Avaya is one of the largest providers of enterprise communications products and services. It is a complex company of 158 separate entities that employ about 9,700 people worldwide. Most of its entities in North America, representing about 3,800 of its employees, filed for Chapter 11 reorganization earlier this year.
Avaya reported 2016 revenue at $3.7 billion. Despite an annual adjusted EBITDA of $940 million and positive free cash flow, it has a debt problem. It owes about $6 billion due to multiple investors spread over multiple maturity dates over the next several years.
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Avaya tends to describe its Chapter 11 filing as “capital restructuring” rather than “bankruptcy,” and it’s looking to reduce its debt through asset sales, debt-to-equity swaps and negotiated refinancing. The first shoe dropped two weeks ago when Avaya accepted a bid from Extreme Networks to acquire its networking division. This initiated a stalking-horse bid process for that division.
There are more questions than answers about what’s going to happen next. Some believe Chapter 11 will be quick and painless, while others expect the entire company to be split into pieces. This post speculates four possible outcomes.
Company management has its preferences, but it is important to note they are not in full control of the process. The Chapter 11 process shifts aspects of control to the court, and unlike management, the court prioritizes the needs of the debt holders above the needs of the shareholders.
1. Restructure and go
When Avaya announced Chapter 11, it positioned the restructuring as a hiccup that would have little or no impact on operations (certainly customers of the networking division will disagree). However, it is possible for the rest of the company to emerge intact.
In this scenario, the bondholders receive shares in the restructured company through debt-to-equity swaps. It’s more complex than it sounds because the debt-to-equity conversion rate will vary for each type of loan in order to account for differences in interest rates and maturity dates.
The board of directors will also become an issue because the current majority owners TPG and Silver Lake will be replaced with new owners. Avaya claims the equity swaps will not create a single majority shareholder. This means there will likely be a battle for majority ownership and board control. It is likely that many of the new owners will liquidate their shares quickly, possibly creating a new, unrelated majority owner.
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It’s believed Avaya pursued this path before Chapter 11, but it was unable to reach voluntary agreement with the debt holders. Voluntary agreement may no longer be required with Chapter 11.
What is important to note in this scenario is that Avaya could emerge financially very strong. That’s because Avaya has been servicing its debt while maintaining positive cash flow. Avaya’s cash flow could significantly improve because most of its debt would be restructured as equity. This would free the company to potentially accelerate research and development or expand possibly through acquisitions.
However, without clarity on the ownership or board of directors, it’s also possible that an alternative strategy is adopted. For example, the new owners may decide not to expand or grow the business, but to liquidate it.
Another possible outcome is the company simply gets acquired. In this scenario, a buyer merely buys out all debtholders, including the pensioners. The buyer would then be free to rebuild or harvest the company assets without restrictions. Of course, this option was possible before Chapter 11, but perhaps the various bondholders are more negotiable during the Chapter 11 process.
Avaya’s total debt is generally perceived to be higher than the value of the company, so the variables are actual acquisition cost and return on the investment. A strategy to cut costs and/or increase profits could realize a reasonable return on the investment. This could be achieved in many ways, including synergies from the acquirer, Avaya’s patent portfolio, or technologies in Avaya’s labs.
3. Sell off more divisions
There has been considerable discussion and speculation about which portions of the company would be most logical to separate and sell off to raise funds. There are many ways to view Avaya, but the logical structures are:
- Small busines and mid-market unified communications (UC) (IP Office)
- Contact center/enterprise UC
The networking unit is the easiest to separate, and Extreme Networks has already started that process. The SMB and mid-market UC solution is centered around the Avaya IP Office. Another UC company, such as Mitel, could be interested in the product, channels and customer base.
The contact center leverages the Avaya Aura UC infrastructure, so these assets are more difficult to separate, though it is conceptually possible. Avaya is a leader in the contact center space, and these implementations are not easily unseated. The contact center division is the most viable as a standalone business.
Prior to recently being acquired, Interactive Intelligence focused primarily on contact centers and was able to drag UC sales where appropriate. This model would allow a contact center-focused Avaya to continue to profit from its enterprise UC portfolio without the costs of competing as a standalone UC solution.
Reportedly, several bidders were interested in the contact center solution prior to Chapter 11. Many of these interested parties are likely back at the table, now in a stronger position.
4. Sell off its services
In addition to product divisions, Avaya can also be viewed in terms of revenue buckets. From this perspective, Avaya’s services division is very attractive. Avaya Support Services includes 28 centers processing more than 2 million support requests annually across 42 countries. Avaya services include support, consulting services, managed services, and complete outsourcing of communications and networking solutions.
The company has been aggressively transitioning away from hardware and toward software and services. Last year, Avaya reported software and services represented 74.9 percent of total revenue (up from 71.3 percent from the prior year). Recurring revenue was 52.1 percent of total revenue.
It’s rare for a software application vendor to have such a strong services play. Concurrently, the services sector is consolidating. Recently, HP Enterprise spun off its enterprise services and merged it with CSC, NTT acquired Dell Services, and Atos acquired Xerox ITO services. Atos is particularly interesting because it previously acquired the UC vendor Unify. Avaya services will likely be attractive to these and many other services firms.
Which of these outcomes is most likely? It’s too early to tell. There are, of course, countless other possible outcomes. There’s very little public information available now, so we just need to wait for the backroom conversations to finish.
The Avaya customers I’ve met with do not seem too concerned. They know Avaya’s most valuable asset is, indeed, its installed base. Most likely, regardless of what happens, there will be efforts to protect current customers.
Wait and see is probably the best course of action for existing customers. Those who need to make a major commitment right now might be put off by Chapter 11. This is unfortunate but understood by Avaya, which fuels the desire to get Chapter 11 behind it as soon as possible.
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