Avaya

Telecom Implosion                                                     12/1/2011


 Overview and History
Avaya’s history can be traced back over a century to the acquisition of Western Electric by American Bell Telephone Company in 1881, the predecessor to AT&T.  In 1984, after the US government forced the breakup of AT&T, the equipment business was renamed AT&T Technologies, and in 1996, spun off again as Lucent Technologies.  In 2000, Lucent spun off to its shareholders its Business Communications unit, naming the new company Avaya.   On October 1, 2000, Avaya began trading on the New York Stock Exchange as an independent, public company.  In 2007, Avaya was taken private by two private equity companies, TPG Capital and Silver Lake Partners, in a $8.3 billion leveraged buyout (LBO) at the height of an economic boom fueled by a bubble in residential housing.  In 2009, Avaya purchased Nortel’s Enterprise Solutions business (NES) for nearly $1 billion, bolting on approximately $2 billion in incremental revenue and giving it  access to Nortel’s data hardware business, patents, and a trove of new technology. 

Today Avaya, with over $5 billion in worldwide revenue is a behemoth in the business telecommunications world.  It is the leading global provider of next-generation business collaboration and communication solutions according to an advertisement placed at the beginning of a recent filing with the SEC.  It claims to do business with 85% of the Fortune 500 companies and has operations around the globe with over 400,000 customers at 1 million locations.  Along with its direct sales force, Avaya has a large and sophisticated global supply chain that is run by 10,200 indirect channel partners allowing it to deliver technology solutions anywhere there’s a business need. 

Even with its global footprint and clout in the industry, make no mistake about it, Avaya faces serious financial challenges.  It faces competitive threats on all fronts from new, cloud-based, communication technologies and has a leveraged, insolvent balance sheet leaving it vulnerable and exposed to macroeconomic risk.  In addition, it has consumed most of its operating income to service the required interest payments.  Its 2010 net loss of $874 million ($936M counting accrued dividends on its preferred stock) earned it honors as the company with the 15th largest loss in the Fortune 500.  Through nine months in fiscal year 2011, Avaya has already racked up net losses of $764 million dollars and is on pace to top last year’s poor performance. 

Avaya Business Partner Network

Mention the name Avaya to almost any of its US channel partners, from small PBX VARs to executives at one of its largest distributors and they instantaneously beam with pride. Ask about its current financial position and most tend to give off an initial chuckle, then mention something about Avaya being a big company and finish the sentence with the fact they have “no concerns”.  Most view the brand with a reverence reserved only for a select few things in life and feel honored to be associated with a relatively large manufacturer in the fragmented world of telecom hardware equipment makers.  With ease, they can tick off a few generalized facts overheard at the annual dealer conference in Las Vegas or from a promotional brochure or other company advertisement.  Probing deeper for specifics, most will quickly mention that Avaya was “purchased by sophisticated owners…” adding only that, “...they know what they’re doing.”  Ask about the company’s recent financial results and they will quickly demur to the fact that Avaya is private and any information on their financial results is simply speculative and not based in fact. 

The failure to understand Avaya’s current financial performance and the potential long-reaching effects it could have, whether by omission, naivety, or simply blind faith, by its channel partners is both shocking and concerning.  It is also one of the cornerstones to the thesis that most PBX VARs won’t be around a few short years from now.  Regardless of what is truly driving its partners failure to grasp reality, the simple fact is: Avaya has and continues to publish information to the public detailing its financial results, risk factors, and business outlook in a straightforward, direct manner to the SEC every year since being spun-off from Lucent in 2000.  More recently, Avaya filed an S-1 prospectus with the SEC detailing the current state of the business in an effort to take the company public once again and sell its shares on the New York Stock Exchange. (Link: AVAYA S-1)

At the very least, I would encourage all Avaya Business Partners to read though this document (it’s 376 pages printed), going deeper of course than first 4 pages of advertisements and spend some time understanding the company from an objective point of view and developing your own questions to ask Avaya’s Regional or Executive managers next time you have the opportunity.

Background

The audience for this paper is all technology business owners and the key management running companies focused on providing voice and data solutions to business clients.  In my last paper (see: Death of the telecom VAR), I detailed some of the major concerns involved with the continuing viability of the on-premise PBX and more specifically, how that will impact many of the resellers in US that can’t adapt to the changing trends in the marketplace.  Following its publication, there were numerous follow-on discussions that ensued and in many cases, the conversation quickly turned from the dealers to the manufacturers and their financial health.  Avaya is the largest pure-play producer of PBX systems for small, medium and enterprise businesses in the US so it made sense to use them as the example; however, much of the same conversation and syntax could probably be applied to any one of the major telecom PBX manufacturers focused in this dying space of the market.

