Playing to Win

By all accounts, Avaya Inc. was ready to get Wall Street off its back. Competition in IP and unified communications is hot, hot, hot. And Avaya has spent its time reacting to investors looking over its shoulder. Certain things can inhibit some longerterm strategies, says an Avaya spokesperson.

So, after weeks of speculation, Avaya on June 4 announced it had agreed to a leveraged buyout. But rather than merging with another equipment maker the Wall Street Journal had named Nortel Networks as the most likely player Avaya went with private equity firms Silver Lake and Texas Pacific Group Capital (TPG). We are playing to win, Avaya executives told employees in a June 5 memo filed with the U.S. Securities and Exchange Commission (SEC). The $8.2 billion acquisition promised to reward stockholders with $17.50 per share. That totaled a 28 percent premium over Avayas May 25 stock price, the day M&A speculation started in the press.

The deal should close this fall. Still, Avaya negotiated a clause allowing it to solicit other offers until July 24. And if the company decided not to dance with the one who brought them, Silver Lake and TPG would receive between $80 million and $250 million as a consolation prize.

Analysts didnt expect that to happen. Thats because teaming with Nortel or even Cisco Systems Inc. or Alcatel-Lucent would have created too much chaos, says Brian Riggs, principal analyst, enterprise telephony, for Current Analysis Inc. There would be redundancies that would have to be cut out. There would have been just a huge shakeup in the product line. Mark Sue, an analyst for investment bank RBC Capital Markets, concurred in a research note. Even if it were financially possible, an acquisition of Avaya by Nortel would likely have been messy, fraught with integration issues.

Silver Lake and TPG do own technology companies, although none that would compete with Avaya. For example, Silver Lake holds entities including research firm Gartner and securities market Nasdaq. It also bought IPC, a VoIP technology developer. IPC partners with callmonitoring provider NICE Systems. Presumably, the private equity firms could mesh the strengths of IPC and Avaya to challenge corporations such as Microsoft, which is muscling its way into the unified communications space. Microsoft is relying on partnerships with Nortel and Cisco to achieve its goal. Meanwhile, Avaya is creating its own unified communications product; Silver Lake and TPG could have a formidable Microsoft foe on their hands if they go about things correctly. Whether that [platform] can be brought to market independently is really a question now for the new owners to consider, says David Molony, principal analyst for Ovum.

Thats just one of several unanswered questions about a private equity takeover.

Others include: How do Silver Lake and TPG view the channel? Will the firms keep Avaya intact or sell off bits and pieces? To be sure, channel partners are anxious to hear more about Silver Lake and TPGs plans for Avayas indirect channel. It does appear encouraging that Silver Lake, especially, has experience with, and apparent respect for, indirect channels as distribution methods (à la IPC and NICE). Thats not enough to go on, though. The one thing that were very, very keen to understand is Silver Lakes position on the continued recognition of the value of two-tiered distribution, says Barry Shakespeare, executive vice president for Westcon Group, Avayas second-largest distributor in the United States.

That sentiment undoubtedly is a prevailing one. However, specifics were difficult to ascertain as ScanSource Inc., Avayas biggest U.S. partner, does not discuss its vendors business moves, a spokesperson says. And CDW, also an Avaya giant, could not comment because it was in the midst of its own private equity buyout. Executives at rival IP telephony vendor M5 Networks chimes in that, because of the channel unknowns, the deal seems negative for Avayas deeply embedded indirect partners. That means it presents a positive for Avayas competitors, says Dan Hoffman, president and CEO of M5 Networks.

Like Hoffman, analyst Riggs speculates that resellers might be tempted to turn to Nortel or Cisco, given the ambiguity of Avayas direction. Yet Westcon Groups Shakespeare does not foresee an exodus. Avaya partners are pretty loyal and theyve invested too much time and money to make any sudden moves. We dont see any major concerns, he says. We dont see anyone making any big decisions to change.

Finally, another issue is whether Silver Lake and TPG will keep Avaya intact so end users can be assured of product development and support into the future. Avaya has made some very vague statements about this deal benefiting customers and, by extension, resellers, but hasnt backed any of that up, at least not to the majority of the market, says Riggs.

Avaya and its intended new owners werent able to provide much insight into these matters. A spokesperson for Silver Lake could not discuss the firms approach to the channel or Avayas future, since the transaction had not closed. A spokesperson for Avaya could only offer the organizations business as usual message. However, Avayas top executive seemed upbeat. In that June 5 memo to employees, Louis DAmbrosio, president and CEO, noted that Silver Lake and TPG are completely aligned with our strategy and mission.

Westcon Group execs agree, predicting little disruption as Avaya goes from a steady performer on the New York Stock Exchange to a private company. We really feel quite comfortable with the deal, Shakespeare says. Avaya will be able to think more proactively about responding to market demands, he adds.

Riggs further says going private gives Avaya a chance to focus on its core competencies: PBXs, contact center platforms and voice systems for SMBs. Avayas attempts to be a leader in the European market didnt go so well, he says, nor have its efforts to be a professional services organization. Hopefully with taking the company private, the company can really focus a lot more on building products that are highly competitive.

Why Now?

Avaya says Wall Street can inhibit some longerterm strategies. So if the manufacturers aim in going private was to eliminate earnings pressure and unleash creativity, the timing couldnt be better. Avayas stock was as good as it was going to get, a number of industry observers say. Current Analysis analyst Brian Riggs agrees. Avayas books were clean and the company was profitable. Still, news of the acquisition was a bolt out of the blue, he says. Its a very unusual and unexpected move on the part of Avaya.

Because of that, financial analysts took a cautious approach to the news. Standard & Poors on June 5 hit Avaya with a downgraded credit rating, noting that probably was an interim step and that ratings could be lowered further. Ben Bubeck, a Standard & Poors credit analyst, said in a research note the firm lowered its Avaya ratings because the companys lease and pension debts stood to increase dramatically.

Investment bank UBS, meanwhile, held its Avaya rating at neutral.

The Avaya announcement followed another major telecom deal: Mitel Networks Corp.s proposed $723 million buyout of phone-maker Inter-Tel Inc. That transaction was fraught with its own drama at press time as Vector Capital Corp. tried to lure Inter-Tel away from Mitel.

Who Are Silver Lake and TPG?

Headquartered in Menlo Park, Calif., Silver Lake makes a point of buying technology companies. The firm was founded in 1999 and now claims 40 investment professionals who scour the landscape for ripe takeover opportunities. It doesnt publicize the amount of capital it manages.

Texas Pacific Group Capital (TPG) manages $30 billion of capital. Its a smaller firm than Silver Lake, but one that also focuses on technology. Perhaps its most publicized acquisition is the 2002 Burger King deal. TPG bought the fast food chain for $1.5 billion and later helped it go public. It was founded in 1992 and is based in Forth Worth, Texas.

Avaya Inc.
Cisco Systems Inc.
Current Analysis Inc.
Gartner Inc.
Inter-Tel Inc.
M5 Networks
Microsoft Corp.
Mitel Networks Corp.
New York Stock Exchange
NICE Systems
Nortel Networks
RBC Capital Markets
ScanSource Inc.
Securities and Exchange Commission
Silver Lake
Standard & Poor’s
Texas Pacific Group Capital
Vector Capital Corp.
Westcon Group

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