Allan Sulkin
Allan Sulkin, president and founder of TEQConsult Group (1986), is widely recognized as the industry's foremost enterprise communications market/product analyst....
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Allan Sulkin | July 21, 2009 |


The Motivating Reason Behind the Avaya Bid for Nortel ES?

The Motivating Reason Behind the Avaya Bid for Nortel ES? Most of the analysis and commentary has been about market issues. It's also just as important to look at the long term financial implications for Avaya's owners.

Most of the analysis and commentary has been about market issues. It's also just as important to look at the long term financial implications for Avaya's owners.

If Avaya is successful in its attempt to acquire Nortel's enterprise business it will effectively double the size of its installed customer base, almost double its global market of annual CPE line shipments, improve its market coverage through additional partner channels, and significantly expand the size of its product portfolio. These have been the most commonly touted results of a merger between two of the world's leading suppliers of enterprise communications systems, but there may be an even more important reason behind Avaya's "stalking horse" bid, one that is almost purely financially motivated.Silver Lake/TPG paid $8.2 billion for Avaya in a leveraged buyout two years ago, a sum only fractionally offset by Avaya's cash assets at the time. The purchase price was about 1.5 times the company's revenues at the time. I personally think that the private equity firms overpaid by a few billion dollars, for a variety of reasons, chief among them the specter of two deadly competitors. Two years ago Cisco had supplanted Avaya as the North American market leader in terms of line station shipments and had strong momentum to increase its market share lead going into the future (as has been the case). During VoiceCon Orlando earlier that year Jeff Raikes, then President of the Microsoft Business Division, announced the imminent release of Office Communications Server 2007 public beta and outlined Microsoft's intentions to enter the voice communications market by unifying communications through its software solution. Avaya's best days may have been behind them, unless something dramatic was fated to take place.

The financial implosion of Nortel and the subsequent filing for bankruptcy created the opportunity for Avaya to acquire the Canadian-based company's enterprise business operations at a fire sale-like price. Avaya's "stalking horse" bid of $475 million is less than one third of this year's projected Nortel ES annual revenues. Nortel ES revenues have declined significantly during the past two years, devaluing the business unit substantially. There are several reasons for the decline, but one has been beyond Nortel's control, the economy. The economy is forecast to improve during the next year and contribute to stronger market revenues. During yesterday's webcast to industry analysts and consultants Joel Hackney, President of Nortel ES, said that their revenue situation improved during the past fiscal quarter compared to the previous quarter. If revenues for Nortel ES operations hold steady or increase during the next two years that could be a financial bonanza for Avaya's owners who plan to take the company public, again, when circumstances are more favorable than today.

During last year's Avaya industry analyst meeting a Silver Lake executive explicitly said that the strategic plan was to take the system supplier public, again, after a few years of revenues growth at a higher offering price than originally paid, similarly to how they handled their Seagate Technology investment. I don't think Silver Lake or TPG knew at the time that there would be dire eonomic times ahead that would significantly shrink the size of the market and resulting Avaya revenues. Avaya revenues very slightly declined during its last fiscal year and will decline measurably the current fiscal year (discounting Nortel ES revnenues if the acquisition goes through). The downward financial situation puts a major crimp in earlier plans to go public, likely delaying it two yars or more from an original time schedule.

Buying Nortel ES can significantly ease an Avaya public offering for several reasons:

* Unless the merged company completely implodes it would be able to state in an SEC filing that it was the North American and global market leader in enterprise communications by almost any important metic (revenues, shipments, installed custome base), something that would appreciably help support a targeted public offering price per share;

* The combined revenues of the two organizations would demand a higher market capitalization price based on a greater multiple than the Nortel ES acqusiition factor: a multiplier factor of only one times sales would increase the current market value of Nortel ES revenues by about $1 billion (a nice tidy sum)

* The merged entity would presumably be a stronger competitor against Cisco, Microsoft and the rest of the field.

Without Nortel ES there is little probability that Avaya's market capitalization could remotely approach $8.2 billion in the foreseeable future (unless the financial market turns so bullish that stock prices soar beyond previous highs, not a likely scenario during the next few years). If Microsoft successfully implements its planned OCS strategy and makes strong inroads into the market for enterprise voice communications Avaya has a lot to lose in terms of installed base and revenues. If Google enters the market sometime down the road with a Cloud-based solution it would further erode Avaya's market position in the long run. And Cisco is likely to continue increasing its market share at the expense of the compeition, Avaya included. The sooner Avaya is taken public again, the better for Silver Lake/TPG. The Nortel ES acquisition may be the only quick fix available to cut losses while they can. I seriously doubt that Avaya will go into a tailspin, go bankrupt and lose almost all of its market value, but there is a strong probability that it will be worth a fraction of its earlier high value in five or ten years.

Most of the analysis and commentary centering around the Avaya "stalking horse" bid for Nortel ES has been about market issues. It's also just as important to look at the long term financial implications for Avaya's owners, Silver Lake, TPG and the investors the two private equity firms. The two most recent sales of name brand enterprise communications system suppliers, Ericsson and Siemens, were at bargain basement prices. It appears that Silver Lake/TPG hopes to reverse this trend with Avaya using its acquisition of Nortel ES as an increased market value generator. If the merger of the organizations, products, and channels goes smoothly then there is a chance for the larger company to recapture lost market share and grow in the future. Any difficulties would mean loss of big dollars, more than the acquisition price of Nortel ES itself.

The primary business objective of Avaya is to remain a competitive supplier of enterprise communications products and services tomorrrow and for generations to come; the primary business objective of private equity firms is to generate targeted returns on investment, the sooner the better. The two objectives do occasionally intersect, but are not identical. This must be taken into account anytime there are large sums of money at stake. Improved market dynamics resulting form a merger of Avaya and Nortel ES operations are important, but financial results for the stakeholders are usually more important. And don't forget that top Avaya executives at the time of the acquisition two years ago were required to invest a sizable portion of their multimillion dollar proceeds from the sale back into the company. Money is always a great motivator for doing business.Most of the analysis and commentary has been about market issues. It's also just as important to look at the long term financial implications for Avaya's owners.


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