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Avaya & RingCentral: The Good, the Bad, the Ugly
As has been discussed on No Jitter, including here and here, Avaya earlier this month announced a partnership with RingCentral whereby RingCentral would offer an Avaya-branded UCaaS service based on the RingCentral platform. This new offer, Avaya Cloud Office by RingCentral (ACO), would be marketed through the Avaya channel as the UCaaS migration platform for the existing installed base.
Before getting into the substance of the relationship and what it means, I first must address the issue of the “ugly” in the announcement.
Avaya, the combination of the installed bases of two of the largest brands in traditional PBXes (Lucent Technologies and Nortel), failed to invest in or innovate to create a true multitenant cloud platform to which it could migrate legacy on-premises customers (other than the hosted options that many larger customers have opted for as an economic cloud model). Trapped by the “innovator’s dilemma,” Avaya wasn’t able to produce modern communications software designed to run on a public cloud infrastructure with an underlying modern multitenant architecture. While Avaya had a multitenant cloud offer in the Multimedia Communications Server, or MCS, platform it picked up from Nortel, it chose to stay with its decades-old technology and not to invest in the new software paradigm that is now driving industry innovation.
The key question is whether Avaya will now be able to mitigate that significant lapse in management judgement through this new relationship with RingCentral.
A Great Deal for Avaya
In analyzing this deal, I’ve come away feeling this is a good, if not great, move for Avaya — considering how challenging its market and industry positions have become. To understand the positive impact this partnership will have on Avaya, it’s important to review the four strategic challenges Avaya was facing prior to this strategic decision.
As noted, Avaya didn’t have a true multitenant, next-generation software strategy in place for any of its core product markets: large enterprise, SMB/midmarket, contact center. Let’s take a look at each market area and the challenges Avaya was facing:
- Large Enterprise — Avaya is a clear leader in installed base market, with Aura, Call Manager, and the Nortel CS1000 systems, and it has had success with subscription-based cloud migration models in this space. In fact, it has an incredible opportunity in providing the Avaya PBX cloud-hosted solution. For example, Bosch signed a five-year contact for subscription hosting of over 150,000 users (see related No Jitter post). The reason Avaya sees high demand for PBX cloud hosting is that the majority of its customers in this segment look to the company for telephony but not for advanced UC features such as video, instant messaging, collaboration, team messaging, and so on. For those, many (or most) have decided to use Microsoft Office 365. Back in 2016, a No Jitter survey found that almost 60% of enterprises with over 5,000 users were committed to Skype for Business. For Avaya, this has and will dramatically limit the UCaaS potential in this space (about 75 to 80 million of the 100 million total Avaya installed base seats). Clearly, investing heavily to compete with Microsoft has significant challenges, as evidenced by the difficulty Cisco is facing in this arena. Microsoft’s bundling of collaboration into the basic O365 license has clearly made it an easy decision for IT organizations to use Skype for Business/Teams. However, when a large enterprise legacy customer did decide to evaluate UCaaS (with cloud implementation and multitenancy) as a telephony replacement option, the Avaya team, sales and channels, didn’t have an Avaya-branded product to offer.
- SMB/Midmarket — With IP Office, Avaya has carved out a 20 to 25 million seat installed base in the smaller organizational segment. As in the large enterprise market, the Avaya cloud offers in this space have been single instance — in other words, IP Office runs as a single instance (either on a server or as a virtual machine) in data centers. Clearly, the SMB/midmarket is where UCaaS providers are having the most impact with their next-gen multitenant cloud services. The rate of scale and innovation in this market can only be achieved using the modern cloud software architectures and tools that Avaya has failed to deliver. In this space, the shortfall in Avaya’s portfolio is becoming critical as an ever-increasing percentage of customers transitioning from outdated on-premises phone systems to modern UC platforms will do so using the UCaaS model. Assuming the business communications/PBX/telephony market transitional churn of 5% a year continues (each year 5% of the installed systems is replaced with a new vendor, either premises or cloud), the inability to win new customers without a UCaaS solution is limiting Avaya’s ability to replace the shrinking premises base. In addition, the lack of an Avaya UCaaS option has led the channels to offer UCaaS alternatives, including from RingCentral.