Canary in a Coal Mine

Listening recently to passionate dissertations by business owners on why they will continue to sell PBX systems to businesses forever reminded me of something I found a few months ago while looking though a closet in my house  that I use to store old mementos and other artifacts from my past that I want to keep safe and reference- maybe even show my kids on day.  In there, I ran across some pictures I had taken, framed and proudly kept from a college photography class I had enrolled in around 2000 or 2001.  These images of inanimate objects, were shot on 35mm film and transformed in a small darkroom, through the progression of the class, from a tiny film strip to large, glossy pictures that could be framed and hung on a wall.  At the time, I remember being entranced with the “technology” that could take these tiny pictures on a film strip, barely viewable, and make them life-size and able to be viewed by all.  I knew instinctively that photography would always have a place in society as a way to capture and preserve life’s finest moments and 35mm would be the medium to do it.  The University clearly knew this too and backed up their vision with payroll dollars, real estate and college credit for taking and processing pictures on 35mm cameras.  Another company, Eastman Kodak, also saw a bright future for photography as well.  At the time, Eastman Kodak had a 100+ year storied history, produced $13 billion in global revenue and was the largest photo supplier in the world.  It clearly dominated the landscape in film and film processing.  Everyone knew that photography was the way of the future.  What could possibly displace it?  If I had only been more focused on finance rather than visiting the local taverns at the time, I surely would have bought some shares of Kodak stock or maybe even opened a 1-hour photo store in my hometown.  Everyone- the University, the largest film company in the world and myself - was confident photography, as it was, would not change and you can be sure no one saw any risk or major displacement to Kodak on the horizon.  And we were all dead wrong.

Eastman Kodak

The founding roots of the Eastman Company (renamed Eastman Kodak in 1892) began in 1880 by George Eastman who had invented the world’s first, non-professional camera and had patented the name Kodak in 1888.  This new camera, capable of capturing round 2 ½ inch diameter pictures on a roll of 100 exposures, was an instant sensation as well as a game changer. Overnight, the amateur photography industry was born with an advertising phrase coined by Eastman, “you press the button, we do the rest.” 

Through much of its history, Kodak was known as an innovator.  It introduced the first pocket camera in 1895, invented the first 35mm color film called Kodachrome in 1936 and created many of the chemicals and processes needed to take film from a mere negative to a full-sized picture.  It had a team of scientists on staff and invested heavily each year into research and development of new technologies.

But along the way, something happened that destroyed this once great company.  While some would speculate hubris of senior management led to its demise, others point to Kodak underestimating the impact of digital photography and still others blamed the deteriorating financial position of the company as it progressed through the last decade.  While no one single factor can probably be wholly blamed, the fact is, Kodak has lost its relevance in the marketplace and depends on patent litigation and asset sales for much of its revenue today.  Its demise will surely provide material for business school students to study for years to come. 

 

How could this happen to one of America’s most respected companies that provided a technology everyone needed, wanted and used on a regular basis?  The answer to that question takes you back to the year 2000 and my college photography class.  Kodak was a major player in the global imaging market, earning nearly $14 billion in revenue, and saw a bright and profitable future.  On page 37 of its 2001 10-K filing it boasted to investors, “we expect to generate $6 billion dollars of cash flow after dividends in the next 6 years”, further stating this cash flow would be used to pay down debt, maintain or increase the dividend to shareholders, or fund acquisitions that promote profitable growth.  So how did it fare in its quest to predict the future?



Rather than produce an average of $1 billion in cash flow each year from 2002 to 2007, it generated a mere $70,000,000 or 7% of management's stated goal, only hitting the target in one of  the six years.  And, that was before dividends to the shareholders.

Kodak is clearly an example of a once-great company that lost its way.  If you had invested $1000 in the company in 2000, it would only be worth $20 today.  In December 2010, Standard and Poor’s, noting the company's fall from greatness, removed Eastman Kodak from its S&P index and today the company’s market capitalization sits under $300 million, valuing the company for less than the cash on its balance sheet. Barring a miracle, Eastman Kodak, like life’s moments it helped so many capture, will be nothing more than a memory within one year’s time.  

