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We downgrade our recommendation on Arris Group Inc. (ARRS - Analyst Report) to Neutral ahead of its first quarter of fiscal 2013 financial results, which will be released on Apr 24, after the closing bell.

Why the Downgrade?

We downgrade Arris based on its high-level of current valuation. Arris is currently trading at a significantly higher multiple with respect to several valuation metrics compared with the S&P 500. The stock price has soared over 50% over the last year and is currently trading at a 52-week high end. We believe that Arris is currently fairly valued as this high level of valuation will restrict above-market gain anytime soon. Arris currently has a Zacks Rank #3 (Hold).

Risk/Reward Almost Balanced

Arris is solely dependent on cable operators for its revenue. Lack of industry diversification may result in limited business prospects. Potential shifts in industry dynamics may adversely impact the cable TV service providers. This is evident from the fact that large telecom carriers in the U.S. are increasingly expanding their high-speed fiber-based network and satellite TV providers are also upgrading their networks. Cable MSOs are gradually losing their basic video customers to low-cost satellite TV and Internet video service providers.

On the positive side, Arris recently acquired the cable set top box business of Motorola Mobility, a subsidiary of Google Inc. . This acquisition will undoubtedly help Arris attain a strong foothold in the video offerings market. The merged entity will have a global presence of more than 500 customers in 70 countries. This will reduce Arris’ dependence on Comcast Corp. (CMCSA - Analyst Report) and Time Warner Cable Inc. (TWC - Analyst Report), which together constitute about half of the company’s total revenue.  

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