Analyzing the Avaya Path Through Bankruptcy
Continued from previous page
Time for Strategic Refinement
Even if Avaya has a go-forward plan, management and the new owners need to take this opportunity to redefine the strategy and overall business model. The pre-bankruptcy thought, as revealed in the public documents, was to partition the company into UC and contact center pieces, with each business maintaining its respective services and services organizations. While the potential partitioning of the contact center business led to interest from several parties and, ultimately, a $3.9 billion offer (as disclosed in bankruptcy-related documentation), the attempt to sell off that chunk of the business failed, seemingly due to the business, customer, and technology complexity of separating contact center from UC. Another alternative considered was a split based on size, with the separation by large enterprise and SMB/midmarket assets.
While splitting the company on products or size are obvious options, better in my mind would be to split out the services business as a separate entity from the product organizations. Avaya could do this either as part of its proposed restructuring plan or by splitting up assets if bondholders can't agree on a plan and Avaya must sell off the assets.
While delivering software and services has been the new Avaya's mantra, the reality is that high-tech companies, whether offering hardware or software products, generally do not have large services organizations. While product companies provide support for their products (updates, patches, warranties, etc.), they generally outsource services such as installation, break-fix, monitoring, and professional care to a range of third parties -- the channel, systems integrators, consulting companies, and others. By having a large services organization with 50% of revenue and requiring customers to buy Avaya services, Avaya's relationship with its channel and other partners has become challenging. The result is that channels often recommend against upgrades or sell competitors' platforms to protect existing services revenue streams.
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The value of the services business should be another factor in deciding to split that part off. The services business provides value in two ways -- from the actual revenue stream and from the relationships that Avaya services has with a significant percentage of large U.S. and global companies. Using a current revenue stream of about $1.2 billion for non-product support services (reduced from the public documents by 10% to account for the impact of the bankruptcy process) and current EBITDA of about 25% to 30%, the revenue stream can extend five years.
Based on management projections and assumed impacts of the bankruptcy, projecting the average annual five-year services business revenue to be about $1.1 billion, and with a 25% EBITDA, is reasonable. The resulting five-year average EBITDA would be about $303 million. If the EBITDA multiple is assumed to be at the top of the generally accepted range due to the value of the relationships and the ability of an acquirer to use those relationships to sell other services offers, a 12 times EBITDA multiple is achievable.
With this analysis, the services business could have a $3.6 billion value on the market -- and this would dramatically reduce the debt load on the remaining core UC and contact center product businesses. In addition to the basic value of the revenue stream, acquiring the Avaya services business could be an attractive way for any number of managed services providers to expand their market positions.
While Avaya customers have been used to getting Avaya services and products together, I believe the customer base would clearly understand splitting off the services organization and would be generally accepting of a new services partner that could both service their Avaya portfolios as well as a wider range of IT systems. This vendor-services relationship matches other vendors' services strategies, and the resulting organization could expand the strategic services footprint in many Avaya customers. The resulting organization could also become a channel and compete with other channels in the market.
A non-Avaya connected services organization could make substantial inroads into services adjacencies like Cisco networking and Microsoft Skype for Business services that are not available to a services organization as part of Avaya. Finally, with many of the new Avaya offerings including a strong digital transformation component, having the Avaya services organization acquired by an organization with strong digital transformation skill sets could accelerate the position of those offerings in the market.
Little Promise in Networking
Data networking is the other business that needs consideration. In discussions at the analyst and consultant sessions at the recent Avaya Engage meeting, Avaya executives made clear that UC and contact center are core. They did not include the data networking business in that grouping.
While the new fabric networking has some significant differentiation and value, the Avaya data networking business is very challenged, both in market share and financially. At the 2016 level of $250 million annual revenue, its market share is less than 1%. The result of this position is that the data business has had a negative EBITDA of $259 million over the last three years. The negative EBITDA has been increasing, resulting in a negative EBITDA of $100 million in 2016. As actual cash burn is generally higher than EBITDA in a negative situation (EBITDA is before some costs like restructuring, taxes, debt, etc.), the actual cash burn is probably higher, closer to $120 million to $140 million for 2016.
Unless Avaya realizes an immediate dramatic (100% plus) increase in revenue, with prospects for even more future growth, this business probably does not have a high current value. It's likely that a result of the restructuring will be the sale of the networking business, assuming a buyer can be found that will support the existing customers. For customers of Avaya Networking and fabric networks, this may be the best outcome as it will assure an ongoing level of support and potential increased investment levels that will be challenging for the networking business as part of Avaya.
Addressing Root Cause
How Avaya emerges from the bankruptcy process and the structure of the company going forward is critical for both Avaya's success and the industry overall. For the last five years, Avaya has had an average revenue decline of about 6%. This ongoing decline is not due to the capital structure, but rather due to market conditions and Avaya's competitive position within the market. Avaya must take advantage of the reorganization process to change the company strategy and position. The result of just having a "successful" capital structure exit from bankruptcy may be just a continued gradual decline if Avaya doesn't address the underlying business issues.
If Avaya takes advantage of the opportunity that the capital restructuring offers to address the basic strategy, positioning, and competitive situation, the potential for a new path forward based on the innovation and new products entering the portfolio is strong. Focus on the key elements for success is critical -- a combination of great vision, strategy, innovation, positioning, and execution. To succeed in an ever-more competitive marketplace, Avaya needs to make sure that it clearly understands and aligns these elements going forward.