Avaya's Public Stock Offering (2nd IPO) - A Customer-Centric Perspective

Avaya filed a Form S-1 Registration Statement ("S-1") with the SEC on June 9, 2011 in preparation for a public stock offering. Eric Krapf's article at NoJitter.com describes the financial highlights of this $1 billion stock offering.

This will be the first public offering of Avaya stock since Avaya was purchased by private equity firms TPG and Silver Lake in 2007. The Wall Street Journal recaps Avaya's history and suggests this offering will value the company at about $5 billion, though it appears the $1 billion will only buy about 12.5% of the outstanding shares, valuing the company at closer to $8 billion, about what was paid in 2007.

What does this event mean to current and prospective Avaya customers? As independent consultants, UniComm Consulting has reviewed the S-1 from what we believe is the perspective of our enterprise clients. This article comprises a list of customer expectations that we most often hear from our large enterprise clients and from other large enterprise IT and Communications management whom we meet in the industry venues. Each expectation is accompanied by discussion of the degree to which the S-1 Registration Statement and the public offering are responsive to those expectations and by our consultants' commentary on the topic. All text within quote marks (" ") is directly copied from the S-1 Registration Statement.

Core Enterprise Telephony

Most customers look to Avaya primarily for core enterprise telephony solutions, especially those that require high reliability and that must serve multi-location and multi-national organizations.

S-1 Response: The S-1 opens with, "We are a leading global provider of next-generation business collaboration and communications solutions..." The S-1 certainly points out that Avaya has been a "leader in enterprise voice telephony and messaging [note: this is voice messaging, not e-mail] for more than 10 years and in unified communications for the past four years," but the emphasis throughout is on the idea that Avaya will be a leader in the $77 billion market for collaboration solutions. This is repeatedly positioned in the S-1 as the delivery of a new "intuitive and personalized user experience, seamlessly integrating various modes of communications and collaboration, including real-time voice, video, instant messaging and conferencing, and non real-time email, voicemail and social networking."

Commentary: The Avaya focus on a transformation of user experiences is important, since enterprise voice communications is increasingly augmented by video, and both voice and video calls are being displaced by unified communications capabilities such as presence, instant messaging, e-mail and collaborative workspaces including business versions of social networks. However, this direction may not align with the core telephony expectations of many business enterprises and will be compared with many non-telephony-based customer alternatives for communication user experiences. Some of these new areas are well outside Avaya's traditional areas of strength, both from development as well as channel go-to-market capabilities.

Call and Contact Centers

Almost all enterprise customers consider Avaya a predominant leader in this category for almost two decades. Customers expect or rely on Avaya to continue to advance in this market category, building on the best of both Avaya and Nortel solutions. Customers look to Avaya for support of multiple media formats in their contact centers and for effective interfaces to new consumer communication methods such as social networks.

S-1 Response: The S-1 is very clear that contact centers are a key area of strength for Avaya today. Also, the S-1 emphasizes the need for Avaya to respond to the changing customer expectations for contact center functionality. The use of SIP technologies in Avaya's Aura product line is highlighted as a vehicle to facilitate both development by Avaya and solution enhancements and customizations by value added partners and customers. It is clear that Avaya places a high value on sustaining competitiveness in this area.

Commentary: It seems very likely that Avaya will remain focused on and responsive to contact center customer expectations. They must be sure to care for multiple media and social network evolutions. Notably, competitive offerings (e.g., Aspect and Interactive Intelligence) stress unified communications capabilities within the contact center. Although Avaya's overall positioning emphasizes "collaboration," there is little mention of UC in the contact center capabilities. Also, seamless integration and migration options for the Nortel Symposium customers will be critical.

Economical Migration Plans from Nortel and Earlier Avaya Versions

All of the former Nortel customer base and a large continuing portion of the Avaya customer base are not yet upgraded to the new Avaya Aura technologies. Most of those customers are waiting for clarification of the migration options and the associated economics.

S-1 Response: This issue is not highlighted to the investors in any detail (the words "Definity" and "Meridian" don't even exist in the S-1). The S-1 does say, "During the second half of fiscal year 2010, we completed the integration of the Avaya and NES product lines..."

