Avaya buyout speculation reflects churn in VOIP market

Changes in the enterprise telephony landscape are certain, no matter where Avaya ends up, analysts say

With speculation that Avaya is in play for an acquisition, things will be different for VOIP users or the overall market, analysts and observers say, no matter what happens.

While reports fluttered last week that Avaya is seeking a buyout, either from a private equity firm or from corporate VOIP rivals Nortel or Cisco, observers say this activity could be a warning sign to IP telephony buyers to sit tight for now. With Avaya's large market share and installed-based enterprise telephony, where the company lands -- if it does indeed land somewhere new -- will have rippling effects.

Questions about Avaya's future were raised in a Wall Street Journal article last week, which reported that Avaya was in talks with private equity firm Silver Lake Partners, which owns several IT, networking and communications companies, including Network General, IPC, Sabre and Seagate, as well as electronics manufacturers Avago and Flextronics.

It was also reported that Avaya had already been in talks with Nortel about an acquisition in early May. That deal reportedly fell through as the two sides could not agree on whether to base the deal on Nortel cash or stock. Speculation about where Avaya would land became even greater later in the week as Cisco was mentioned in several blogs and news sites mentioned the networking giant as a potential acquirer.

"I don't think Avaya can put this one back in the box," says Gartner analyst Bern Elliot of the acquisition speculation. "Once they start being as open as this about the possibility of acquisition or buyout, it casts a very, very long shadow. There's no way it can ever make it back the way it was."

(Elliot says he has now inside knowledge about Avaya's plans or discussions, although Gartner, his firm, is owned by Silver Lake Partners, which was reported to be talking with Avaya about a buyout).

A buyout by a competitor would certainly be a cause for alarm among Avaya's installed base. "If someone were acquiring Avaya to leverage it's installed base, then there would likely be a faster move to different platforms based on the acquiring company's products," Elliot says. Enterprises considering a major new IP telephony installation with Avaya technology "probably want to wait" until buyout speculation is settled.

Avaya is not in financial trouble, observers point out. It made US$5.2 billion in revenue and US$220 million in profits in its last fiscal year, and is worth US$6.2 billion overall. Market share-wise, Avaya is also powerful; it accounted for around 12 percent of all business telephony lines (IP and TDM) installed last year -- behind Nortel's 13.4 percent but ahead of Cisco's 8.5 percent.

Observers say a Nortel-Avaya deal would bring a single dominant player to the enterprise VOIP market, similar to how Cisco dominates enterprise routing, switching and security. But this could also bring confusion for IP PBX buyers.

"Nortel purchasing Avaya would create a huge North American PBX powerhouse that could put up a united front against the threat of Cisco," says Bryan Riggs, an analyst with Current Analysis. "That would be the advantage there. But massive product overlap would have to be addressed."

The same would also have to be said for a Cisco-Avaya deal.

"That's one of the more ridiculous things I've ever heard," regarding Avaya's acquisition fate, says Zeus Kerravala, an analyst with the Yankee Group. Cisco's post-bubble acquisition strategy has been to acquire small companies with technologies that complement or add to its own products. (Location in Silicon Valley is also preferable, CEO John Chambers has said). Large acquisitions, such as Scientific Atlanta or WebEx, have been to enter entirely new markets Cisco sees as strategic. The nearly 100 percent product overlap with Avaya would just be to purchase market share, which Cisco does not do, Kerravala adds.

One company possibly with more to gain than any VOIP competitor from an Avaya buy is Alcatel-Lucent, says Current Analysis' Riggs.

Lucent divested itself of a 35 percent share of the US PBX market. Now the company has merged with Alcatel, which has around 3 percent to 5 percent of the U.S. voice market (although the Alcatel-Lucent merger was mostly focused on carriers and telecom gear).

Alcatel has always struggled in the United States, and a match between Alcatel and Avaya would make sense, in terms of creating a global enterprise communications concern. There's product overlap, but no more so than if you had an overlap with a Cisco or Nortel coming in.

"[Alcatel-Lucent CEO] Pat Russo sat on Avaya's board at one time," Riggs says. "And she's publicly stated that she regrets that Lucent had spun off Avaya."

According to Riggs, since Lucent divested itself of Avaya in 2000 and merged with Alcatel last year, it has gone from having more than a third of the U.S. TDM PBX market, to less than 3 percent -- which is roughly where Alcatel's share of the market is.

"Alcatel has always struggled in the U.S. and a match between Alcatel and Avaya would make just phenomenal sense," Riggs says.

Sweeping changes in the enterprise voice industry could drive a wave of consolidation, observers say. This year, the mergers of mid-tier VOIP players Mitel and Inter-Tel, as well as IP phone vendors Polycom and Spectralink, are already pointing in this direction. One driving factor is Microsoft's naked ambition to make corporate VOIP just another software offering, alongside e-mail, messaging and office applications. (Office Communications Server 2007, expected later this year, is the vendor's approach). Other forces include the proliferation of services such as Skype inside of companies, as well as business users who talk on cell phones more than desktop handsets, tied back to a PBX or IP call server.

"In an industry that is clearly in flux, all of the equipment stand-alone communications vendors have to look at scenarios" involving drastic change, says Gartner's Elliot.

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