In an SEC filing today, Harmonic indicated Comcast has completed field trials for Harmonic’s CableOS, a next-generation software-based Converged Cable Access Platform (CCAP) solution.
The filing addresses a milestone in the vesting of a portion of warrant shares stemming from a September 2016 agreement between Harmonic and Comcast. As described in Harmonic’s 10K, the warrant agreement with Comcast is intended “to further incentivize them [Comcast] to purchase our products and adopt our [Harmonic] technologies, particularly our CableOS CCAP systems.”
Comcast was the single largest customer of Harmonic in the latest quarter. Sales to Comcast were 15% of Harmonic’s revenue in the quarter or $15 million in aggregate.
The customer relationship captured in the warrant agreement is a fascinating evolution of a technology customer / technology supplier relationship in the media industry. These types of arrangements are somewhat common in the cable sector, but still a great discussion point for the broader media technology sector.
First, consider the relative size of the customer and the supplier. Comcast is one of the largest media companies in the world, having annual revenue of over $80 billion and a market capitalization of over $150 billion. In contrast, Harmonic has annual revenue of around $360 million (2017) and a market capitalization of approximately $450 million as of today.
Next, it is important to clarify the warrant agreement is not an investment in Harmonic by Comcast. Rather, a warrant is the right, but not the obligation to purchase shares of a given stock at a set price. During the term of a warrant, the holder has every motivation to exercise the option to purchase the underlying shares only to liquidate the position.
Comcast’s warrants in Harmonic have an expiration date of September 26, 2023 and an exercise price of $4.76. Comcast would then have no economic motivation to exercise the warrant before September 26, 2023 unless it felt the prevailing market price of Harmonic (above $4.76) was sufficiently enticing to liquidate the position and capture the underlying gain in the stock.
In this way, the cost of the warrant was/is the dilution of Harmonic’s existing shareholders. If Comcast proceeds with CableOS purchases consistent with the warrant agreement, then Comcast would receive the maximum warrant shares of 7,816,162, which was slightly less than 10% of Harmonic’s outstanding shares at the time of issuance in September 2016 (it is even less today). To keep the math simple, if we assume the Comcast warrant were 10% (again it is less) of the outstanding shares of Harmonic then almost 10% of every penny of Harmonic stock gain above $4.76 belongs to Comcast, not Harmonic shareholders. (Note: the math isn’t that clean, but it is representative of the economic relationship). At the same time, Comcast bears no investment risk given the nature of a warrant.
The trade off for Harmonic is an incentive for a large customer to purchase its products in a structured manner. My reading of the original agreement suggests with the most recent announcement, Comcast has now vested a total of 2,735,659 warrant shares or 35% of the potential total. The remaining tranches of vesting are based on meeting remaining deployment milestones and then sales receipts from Comcast. (For those interested in the accounting of the warrant, the change in the warrant’s value is treated as a reduction in revenue).
At the time of issuance and in all subsequent statements, Harmonic’s management has indicated the net effect of the Comcast agreement will be accretive to Harmonic shareholders. Because a variety of the specifics of the deal have been redacted (for good reason), we not in a position to verify this statement in the absolute.
The reaction of Harmonic’s stock is a good proxy for the verdict of the shareholders. Ironically Harmonic’s stock closed on Wednesday’s trading session at $4.75. It then traded up $0.50 during today’s session, which was informed by the SEC filing. This is directional evidence that the benefit of greater Comcast purchases exceeds the resulting dilution.
Press Release Announcing Harmonic Comcast Warrant Agreement
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