The takeaway and application to the world of technology is simply this: what the marketplace demands is a constantly moving and ever-changing target.  Companies that choose to rest on their laurels and sit behind recognized brand names rather than continuing to lead with innovation and adaptation will be punished.  Finally, a lesson many camera and one hour photo shops learned the hard way- any business or person with equity, either directly or indirectly, depended upon an upstream supplier has an obligation to formulate independent thinking and assessment as it pertains to said supplier and the general state of the industry in which they operate.  Failure to assess the business and its prospects objectively and filter management's rhetoric against unbiased information is both naive and senseless.

Avaya

From its initial spin-off in 2000 from Lucent as an independent, standalone company, Avaya performed rather well.  After stumbling some out of starting blocks, the business appeared to be gaining momentum as it approached mid-decade.  It rode a rising tide of increasing unit sales and strong demand for its core, on-premise PBX technology.  It was also able to grow its gross margins from 42% in 2000 to 46.1% in 2006.  Most would consider the business conservatively managed, using cash flow to pay down debt, divesting of non-core assets and investing in R&D.  In fact, by 2006, it had paid down all of its long-term debt, increased shareholder’s equity to over $2 billion and was earning a steady and respectable 4% net profit for its shareholders.



Leveraged Buyout of Avaya

As the nation approached mid-decade and the housing bubble fueled exuberance, private equity companies were once again in vogue and able to raise huge sums of money from investors.  These investors, expecting outsized returns on their capital, turned to firms that could employ alternative wealth management strategies needed to generate large profits. One way in which private equity firms had historically achieved these types of returns for their investors was by taking large companies private and re-engineering them in a transaction known as a leveraged buyout or LBO.  In a LBO transaction, the buyer, typically referred to as the financial sponsor, acquirers a company and finances a large portion of the purchase price with debt.  LBOs and other leveraged transactions have been around since the 1950s (known then as bootstrap deals) and  over time, the playbook has changed little.  The investment firm, looks for a company that has a history of stable cash flows, low or no existing long-term debt, and hard assets that can be pledged against the new debt generated in the transaction.  In 2007, Avaya fit the mold perfectly.  At the end of its fiscal year, the company had significant cash flows ($266 million in Earnings from Operations), a pristine balance sheet with not a dollar of long-term debt, and $4.5 billion in reportable hard assets (subtracting Goodwill and other intangible assets). 

The stage was set and in June 2007, private equity giant TPG Capital, along with smaller, technology focused Silver Lake Partners, announced their intention to purchase Avaya for $17.50/share or about $8.2 billion.  In the official press release, John Marren, a partner of TPG said “As one of the earliest private investors in technology and telecommunications, TPG has come to know and admire Avaya for its roster of leading customers, history of product innovation and commitment to customer service.”
  
TPG and Silver Lake officially completed the purchase of Avaya Inc. on October 26th of 2007 using a holding company set up on June 1st of 2007 named Avaya Holdings Corp. (formerly Sierra Holdings Corp). The final purchase price amounted to $8.3 billion dollars, which included just over $5 billion in new debt.  The timing couldn’t have been worse for TPG and Silver Lake, completing the transaction just as private-equity lead LBOs deals reached their peak and the economy bordered on collapse.  The macroeconomic environment was deteriorating by the day and the uncertainty was forcing businesses to hold cash and postpone or cancel any major capital investments.   The year 2007 was also significant from the perspective that measurable increases in the adoption rates for business hosted phone systems were first seen, driven by advances in soft switched technology and falling monthly usage prices.  Using the internet, companies, particularly smaller ones, could now move their PBX to “the cloud”, saving money they would once have had to spend on an on-premise solution from companies like Avaya and the telecom VARs who installed them. 

Macro demand aside, internally Avaya was coping with its own financial issues.  The interest payments needed to service the massive amount of new debt on the balance sheet, falling gross margins driven by price cuts needed to stimulate demand and other acquisition and integration costs were starting to pile on and take their toll.  All told, by the time its 2008 fiscal year ended, Avaya had watched as its gross margins fall to an all-time low of 41.1%, added a net $5.2 billion in new debt to its balance sheet and recorded a staggering $1.3 billion net loss, all while burning though $676 million dollars in cash.   As the dealers and other business partners gathered in Las Vegas that year for the fun filled annual meeting, one can only wonder how many were aware of what was really happening.

