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Avaya Braces for Big Changes to Avoid Chapter 11 Again

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Image: Klaus Ohlenschlaeger - Alamy Stock Vector
Last week, Avaya dropped a few bombshells. First, it issued a preliminary third-quarter warning that it now expects a major decline in third-quarter revenue and then announced a new CEO.
 
The company now believes third-quarter revenue (ending June 2022) will land between $575-580 million, down from its previous guidance of $685-700 million. Actual results are expected to be reported on August 9, 2022.
 
The miss is very concerning for three reasons. First, the sudden change indicates revenue is declining far faster than expected. The company is missing targets that were revised lower last quarter. Secondly, a month ago, the company raised $600 million, which was presumably based on previous guidance. The third and biggest concern is that the revised revenue forecast is expected to generate only $50-55 million in EBITDA (down from $140-150 million). Avaya spent $54 million on interest expenses last quarter alone, signaling an impending cash crisis. To counter, Avaya also announced a severe cost-cutting measure, but that’s unlikely to be enough.
 
Regarding the change in leadership, a separate press release stated Jim Chirico “will be removed from his positions as president and CEO of Avaya.” The wording was urgent and authoritative, and it appears to cast all blame on the CEO. But many of us have wondered why the board didn’t act sooner — years sooner. Avaya’s new CEO will be Alan Masarek, who was the CEO of Vonage from 2014-2020.
 
Looking Back at Avaya’s History
This news certainly requires a lot of unpacking. Let me start by saying Avaya is one of the most complicated companies in our industry. That’s because Avaya has a direct lineage back to Ma Bell. Long story short, the original Bell System had a division called Western Electric that was founded in 1869. It built most of the switches used in the original PSTN. The company/division has gone through a lot of names and owners over the past 153 years, but there is a direct path to Avaya.
 
There’s more to its complexity than history. The enterprise communications sector has gone through three major disruptive shifts in the past few decades: to converged IP communications, from hardware to software, and from products to (cloud-delivered) services.
 
Most of the incumbents did not complete the journey, including Aastra, Ericsson, Nortel, Mitel, Siemens, ShoreTel, Toshiba, and more. Avaya itself ended up in Chapter 11 in 2017. Transformation is hard, and many of the top providers today haven’t gone through such existential challenges.
 
At the end of 2017, Avaya named Jim Chirico its new CEO. Chirico had been with the company for ten years and was most recently its chief restructuring officer. This would be his first CEO opportunity. He wasn’t technical but had Laurent Philonenko, SVP solutions and technology, and Mo Nezarati, VP cloud and GM (and architect) of Zang (Avaya’s CPaaS product), to guide him. Philonenko had senior leadership experience from two of Avaya’s top competitors: Cisco and Genesys. Nikos Nikolopoulos also returned to Avaya as its SVP for strategy and corporate development.
 
In early 2018, a lot of optimism and excitement surrounded Avaya. As the Chapter 11 process ended, Avaya once again became a publicly traded company. Despite some losses, its impressive customer base was proven loyal and still included many of the largest companies and governments in the world. The bankruptcy process reduced its debt, enabling Avaya to invest in its future once again.
 
It was clear then that the cloud was the future, so the strategy was to build a UCaaS and CCaaS solution for both new and existing customers. The company had the brand, customers, channels, and cash to pull this off. One of Chirico’s first big hires was Mercer Rowe to spearhead the development of Avaya’s cloud.
 
Avaya started 2018 with a bang. In January, it announced the acquisition of Spoken for approximately $180 million. Spoken had supposedly cracked the code on adapting Avaya solutions for the cloud. The Spoken team would report to Mercer Rowe… at least until he departed a few months later. Avaya then hired Gaurav Passi in November as its new cloud president.
 
While the company was working on Spoken, it also had a few other notable cloud assets. It had done an admirable job of adapting its IP office solution to a cloud service known as IP Office Cloud. Avaya launched a UCaaS service in Europe that it co-developed with 2600Hz. Also, Avaya launched a CPaaS and meeting cloud service called Zang in 2017 under its previous CEO.
 
No cloud service ever came out of the Spoken acquisition, and today, no Spoken executives remain at Avaya. Nezarati left Avaya in May 2018. Avaya was back to the drawing board for a cloud solution in 2019. The company rehired Chris McGugan as its CTO, who previously worked at Avaya from 2005-2014 in various technical leadership roles. Nikolopoulos and Philonenko departed Avaya in early 2019.
 
RingCentral Enters the Picture
Avaya concluded that it was better to partner than build its UCaaS solution. In October 2019, Avaya and RingCentral announced a partnership that created Avaya Cloud Office by RingCentral (ACO). The idea was to allow Avaya to monetize its SMB base immediately, which would allow it to focus on the development of a next-generation cloud contact center.
 
The RingCentral partnership was significant for Avaya in many ways. This was the first time Avaya offered a third-party solution as a primary platform. Avaya had to compete with essentially identical offers from other RingCentral partners. ACO accelerated Avaya’s shift to a subscription-based revenue model, which it was able to replicate with enterprise customers on OneCloud.
 
