Ottawa-based unified communications service provider Mitel’s reported bid to acquire U.S. competitor Avaya is aimed at creating a combined entity with the heft to battle “800-pound gorillas” Cisco Systems and Microsoft for market share, a prominent analyst says.
According to the Wall Street Journal, Mitel is in talks to merge with California-based Avaya in an all-stock deal valued at between $2.2 billion and $2.4 billion (all figures U.S.). The deal would value Avaya at $20 to $22 a share, a slight premium over its Friday morning trading price of just above $19.
If the two firms are able to reach an agreement, the report said, the merger could happen within the next month. Mitel did not respond to a request for comment on Friday, while a spokesperson for Avaya said the company "does not comment on rumours or speculation."
Pegging the likelihood of the deal going through at about “70-30,” Boston-based analyst Zeus Kerravala of ZK Research said it would fit well with Mitel’s long-standing strategy of growing through acquisitions. He referred to Mitel CEO Rich McBee as “the J.R. Ewing of the communications industry” – a reference to the infamous oil baron from the long-running television series Dallas – for his aggressive approach to courting potential targets.
“He’s always looking to make a deal. His vision has been that this industry needs to be rolled up, and I do think that’s true. I think there’s too many suppliers and not enough demand.”
Merger makes sense: analyst
Mitel itself was acquired by Searchlight Capital Partners late last year and taken private in a $2-billion all-cash deal. After years as a publicly traded entity, Mitel said going private would give it more flexibility to focus on going after the cloud-based communications market without having to worry about satisfying short-term shareholder demands.
Kerravala said the potential deal for Avaya makes sense because the two companies bring different strengths to the table.
While Mitel tends to focus on small and medium-sized customers, for example, most of Avaya’s sales come from larger enterprises. Both firms have a strong presence in North America but are each dominant in different parts of Europe.
In addition, Mitel’s offerings are geared more towards the “public cloud” – that is, Mitel is responsible for storing customer data and maintaining and managing servers – while Avaya targets customers who have their own data storage facilities.
“I think there’s a good complementary niche to it,” Kerravala said. “The two would create a much bigger service provider and I think if you look at what’s happening in this industry, scale is becoming important. You’re competing with Cisco and Microsoft. So it’s not just one 800-pound gorilla, but two of them. That’s a much more difficult competitive dynamic.”
Avaya would also give Mitel an instant base of new potential cloud customers. The California firm is No. 2 in overall market share in the unified communications space behind Cisco, and it’s the clear leader in desktop handset sales with about 40 per cent of the market.
Transitioning business model
Mitel’s revenues run in two streams: the traditional, on-premise portion that involves the sale of telecommunications hardware such as handsets as well as other services; and the cloud service that provides telephone communications software on a monthly subscription basis.
With the traditional business in decline before its acquisition – Mitel’s on-premise sales fell eight per cent year-over-year in the first quarter of 2018 – the firm was banking on the cloud side of its operations to pick up the slack. But Mitel has struggled to convert existing on-premise customers to the cloud and wasn’t gaining new bookings as fast as it had expected.
Kerravala said Mitel has faced hurdles in building its cloud business because many of its existing customers still think of it more as an on-premise equipment provider and not as a leader in the rapidly evolving communications software space. Bringing Avaya into the fold could help alter that perception, he added.
“If they could flip that base, they’d have the largest cloud install base out there,” he said. “This has got to be an acquisition about looking forward and building a big cloud install base. It certainly gives them the assets to do it. From there, it would come down to execution, which is really the hard part. I think it makes sense for a lot of reasons. But if it didn’t happen, it wouldn’t kill either (company).”
Although Mitel would be the buyer in the transaction, Avaya is the larger player.
Mitel, which employs more than 500 people at its Kanata headquarters, has a total workforce of about 3,800. Its revenues for fiscal 2018 were expected to be in the range of $1.3 billion, while its California counterpart topped $3 billion in sales last year and employs about twice as many workers.
Originally a spinoff of Lucent Technologies, Avaya was a public company from 2000 to 2007 before being acquired by a pair of private-equity firms. It went public again in 2017 and emerged from Chapter 11 bankruptcy protection later that year.
A hardware-focused firm earlier in its existence, Avaya has shifted toward a cloud-based business model in recent years. In 2018, it acquired Seattle-based cloud infrastructure maker Spoken Communications and now generates about 80 per cent of its revenues through the cloud channel.
The art of the deal
While Kerravala says the proposed merger would be a good deal for both sides, it’s not a sure thing. Other suitors are also reportedly wooing the California firm, and Kerravala says with the company’s debt load tacked on, the purchase price will really be closer to $5 billion, “which is very big for Mitel. But I think Rich McBee has got the confidence of Searchlight Capital, who I imagine would be one of the ones funding that.”
Kerravala notes that Mitel’s chief executive is known for being patient, adding McBee won’t sign on the dotted line unless he’s convinced he’s getting good bang for his buck.
“He’s really masterful at the art of the deal.”
He points to Mitel’s acquisition of California-based ShoreTel for $430 million in 2017 – three years after McBee’s first offer of $540 million was rejected – as evidence of his willingness to play the long game.
“He waited it out and he actually got it for less,” Kerravala said. “He’s really masterful at the art of the deal.”