Next two years

If 2008 seemed like a hard year, things wouldn’t get easier anytime soon.  Avaya was beginning a dangerous free fall in many key areas of its business.  Organic revenue began to slide and would end the year $773 million dollars lower than in 2008.  The company continued to bleed red ink, finishing 2009 with an $845 million net loss.  It would maintain its cash levels by issuing more debt.  If there was a bright spot one could point to, it would have been gross margins, which did improve from their 2008 historic low, but still finished 2009 at an unimpressive 45%, well off their previous few year's margin rates.  With its core business deteriorating and the broader economy still weak, Avaya desperately needed something to get it back on track and ignite its sales and profits.  With the sheer size of its business, small changes or acquisitions wouldn’t move the needle.  Avaya needed a game changing transaction.

In June of 2009, Nortel announced that it no longer planned to emerge from bankruptcy and would seek a buyer for all of its business units.  Avaya, seeing just the opportunity it needed to curtail its downward slide, wasted no time and, on July 20, 2009, announced a “stalking horse” bid of $475 million for a collection of assets that included Nortel’s Enterprise Solutions unit, a stake in Nortel Government Solutions business and DiamondWare, an ill-timed acquisition made by Nortel in 2008 which developed 3D high-fidelity audio.  The business units being considered generated nearly $2 billion in revenues and would give Avaya access to new customers and new technology.  Other bidders also saw the opportunity and joined the auction for this once crown jewel of Nortel’s carcass, which caused the asking price skyrocket.  On September 16, 2009, Avaya emerged as the winning bidder in bankruptcy court with a final bid of $933 million, nearly double its initial offer.  A transaction of this magnitude would take massive funding and Avaya wasted no time, quickly raising nearly the entire purchase price in debt and piling that on to the $5 billion already on its balance sheet.  Avaya carefully calculated the transaction could be viewed as 2+2=5 and by combining Nortel’s assets base with their massive distribution network and leveraging the synergies, it could be just the game changing opportunity needed.  While the transition has been accretive to revenue and brought with it the promised new customers, technology, patents, and a low margin data business now called Avaya Networking, the financial benefits, especially profitability, are still yet to be seen. 

2010 and today

There is no doubt the last three years have been challenging for Avaya.  In a broader sense, America suffered a recession unlike anything it had seen in decades.  The downturn in the economy was sharp and swift and nearly every business felt its pain. Companies large and small have had to reexamine their own business strategies and adjust to the changing environment.  Most companies today say they are feeling much more optimistic concerning their outlook and those listed in the S&P achieved record levels of profitability last year.  For Avaya, the road to recovery has been longer and the hill much steeper to climb than most.  It is currently producing some of the worst financial results in its history.  Dealers and most anyone else with Avaya’s logo tattooed on their company’s polo shirts should have serious concerns about the current financial health of Avaya and its long-term viability as an operating business.  So why then are its business partners, those who are dependent on it as a major supplier to their business, so docile when the conversation comes up?  Most simply don’t have the facts correct.  When asked about Avaya’s financial health, many dealers will state that the business is, and has always been, profitable.  No concerns, period. End of story.  Well, let’s explore that conjecture further starting with its profitability.

Profits


Since 2007, Avaya has failed to earn a profit.  It recorded staggering net losses of $1.3 billion in 2008, $845 million in 2009, $871 million in 2010 and has recorded $764 million in losses through the nine month period in fiscal year 2011 (ended on June 30) making it well on its way to another potential $1 billion loss for the full fiscal year.

Equity

Turning to the balance sheet, if you were to equate a business’s financial statements to a high school report card, the profit and loss statement becomes your GPA for the most recent semester and the balance sheet would be your cumulative GPA, showing how well you’ve done during your entire time at the school.  Watch most business owners when shown their financial statements for the first time after the close of an accounting period. Their eyes will glace at the net profit line on the P&L first and then quickly move over to the equity line on their balance sheet, showing them how much their stake in the business is worth in comparison to the previous period.  Of course, the equity line is usually never the same as the true market valuation of the business, but, it tends to give a pretty good indication if the business is doing the right things and creating or destroying value for its owners over time.
  
