clear that there's a great strategic fit in the business and we thought it was a pretty good time to do it."

OUTSIDE THE TRANSMISSION BOX

As the industry's largest broadcast transmission provider, Harris' broadcast communications division has seen its revenues ebb and flow since the DTV transition got underway approximately seven years ago. Harris benefited greatly as broadcasters built out their digital broadcasting transmission facilities to comply with FCC deadlines (and expects to see increased business as the radio industry transitions to digital). However, as the pace of digital transmitter purchases has slowed, Harris Broadcast has been attempting to broaden its product focus. Wensinger says such prevailing opinions about Harris' outlook simplify the situation and that the digital transmitter business remains healthy.

"In terms of full power and channel selection, we believe there's about another 40 percent to go in the U.S. in terms of transmission," Wensinger said. "Even though [broadcasters] are transmitting digital, they're not transmitting at the right power level or are at the final channel selection."

Harris executives characterize the Leitch acquisition as a vote of confidence that the worldwide digital media market will see a healthy expansion for the foreseeable future, and that the larger company will be well positioned to take advantage of increased efficiencies brought about by digital technology that will expand beyond broadcasting and into cable, satellite, telco and the Internet.

"Digital content and HD broadcasting together are changing the nature of the global broadcast industry landscape," said Roub. "Broadcasters have already made significant investments in DTV transmission capability. Now they are making significant investments in the hardware and software systems to manage and distribute their content and their HD signals through a variety of delivery alternatives, including over-the-air, cable, satellite and telephony. This will drive very attractive market growth in the range of 10-12 percent, first in the U.S. and then in the international markets."

MC MARKET GROWTH

Harris sees growth potential in the digitization of master control facilities, which also made Leitch an attractive acquisition.

"The digital media and infrastructure products provided by Leitch address large, fast growing markets," said Roub. "The underlying driver for this market growth in the broadcast segment is the conversion to HD master control and HD production studios by networks and broadcast stations."

Roub pegs the average cost of an HD master control system at approximately $1.3 million and about $3.3 million for a typical HD production studio. With the addition of the Leitch product line, Harris expects to be able to provide about 60 percent of the gear, or around $2.7 million per typical installation.

"The current estimated penetration [in the U.S.], is only about 45 percent for HD master control and only about 10 percent for HD production studios," he said. "There is clearly a lot of market growth ahead of us as customers continue to move down the line of conversion."

Roub adds that the Leitch purchase not only expands its addressable market, it increases Harris' revenue growth potential into adjacent sectors. While Leitch's target market has been the traditional broadcaster, Harris' most profitable customer is the U.S. government, and Harris Corp. CEO Howard Lance expects the company will quickly integrate and market the Leitch product line to this market as well as growing corporate and education sectors.

"I see opportunities for Harris to introduce Leitch products as part of the broader digital media solutions into our government base of customers, as well," Lance said. "Harris has some niches in other businesses--the enterprise space outside of broadcast--so I see both of those offering upside opportunities for the company. If you think today about the volume of digital media that the U.S. government is dealing with in DoD and Homeland Security, for example, it's becoming quite significant."

Because of the lack of redundant products, Harris Corp. executives said they don't expect many layoffs.

"There are some public-company related costs and opportunities in the general administrative area for taking advantage of our larger scale," said Lance. "There's not a large amount of overlap so we don't expect a large amount of redundancies to result."

As for the Leitch name, Lance said that while Harris expects to see some "co-branding," for the time being, the Leitch brand "has value and we will look very closely at that before making any changes."