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Mitel and the Painful Cloud Chasm Crossing

I had a chance to talk with Mitel CEO Rich McBee after the company announced its latest quarterly financial results last week, and much of the conversation centered around the transition that Mitel is making from being a legacy CPE provider, toward the new world where cloud, mobility, and contact center play a much more significant role for Mitel (and just about every other enterprise communications vendor, by the way).

Simply put, Mitel seems to be finding itself in the same spot where other vendors either have been or will be: By more aggressively targeting the cloud, Mitel is confronting the challenge that a recurring revenue model, while potentially more lucrative in the long run, constrains revenue growth in the short run when fewer large up-front CPE purchases are being made.

The numbers are pretty clear: Mitel's total GAAP revenues for the most recent quarter were $276.9 million, down from $288.7 million for the previous year. That decline seems largely attributable to a dropoff in Mitel's premises equipment business: from $264.3 million a year ago to just $215.2 million in the quarter that just ended.

By contrast, Mitel's cloud business is growing nicely -- from $27.4 million to $37.2 million Y/Y, a 36% growth rate, with number of seats growing 76%. But the problem is obvious: It's a much smaller part of Mitel's business, so even a high growth rate can't make up for the decline in the premises business.

McBee shared a telling statistic: Last quarter, Mitel won cloud business that would have brought in $15 million worth of revenue upfront if the customers had gone premises instead of cloud. "There's no kidding about it: The migration to the cloud is a tough transition," he said.

Over the life of those cloud contracts, these customers should bring in more revenue than what would have been realized from premises sales, which is good for the company, McBee said: "A recurring revenue base for our shareholders is a much more stable revenue base."

It's not just customers opting for cloud over CPE that's putting a drag on the premises business, McBee said. It's the ongoing trend to delay new investments in CPE: "The decline has a little bit to do with the refresh cycle," he said. "They're sweating their assets a little longer than we thought." And in Mitel's case, the company's strong position in the European market has been a double-edged sword, as it's "been a pretty tough last nine months in Europe," he said.

Ultimately, there's not much anyone can do to change the fundamentals of the market, he said: "The premises business is the premises business; we just deal with it," he said. "This is the strategy that we built. We knew this transition was to be."

And it's not as if the premises business is headed for zero. McBee said larger customers still are opting for "private cloud," aka premises equipment/software running in the enterprise datacenter; he doesn't expect that to change any time soon.

In the meantime, the company is also working to transition its newly-acquired mobile business from the startup model of Mavenir to one that's more suited to generating profit for Mitel. McBee described the transition as moving from "growth at all costs" to "profitable growth." Like any startup, Mavenir was focused on simply winning business everywhere it could, even if the carrier customers it signed weren't necessarily blue-chip accounts. Mitel is focusing on building longer-term strategic relationships with leading carriers, and saw this pay off with 35% growth in its mobile business last quarter, according to McBee.

Mitel's cloud strategy still looks like the right move, especially at the lower end of the market that Mitel dubs "Retail Cloud" (in contrast to the aforementioned "private cloud" that's based on products we'd consider "premises"). Mitel's average installation for Retail Cloud continues to hover just under 40 seats; and a recent No Jitter survey found that in the sub-100-seat segment, 22% of respondents were already using a hosted service for PBX/call control, and another 28% expect to migrate to the cloud within 12 months -- meaning fully half that segment could be cloud-based a year from now. It's a ripe opportunity for Mitel (and its competitors, of course).

So, bottom line: The high end of the core communications market is sweaty, while the low end is cloudy. It's hard out there for a vendor.

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