In the case of Avaya, the business was managed fairly conservatively through the middle of the decade and, like any well run business, its shareholder equity grew. In 2007, Avaya had $2.5 billion of equity on its balance sheet.  This healthy equity cushion enabled it to absorb the $1.3B loss in 2008, deceasing its equity nearly dollar for dollar in the process.  As the years progressed and losses continued, the equity in Avaya fell proportionately, moving from a high of $2.5 billion in 2007 to a deficit of $1.5 billion in 2010, an almost unbelievable destruction of $4 billion dollars.



Debt

In addition to losing money and destroying equity, Avaya also took on new debt.  From 2008 onward, its balance sheet was loaded up with enormous amounts of debt.  This debt, used by TPG and Silver Lake to fund the initial acquisition and then to prop up declining organic revenue by purchasing NES from Nortel, has become a major problem.


Some debt, used correctly and thoughtfully in the capitalization of a business, can be an important strategic tool, helping to amply returns.  But the use of too much debt can pose problems for any business, essentially handcuffing its owners use of cash flow years into the future and preventing reinvestment back into the business, dividend payments, or acquisitions.  In the case of Avaya, its total long-term debt now stands at $6.1 billion, greater than one full year’s total revenue.  A big problem, that’s only getting worse.

Pick your Payment

The least senior of Avaya’s debt is the senior unsecured cash-pay notes ($700M) and the PIK toggle notes ($834M), both of which are interest only and carry no obligation to pay down any principal until the balloon payment date in 2015.  Examine this debt further, and you’ll discover the PIK notes issued on October 24th,2008 have terms allowing Avaya, its sole discretion, the opportunity to decide the way in which it would pay the interest that accrues bi-annually on the debt, giving it the option to pay accrued interest in cash or by adding additional principal to the face value of the note.  In similar fashion to a residential sub-prime homeowner with a “pick your payment” option on his home mortgage that decides to forgo the monthly house payment because he has no income, letting the principal balance owed on his home rise, Avaya, with little in the way of EBITDA, has also decided to pay their interest-only payments with additional principal.  It subsequently added $84 million in to the original $750 million face value of the notes, bringing their current balance to $834 million.



  

Avaya itself acknowledges the risks associated with its enormous debt in its latest S-1 
regulatory filing on pages 24-26:

“Our degree of leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting obligations on our indebtedness.”

“Our debt agreements contain restrictions that limit our flexibility in operating our business.”

“We may not be able to generate sufficient cash to service all of our indebtedness and our other ongoing liquidity needs, and we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.”

“Despite our level of indebtedness, we and our subsidiaries may be able to incur additional indebtedness, which could further exacerbate the risks associated with our degree of leverage.”

It furthermore states:

Our degree of leverage could have important consequences, including:



making it more difficult for us to make payments on our indebtedness;



increasing our vulnerability to general economic and industry conditions;



requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;



exposing us to the risk of increased interest rates as borrowings under the senior secured multi-currency asset-based revolving credit facility and the senior secured credit facility are at variable rates of interest;



limiting our ability to make strategic acquisitions;



limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions and general corporate or other purposes; and



limiting our ability to adjust to changing market conditions and placing us at a competitive disadvantage compared to our competitors who are less highly leveraged.

IPO

Currently Avaya is attempting to sell around 20 percent of the company to the public for about $1 billion and has plans to use the proceeds to retire long-term debt, preferred shares outstanding and pay additional fees to TPG and Silver Lake as part of a management agreement detailed on page 183 of the S-1 filing in which Avaya currently pays its sponsors $7 million/year in “monitoring fees” under a contract that now expires in 2021 (the contract originally expired in 2017 but has been extended four times).  The agreement, signed by Avaya, has a clause making the entire contract payable at the commencement of any public share offering, resulting in an additional payout to TPG and Silver Lake in the amount of about $70 million dollars, the present value of the remaining contract that would be payable over time.

All Avaya Business Partners should hope its owners are able to sell a slice of the business back to the public.  The resulting debt pay down and slight recapitalization of the business from   selling new equity can only be good for Avaya internally and for its partners.  Although the initial S-1 prospectus was filed on June 9, 2011, Avaya has yet to complete the transaction.  And while the markets have been extremely volatile since the official filing, there are some things investors rarely have an appetite for.  Avaya has the tough task of convincing investors they are not Harry Houdini and won’t make their money disappear like Mitel did in April 2010 when it IPO’d at nearly $13/share, used the proceeds to repay debt and then watched the stock plunge 85% to just over $2/share today. 


