Elliott Management, a hedge fund manager, today disclosed equity investments of about $100 million each in Polycom and Mitel, and stated that it believes that the two companies should consolidate.
In a letter to Polycom's board of directors, Elliot outlined potential financial benefits of such a merger. While there may indeed be some short-term financial benefits, I have concern over longer-term fit and viability.
Elliott's Suggestion
Elliott has quietly become the largest shareholder in both companies, holding about 6.6% of Polycom and 9.6% of Mitel. (It also holds a stake in ShoreTel.) The investor said it believes that market consolidation is necessary, and that both companies will be stronger together than separate. Mitel and Polycom have issued public comments that essentially say, "No comment." Both are public companies currently in quarterly quiet periods.
In its letter to Polycom, Elliott suggested the company acquire Mitel for about $1 to $1.2 billion. That would create a more powerful combined company that nearly doubles Polycom's revenue, to $2.5 billion, with over $500 million EBITDA.
Validation for Mitel
The strategy isn't particularly new for Mitel, albeit reversed. Mitel has been executing on industry consolidation with several recent acquisitions. The largest of which was the purchase of Aastra in 2014. Elliott cited this transaction as a proof point, stating it created a company with $1 billion in revenue that has #1 market share in Western Europe and #3 market share in North America. It noted several financial benefits as well, including improved margins and $75 million in cost synergies.
By most measures Mitel's acquisition of Aastra was smartly architected and implemented, but these two companies were highly complementary. Where one was strong the other was weak. Mitel spent about a year re-aligning its portfolio by cherry-picking the best of overlapping solutions. Mitel and Polycom have much less overlap -- and synergy.
Elliott said it believes that Mitel has a very capable management team that understands M&A, and that a merger between Polycom and Mitel is only a starting point. It hinted that ShoreTel may be next. Mitel approached ShoreTel about a year ago with an offer of $8.50 a share. ShoreTel rejected the offer. Elliott said it believes that rejection was a mistake, and pointed to ShoreTel's $7.80 price today as proof. ShoreTel was 90% through a major portfolio shift, which only launched last quarter.
Polycom's Options
In the letter, Elliott was quick to point out that none of Polycom's attempts to correct its performance have worked and that Polycom's stock price was trading at a near 52-week low prior to this news. Elliott wrote that Polycom has one of the lowest valuations among its enterprise tech peers. In the last two years, Polycom has changed management, pivoted strategy, and cut costs, yet continues to report sales declines in its core products with a stock price that hovers around the price when Peter Leav started as CEO in December 2013.
Elliott suggested that Polycom has four options: maintain the status quo, which it said is a general degradation to the business; acquire younger, more innovative firms, but Elliott pointed to Polycom's track record and ability to attract as barriers; go private, which it said could be a viable option to evaluate as a means to reduce short-term pressure; and, lastly, consolidate, which is what Elliott is encouraging with Mitel.
What Elliott's Missing
Elliott makes a strong case for consolidation and said it believes the combined company would be #2 in video conferencing, #1 in business cloud communications, #1 in Europe IP/TDM PBX, #3 in U.S. IP/TDM PBX, and #1 in Microsoft telephone handsets.
Industry consolidation is inevitable, but the term generally applies to competitors or complementary vendors. Polycom and Mitel are neither. This is illustrated with the claims above. Polycom is already No. 2 in video, and Mitel is already No. 1 in Europe IP/TDM. The combination isn't going to create new claims -- in fact, it may endanger some of them.
For example, Polycom is currently No. 1 in Microsoft telephone handsets. Microsoft and Polycom have worked together on several solutions. This has proven to be a synergistic relationship as the two companies complement each other's solutions. Microsoft attempts to avoid partnerships with competitors, and the near identical Aastra phones for Lync seemed to decline in acceptance after MItel acquired Aastra. Mitel did leverage Aastra's other IP phones, which have emerged as the preferred handsets for all Mitel platforms.
Polycom's phones are doing very well, but again mostly in non-competitive environments such as Microsoft, 8x8, and Thinking Phones. It is unlikely that these providers and vendors will embrace the endpoints from a direct competitor, thus putting Polycom's only growing segment at risk.
Mitel is in the process of pivoting its own business to cloud and wireless solutions. Polycom is active in neither. Polycom just unveiled its approach to the "workplace of the future" and it is a new set of capital equipment for conference rooms. Mitel has been growing its cloud-service revenues and is doing better than its peers in this fast-growing segment. Polycom will add little value to this momentum and the merger itself will likely create a distraction.
To solve video, Mitel partnered with Vidyo. It has integrated Vidyo technology into its applications, devices, and hosted offerings. Vidyo technology is well suited for Mitel's approach. It also has a competitive advantage over low and variable speed bandwidth such as wireless connections. Mitel-Polycom would undoubtedly undo that relationship, and the associated improvements of the past several years.
Industry consolidation will continue, but as I said, this particular combination is questionable beyond some short-term financial gains. Mitel needs more acquisitions that complement its momentum in next-generation wireless and cloud solutions. Both premises-based UC and video solutions are mature markets.
Polycom would also be better suited in a combination that better complements its current solutions -- ideally a combination with Microsoft or perhaps even merging with a direct competitor such as Vidyo or Zoom.
Elliott is very successful at financial engineering. Just this announcement today has increased its wealth. The arguments for consolidation are strong, but fail to address how the combination will better the portfolio or the customers.
Dave Michels is a Contributing Editor and Analyst at TalkingPointz.
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