- Contact Center — While Avaya sells many contact center seats with the communications solutions noted above, the large dedicated contact center market is where Avaya (along with Genesys) has dominated. However, this market is changing rapidly. The addition of technologies like artificial intelligence/machine learning, text, social, and even video, only available from the cloud, is changing the market and the deployment model. The key is that cloud architecture, combined with microservices and orchestration, enables rapid integrations of new modular services like the translation service that’s popping up in UCaaS offers. The new software paradigm accelerates development and allows small modular software releases with continuous improvement. The other factor is that the traditional voice contact center is now a smaller part of a company’s ability to deliver an exceptional customer experience (CX); digital channels such as SMS, social, and webchat are now crucial to reach customers as well. The reality is, without a cloud migration strategy and a valid CCaaS offer, Avaya is challenged in how to migrate the base to the next generation of CX. A further complication of this is the equity value of the larger CCaaS players; for example, Five9’s market cap, at approximately $3.3 billion today, is greater than Avaya’s market cap, which is at about $1.4 billion. This significantly limits the types of acquisitions that Avaya can afford to consider.
Another Strategic Challenge
As part of last year’s post-bankruptcy plans, first-position bondholders received the majority of shares of the newly public Avaya. However, these investors are bond funds and, generally, bond investors (especially focused funds) would prefer to sell their Avaya stock as soon as possible —for a profit, of course. But the opportunity to sell large blocks of Avaya shares at acceptable prices hasn’t emerged in the current share market. For these shareholders (the majority), having a way to sell their shares was a significant goal.
One Deal, Four Answers
As Avaya evaluated strategic alternatives, it would have done so with the goal of moving the bar on one or more of these, and it appears that the RingCentral deal addresses all four challenges in some significant way.
Clearly, from an investment perspective, this deal removes the need to invest in a new UCaaS solution or to buy a vendor. With this deal the focus is on selling ACO to the existing base, so Avaya will incur little in the way development or brand marketing costs.
In the large enterprise customer space, this will have two impacts: First, for those customers that have already decided on O365/Teams, it enables Avaya and its channel partners to focus on maximizing the length of use and revenue value of the installed telephony base. This could be done by enhancing the value of an existing Aura/Call Manager deployment with the Teams solutions organizations are adopting. Second, for the remaining 30% to 40% of customers that haven’t decided on a UC provider (the rest of the base other than the 60% that have chosen Microsoft), it enables Avaya to have a frank conversation; accept a Microsoft Teams decision, or sell existing premises offers or the value of an ACO migration.
To understand the value of the deal to Avaya, we can assume the remaining average life of the Avaya large enterprise base is 20 years (an arbitrary number based on a 5% of the current base leaving each year for 20 years). At this linear rate of decline, Avaya future revenue would be equivalent to current annual revenue for half the total time, or 10 years. Including the services and cloud hosted offers, the ongoing base revenue should be over $10 billion over 20 years. This is based on the current annual rate of over $1 billion of ongoing revenue currently operating at very good overall margins.
For the SMB/midmarket (IP Office), the ACO UCaaS offer, due first quarter of 2020, will enable channel partners and the customers to migrate to an Avaya-branded UCaaS offer (with tools and potential phone reuse), albeit one provided by RingCentral. As with the large enterprise space, the deal with RingCentral enables Avaya to keep the ongoing premises SMB/midmarket revenue as well.
As a result of not having to invest in UCaaS, Avaya will presumedly be able to focus much more attention on CCaaS and cloud contact center migration. While this doesn’t guarantee success, clear focus is often critical to a major repositioning, which is what Avaya is doing with an eye on its future in contact center/CCaaS/CX.
