Earlier this month, ShoreTel announced its intention to acquire M5 Networks. The highlights of the deal include an M5 valuation of $160M (estimated to be about four times revenue), of which about half will be paid in cash. ShoreTel intends to operate M5 as a subsidiary, with key M5 management remaining. This was, in my opinion, a fairly significant announcement for ten reasons:
1) Acknowledgement of Hosted Voice
Hosted voice, enabled by VoIP, has been around for a little longer than a decade. Until VoIP, telecom was severely limited by geography. There were workarounds, but VoIP is naturally geo-independent. Now, a service provider can serve the nation from just one data center. A recent report by Gartner shows the IP Voice-as-a-Service market growing at a 36 percent compound annual growth rate in North America through 2015, to $2.2 billion. But, as Gary Kim points out, when compared to the entire sector, hosted voice could represent less than six-tenths of 1 percent of US industry revenue.
The major premises-based vendors have been slow to acknowledge hosted voice. ShoreTel is the first among them to acquire its way into the hosted space. Mitel and Siemens Enterprise offer hosted solutions based on their own technology. Microsoft appears poised to enter the space as well. Service providers use the products of numerous vendors to create a hosted offering, but for the most part the premises-based providers have remained on the periphery of this emerging sector.
2) Mergers and Acquisitions Likely to Continue
The M&A activity appears to be accelerating. Most hosted voice service providers continue to experience double digit growth, yet the market remains highly fragmented and ripe for further consolidation. Here's a snapshot of some recent activity:
* Cbeyond acquired Aretta Communications in 2010
* Comcast acquired New Global Telecom (NGT) 2010
* Warwick Valley Telephone acquired Alteva in 2011
* Broadsoft acquired iLync Communications (2011)
* West Corporation acquired Smoothstone IP (2011)
* Stage 2 Networks acquired the hosted division of CTI (2011)
* Microsoft acquires Skype (2011)
* Megapath acquired 5280 (2012)
* Shoretel and M5 (2012)
3) Hosted Voice isn't just for SMB
8x8, as a public company, reveals hosted voice is largely adopted by small businesses. 8x8 has on average about 9 lines per customer. M5 appears to be servicing larger accounts, with an average customer size of 30 lines per customer.
Larger companies are embracing various forms of cloud computing and outsourced services at an accelerated rate. As a result, the larger carriers, including AT&T, BT, and Verizon, have entered the sector. Hosted voice and hosted UC are becoming legitimized rather quickly--the sector may see some explosive growth as the average customer sizes head north.
4) Technology Matters
Although M5 initially purchased its platform, it migrated to its own technology. ShoreTel stated that it valued many aspects of M5, including its revenue/customers, technology, and management. ShoreTel determined that acquisition outweighed building its way into the market. To become a hosted service provider, one must either purchase or develop a platform (or purchase wholesale capacity). Most purchase the software, but some including M5, Fonality and Thinking Phone Networks built their own (as did Mitel and Siemens Enterprise).
Whether the software is purchased or developed internally probably doesn't matter much to the end user, but will have a significant impact to the buyer and valuation. For a premises vendor, ownership and control over the platform will be critical. Carriers and peers will want to consolidate their platform, thus a purchased platform will be preferable.
5) Marketing
One key opportunity ShoreTel intends to seize upon is the branding opportunity of a highly fragmented hosted market. Other than a few carriers that are targeting large enterprises, very few hosted providers are well known nationally. One of ShoreTel's key strengths is marketing and branding--there are various indicators that the company has much broader awareness in the market than its size might otherwise dictate. ShoreTel intends to rebrand or expand the M5 brand with the ShoreTel name, as well as likely expand internationally. Conceivably, ShoreTel/M5 could become one of the best known brands in the hosted sector.
6) The Peanut Gallery Likes It
The hosted service providers I've polled seem to like the acquisition. It signals a validation of the business model, offers a reasonable exit valuation, and rewards M5 for hard work and perseverance. ShoreTel's premises-based competitors have not been as vocal, but probably like the idea of ShoreTel's management and cash being distracted.
7) International
International hosted voice is clearly the next logical expansion. It will attract organizations with international presence and/or international requirements for mobility. The challenge with international expansion is economies of scale associated with market traction. Perhaps having two businesses--systems and services--will enable faster growth overseas.
8) The Hosted Contact Center
ShoreTel acquired M5, but prior to that, M5 acquired contact center specialist Callfinity. 8x8 recently acquired hosted contact center provider Contactual. USAN acquired Interactive Softworks to bolster its hosted contact center offering. Interactive Intelligence expanded into hosted contact centers years ago. There's really two separate and complementary emerging sectors--hosted voice and hosted contact centers. Frost & Sullivan, for example, "believes that the hosted contact center market is moving quickly out of the early adopter stage, with immense growth potential for the future."
9) Cash and R&D
The hosted sector is growing quickly. Any growing business requires considerable cash. The hosted providers are pouring every cent they can muster into R&D, customer acquisition, infrastructure, operations, and footprint expansion. Dan Hoffman, CEO of M5, specifically cited "access to capital" as one of the key reasons he sold M5 to ShoreTel. However, ShoreTel is experiencing rapid growth itself and will be handing over the majority of its on-hand cash per the acquisition. This is going to create some strong pressure on cash management and engineering integration. There is some strong upside potential, but the route involves a tollway.
10) The Channel
ShoreTel sells through its indirect channel including dealers and carriers (which ShoreTel refers to as service providers). M5 presents two new challenges--a direct sales force (which ShoreTel intends to further develop), and direct contractual relations with customers. Both represent uncharted territory for ShoreTel. This will create some challenges for ShoreTel regarding channel conflict. The different sales forces (M5, ShoreTel, direct, indirect) is one aspect, but so is reassuring its service provider dealers that ShoreTel/M5 is not a competitor.
Dave Michels is a contributing editor and maintains a telecom blog at TalkingPointz.comTalkingPointz.com