The RingCentral partnership came with some onerous requirements. Avaya granted RingCentral exclusive UCaaS rights to its customers. This meant it had to discontinue IP Office Cloud, which had been building market momentum. Avaya also had to discontinue its UCaaS offer in Europe that it was co-developing with 2600Hz. RingCentral paid Avaya commissions up front, which will need to be returned if Avaya misses on sales.
 
More significantly, ACO conflicted with other Avaya products. Avaya relaunched Zang as Avaya Spaces, which included messaging and video services, but they were incompatible with ACO. RingCentral built a strong integration to the NICE CXone CCaaS, so ACO customers had conflicting contact center options. RingCentral also obtained a seat on Avaya’s board. Soon after the partnership, McGugan and Passi left Avaya.
 
The Revolving Door at Avaya
Throughout Chirico’s tenure, Avaya’s C-suite has gone through a revolving door. Over the next few years, we would see the arrival and departure of many technical executives, including Hardy Myers for strategy and business development, Anthony Bartolo as chief product officer, and Karl Perkins as CTO. It was more than the technical leadership. Over the past five years, Avaya has had multiple CFOs, marketing heads, and sales leaders. Many of which were familiar names from other communications firms, including Dino Di Palma, Jon Brinton, and Becky Carr. All these executives held long-term successful positions with other employers.
 
The cost of turnover is difficult to calculate, but clearly, Avaya’s technical vision and roadmap suffered. The company has not clearly communicated a detailed vision or technical roadmap for some time. The few significant updates that did occur were poorly communicated. Avaya possibly renamed all its products OneCloud to obfuscate the direction and health of individual product lines within its portfolio.
 
Tens of millions of dollars were spent on executive severance packages. I suspect a few executives are waiting to get fired. Passi hasn't listed another position on his LinkedIn profile since departing Avaya almost three years ago.
 
In addition to Spoken and executive turnover, the company has spent hundreds of millions of dollars purchasing its own stock. The board approved up to $500 million in repurchasing stock. In its March 2021 10Q filing, it reported the repurchase of 245,000 shares at an average price of $29.69 a share — near its all-time high. The stock is trading for less than a dollar today. That filing indicated Avaya spent $163 million so far.
 
It’s also worth noting that Jim Chirico took home about $14 million in compensation last year. This made him one of the highest-paid CEOs in the industry. Chirico's compensation consisted of 70%, or $9.7 million, in stock awards. Chirico also received $2.8 million in non-equity incentive plan, $1.3 million in salary, as well as $35,000 in other compensation. He may be eligible for a severance package this year.
 
The bottom line is that Avaya squandered a lot of money and time and has little to show for it. Meanwhile, its competitors are growing. Just last week, Five9 raised its guidance and specifically cited accelerated growth in enterprise CCaaS. Genesys, NICE, and others have been successfully targeting Avaya contact center customers. The UCaaS sector too saw spectacular growth during the pandemic. Microsoft, Zoom, and others offer products and services directly competitive to Avaya.
 
What’s Next
Alan Masarek accepting this position implies his confidence that Avaya can be fixed. But as I said above, Avaya is an extraordinarily complex company, exponentially more complex than Vonage was. This is primarily because of the size and complexity of Avaya’s customers and its global reach.
 
Masarek isn’t going to have the time to get to know Avaya like he should before making significant changes. Fortunately, he’ll be getting a lot of advice from employees, analysts, and former executives. The first priority is assessing the cash situation. Masarek needs to urgently determine if his strategy is to manage the company into Chapter 11 or avoid it. Regardless, he must rebuild trust with investors. It’s important to note that we don’t yet have an explanation for the shortfall in revenue.
 
The next priority is to figure out the cloud. This is probably what attracted Masarek to take the position, as he’s done this before. Vonage first pivoted from consumer to business, then from BroadSoft-powered to a native, new platform. This will start with a build-vs-buy analysis. I assume Avaya has some compelling solutions in its labs. He has time to build as we are still in the early stages of large enterprises adopting CCaaS.
 
I would not rule out Avaya acquiring companies, though probably not with cash. Avaya can instead leverage its global customer base. For example, Google struck a strategic arrangement with Ujet earlier this year that didn’t require a formal acquisition. Also, several struggling CCaaS providers should be open to creative options. Renegotiating a more equitable deal with RingCentral may be possible, particularly with the threat of Chapter 11.
 
I expect Masarek will also prioritize cultural changes; a new CEO will facilitate this through the usual C-level changes and cost-cutting. At Vonage, he implemented several changes to make its offices a desirable destination for employees.
 
Masarek brings to Avaya experience with UCaaS, CCaaS, and CPaaS. He holds a Harvard MBA and has a great track record for successful acquisitions. I’ve always had the impression Masarek truly enjoys this stuff. I recall Vonage multi-day analyst events where he attended and participated in every session. I also remember him working the booth at Enterprise Connect. Avaya ceased analyst events and exhibiting at Enterprise Connect, an event it once dominated, several years ago.
 
I applaud the Avaya board for selecting Masarek. Stock market investors were quick to panic last week, driving the share price below a dollar. Chapter 11 is possible but not inevitable.
 
Let’s hope Masarek and his work at Avaya becomes a future chapter in business school textbooks.

Dave Michels is a contributing editor and analyst at TalkingPointz.

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