Finally, Avaya received $500 million from RingCentral, primarily in stock, as part of the deal. This breaks down into a $125 million investment in Avaya, via stock purchase, and a $375 million investment through a combination of licensing and pre-paid royalties. Of the $375 million, the majority was attributed to the pre-paid royalties.
With this $500 million infusion, Avaya announced that it planned to take $500 million out of its cash reserves to buy back shares. With a market cap of under $1.5 billion, this would mean that Avaya would be able to buy back 35% to 45% of outstanding shares — and provide an exit for a number of the original bond investors. This is clearly the number one priority, since Avaya is using all the cash for this purpose rather than applying some of it to an acquisition or some other innovation investment, or even as general capital use for business expansion. This further demonstrates the current inability to invest in both UCaaS and CCaaS solutions going forward.
So, this deal appears to have addressed all four issues in significant ways:
- It enables Avaya R&D and marketing to ignore UCaaS and focus on CCaaS
- It gives Avaya a UCaaS answer in the market, providing clarity to existing IP Office customers and channels that the UCaaS future is clearly ACO
- It allows Avaya to work more closely on how its large customers can integrate their existing Avaya products with their O365/Teams direction or consider ACO
- It allows Avaya to buy back shares and placate its bondholders turned stock investors
RingCentral — Buying a Hunting License
For RingCentral, this is either a brilliant move or a risky partnership paid for by incredible equity value. In either case, with a little over two million subscribers, the potential of the Avaya base migration makes this a good deal for RingCentral as well. With Avaya, RingCentral has gained access to a 20 million to 100 million seat installed base and thousands of channels with a UCaaS offer that includes some level of migration advantage. While the migration value factors haven’t been fully identified, the combination of phone migration, feature invocation, configuration migration, brand familiarity, partner familiarity, and potentially other factors may provide significant values for IP Office customers to move to ACO. Regardless, access to the channels and their Avaya customer relationships should help accelerate the growth of the RingCentral subscriber base. The challenge is for RingCentral and Avaya to create a compelling offer.
Another factor is average customer seat size. For RingCentral, the average size of IP Office customers is certainly a huge draw. Based on the current numbers, RingCentral has an average of about six to eight seats per customer (350,000 customers and between two and two and a half million seats). With the IP Office base at about 50 seats on average, this is a huge uplift opportunity for RingCentral. Converting just 10% of the current 20 million IP Office base into ACO subscriptions would be almost the equivalent to the current RingCentral base, but would change the average number of seats per customer dramatically. Increases in seats per customer should have significant positive impacts on both churn and operational costs.
Another analysis is the RingCentral cost of customer seat acquisitions. Based on an estimated current per-UCaaS seat acquisition cost of $250, acquiring two million seats in the open market would cost $500 million. So, the payment of $375 million to access that base may be reasonable even if less than 10% of the current base migrates to ACO.
However, to realize the long-term potential fully, the migration percentages must be higher than the volume anticipated in the $325 million pre-paid royalties. Based on comments by Vlad Shmunis, RingCentral CEO, the goal is millions, even tens millions, of migrations to ACO. A key component driving this outcome will be how well Avaya supports the RingCentral effort. If Avaya focuses on this as a long-term revenue opportunity (to get to three to four million seats), the impact on RingCentral in the UCaaS market will be huge. However, if Avaya looks at this as a RingCentral problem to grow and is concerned about the cash costs in the build-up, RingCentral may have challenges reaching goals to justify the expenditure.
Overall, Avaya and RingCentral should be congratulated for striking an “out of the box” solution that has the potential to be transformational for both companies. For RingCentral, this deal provides priority access to one of the single largest PBX premises installed bases, all based on using equity with a high market value. The Avaya management team and its advisors should be congratulated for creating a unique solution to multiple complex strategic issues. Overall, a great strategy… now on to delivery.
In my next article, I’ll examine the relationship in more detail and explore whether it’s a good deal for Avaya.