Summary and Conclusions

While Avaya continues to dominate the market for on-premise PBX systems and other telecommunications equipment, it faces a long, steep road ahead to regain its business health and profitability.  Of course Avaya is not alone.  The entire telecommunications industry is under siege from over leveraged balance sheets and a downturn in demand for the core hardware they sell as evidenced by recent company announcements and news headlines like the one from the Wall Street Journal published on Friday November 11, 2011 describing the mounting pressure faced by the Chief Executive of Alcatel-Lucent to right the struggling telecommunications company after lowering its profit forecast for 2011. 

The Gun is Out of Ammunition

In its quest for profitability, Avaya has few options left.  If it wants to increase gross margins, it will need to continue to migrate away from equipment sales and move towards software centric, hardware agnostic solutions.  This, of course, places a whole host of new requirements on its channel partners from additional training and certifications needed by the dealers to the supply chain stress distributors will feel as they find ways to cope with lowered unit volumes.  It also places the company in dangerous competition with incumbent, well heeled, deep pocketed software companies who also want a piece of the software pie; which can only be likened to hunting a grizzly bear with a butter knife .  Avaya can, and will, continue to cut away at redundant operational expenses as it finishes the Nortel integration that should take its SG&A expenses closer to a historic 30% of revenue vs. almost 34% in 2010 and produce approximately $200 million in expense relief.  It also has the option to squeeze additional revenue from its channel partners by restating the share of the revenue it takes from maintenance agreements and other managed services or decreasing the business partner “discounts."  In an effort to grow its direct revenue, Avaya, in some cases, competes directly with its channel partners, stating in the S-1 filing on page 57:

“…despite the benefits of a robust indirect channel, our channel partners have direct contact with our customers that may foster independent relationships between them and a loss of certain services agreements for us. We have been able to offset these impacts by focusing on other types of services not traditionally provided by our channel partners, such as professional and managed or operations services."

Any action within the channel will need to be balanced with a degree of caution however.  Although most partners seem content “paying-up” for the opportunity to fly the Avaya banner, there is surely a limit to their generosity.

Without an immediate and sustainable return to profitability, the end-game for Avaya could be near.  In the world of LBOs, cash flow is the axis around which every deal turns.  Investors make big acquisitions with the intention of paying the debt down in 5-7 years and exiting the investment at a profit.  In the case of Avaya, the cash flow projections simply didn’t materialize and we are fast approaching the five year anniversary.  Post-acquisition, debt actually increased while revenue, on a real basis, has stayed flat (and backing out Nortel, revenue is down).  Assuming a miracle is not in the cards, I see only three near-term options for Avaya’s investors:  1) continue to hold the investment and prop up any cash flow deficits with fresh cash 2) exit a large chunk of the business via the already planned but yet to be executed public stock offering, using excess proceeds after fees to pay down the debt; or 3) break the business apart, selling off assets to retire debt.  

Of the three options, I would highly doubt there is much appetite for option #1, which leaves a public stock offering or asset sale.  If neither of these options prove viable, the last and final option would be to follow Nortel’s path and file for either Chapter 7 or 11 bankruptcy.  This option looks even more attractive after reading page 195 on the S-1 prospectus stating that nearly all of the $6.1 billion of long-term debt is guaranteed by the US subsidiaries.  In doing a few short calculations, one can quickly figure that the international subsidiaries, operating in expanding markets around the globe, are earning approximately $2.27 billion in revenue with a debt free balance sheet. Leaving a few, to wonder just how valuable that business, if freed from its debt laden brother in the US, could be.  

In thinking about Avaya, I’m reminded of an old Wall Street saying: “cut your loses short and let your profits run.”  With little in the way of profits besides “management oversight” and consulting fees, Avaya’s investors have been extremely patient.  However, as the LBO of Avaya nears its fifth anniversary, and the prospects of a large payday for TPG and Silver Lake dwindle, expect the veneer of patience to start to wear thin.   Avaya’s business partners would be well served to wise up and stop placating the hype.  Dealers need to take an objective look at Avaya’s business results and begin formulating plans for their own business based on a number of possible outcomes.   Ultimately, Avaya’s fate is in its own hands and the hands of its Business Partners.  Everyone should understand the stakes are high and the margin of error is razor thin.  Any deviation from here onward will only prove disastrous for all. 




Sources:

Avaya S-1 filing, filed August 24,2011:

Business week profile of top money losing businesses 2010:
http://money.cnn.com/galleries/2011/fortune/1104/gallery.fortune500_money_losers.fortune/15.html

Press release issued by TPG/Silver Lake after acquisition of Avaya:


13 comments:

Captain Nemo said...

This is a very well articulated and structured study. Remarkable.

Scott said...

Exceptionally well written and documented.

WWT-Griff said...

Great insight! Very well written!!

The Communicator said...

Wow! It is amazing what they've hidden behind the curtain. Another sad & unfortunate train wreck like Nortel.

Scotch said...

The detail reflected in the writing is indeed verifiable. While it may be said the whole of the document is not Avaya friendly, it is in effect no different than those types of opinions expressed by Standard and Poors, or Fitch, etc. It is going to evolve into a sad day for an American icon. All the Kings horses and all the Kings men...

Sri1 said...

Avaya is slowly and painfully reinventing itself as a software company - it does have a lead over all other Telecom majors (except Cisco) by way of acquisitions and R&D - Silverlake has the option to be patient till the overall recession recedes.
Sri1ram (a recent ex-employee)

Vicki said...

I appreciate the author's thoroughness in discussing the Avaya's financial health and it is worrisome. But it is far from the "implosion" mentioned in the article's title. I don't disagree with anything said in the article and it is foolish not to be aware of this information. But it is important to look at all of the numbers. Not to be an apologist for Avaya but to give the full view, total revenues, gross margin, EBITDA, margin and cash balance are all up in the last quarter and in the last 7 of 8 quarters.

Looking at the future of the industry, the author discusses loss of PBX sales to "the cloud." He doesn't discuss what dollar volume that represents nor does he discuss the dollar volume of replacement sales from the (NES) data networking and new technolgoies like Flare and web.alive. Meaning that Avaya IS looking at the future and changing its business.

It is always important to step back and see the whole picture. Recently, when questioned ". . .what is mileading about 397.5 yards per game"?, Green Bay Packers defensive player, Clay Matthews replied, "We're winning."

Molokai said...

Interesting analysis, particularly given the fact that Avaya is in the middle of an antitrust lawsuit with an independent voice and data maintenance provider. Judging from some of the latest pre-trial rulings, things aren’t going all that well for Avaya. They’ve lost the last two motions and are facing the prospect of going to trial, where a jury will decide whether the Ma Bell descendant’s business practices constitute monopolistic behavior. Given the fact that Avaya makes most of its money off of maintenance contracts, and given the likely scenario that maintenance contract customers will soon be free to buy from the maintenance vendor of their choice, chances are, Avaya will start to see those maintenance contracts disappear. What will happen to the bottom line then?

neil moullton said...

The impact of the cloud on pbx sales has been well documented in fact, if not in this report- from 4% of the (uk) market in 2011 (doubled from 2% in 2010) or about 45000 seats most pundits including BT predict this will rise tenfold by mid decade.
We are past the hosted voice inflection point, accelerated by increasing availability of low cost NGA products - the pabx isn't dead but I certainly wouldn't want to be investing in a company like Avaya which has massive debt and no credible hosted strategy.

jd said...

It is a David-Goliath situation ,shortel will bring down avaya in an epic battle & i am happy to be a part of it .

Corpfacts said...

How Prophetic! ... The New Year began with IPO ambitions for this SLV and TPG hopeful …

But the high profile departures begin to accumulate.

In February the departures of Jeremy Butt, WW Channel leader and Anthony Bartolo, General Manager for Avaya’s largest Business Unit, Unified Communications. Both well respected.

By the end of March the departures of their US sales leader, Steve Fitz and Marketing leader Dan Murphy occurred.

April continued with Mohamad Ali – Global Services Leader departing and Alan Baratz Avaya’s Products and Corporate strategy leader.

It is described as a ‘toxic’ environment created by the insecurity plagued Kevin Kennedy – and his execs are voting with their feet. Even the hope of an Avaya IPO can’t prevent the churn.

Question is - When will Silverlake and TPG step in for the assist? Will they do so before the customers vote with their wallets? Rome after all is obviously burning…

Targetlog said...

Amazing analysis. I would love to see an update especially based on the 2015 balloon payment due that was mentioned.

I am wondering how they will pull it off and assuming they will fail, how current US customers will be 'managed'.

elemes said...

And the prophecies came true -- Avaya files chapter 11.