Commentary: The lack of emphasis on this perceived customer expectation is surprising, since it seems this should be a high priority for Avaya. This migration is both a major revenue opportunity if done well and a major risk of customer defection if done poorly. Also, it is not clear if Avaya is prioritizing sales and support resources to this migration, rather than to the prominent 'collaboration' initiatives.

Unified Communications Solution Leadership

Most enterprise customers are making distinctions between unified communications and voice telephony. Unified communications is seen as the ability to provide flexible tools for job-specific packaging of selected real-time and non-real-time communications functionality both to support individual creativity and productivity (UC-U for 'User Productivity') and to allow for optimization of specific communication-intensive business processes (UC-B for 'Business Processes'). Customers expect to buy these in a modular fashion and to be able to integrate them with existing communication infrastructure.

S-1 Response: The S-1 calls out "Unified Communications Software, Infrastructure and Endpoints" as one of "five key business collaboration and communications product categories." However, the S-1 repeatedly expresses this in the context of the "next-generation business collaboration and communications solutions" which is, inferentially, the Avaya-defined Flare experience, described as: "The Avaya Flare Experience is designed to help break down the barriers commonly seen in today's communications and collaboration tools with a distinctive user interface for quick, device-agnostic, easy access to voice and video, social media, presence, instant messaging, audio/video/web conferencing and a consolidated view of multiple directories and context history."

Commentary: It appears that Avaya does not see unified communications in the context of flexible tools for job-specific communications interfaces. Rather, it appears that they logically bundle unified communications with voice telephony and see their investment in the Flare experience as defining a new category of "next generation business collaboration." Avaya may be lagging customer expectations in this area both as to flexibility, since the Flare experience seems to be primarily a tool for information workers, covering only a portion of the enterprise workforce, and since Flare is currently only available on the Avaya Desktop Video Device with broader device coverage pending into 2012 or beyond. Also, Avaya may be underestimating the robustness of customers' alternative UC (and collaboration) choices, since the S-1 has statements such as, "Competitors' collaboration solutions are not designed for the demands of unified communications." and, "Many of our competitors' collaboration solutions use proprietary, closed architectures, which do not integrate well with those of other vendors." It is notable that while the S-1 does mention Microsoft as a competitor, it does not mention many other who are potential customer alternatives in the UC (including voice communications) category including IBM, Google, Skype, SAP or Salesforce.com.

Interoperation With Other Enterprise Systems

Most enterprise customers have significant investments in non-voice communications technologies, in advanced business collaboration tools, and in applications to support business processes. Customers increasingly expect that their new communications technology investments will interoperate with these existing investments. New Avaya solutions would be expected to interoperate with the following product categories produced by the leading or entrant companies listed for each category.

• E-mail, Calendaring, Contact systems: Microsoft, IBM; entrants e.g. Google.
  
  
• Collaboration systems: Microsoft, IBM, Oracle, EMC, Adobe, Open Text; entrants e.g. Google.
  
  
• Instant messaging and presence systems: Microsoft, IBM; public: Skype, Google, MSN, AOL.
  
  
• Business Applications: SAP, Oracle, Salesforce.com, Microsoft Dynamics, many other industry-specific providers.
  
  
• Networks for the above: Cisco, HP, Juniper, Brocade.
  
  
• Hosted versions of the above products and solutions: Provided by companies listed above.

S-1 Response: The S-1 does emphasize the ability of Avaya Aura products to interoperate with other software-based products through a wide range of protocols. Also, the S-1 emphasizes the Avaya intention to support a broad range of user devices, including PCs, tablets, and smart (cellular and WiFi) phones. Interoperation with leading e-mail and presence platforms to enable the new Avaya Flare experience is also stated in the S-1.

Commentary: Avaya appears to continue in the tradition of providing primarily 'end-to-end' solutions which was a hallmark of their predecessor companies, AT&T and Nortel when each of those firms was the de facto national provider of communications services. This is most remarkable when considered in context of Avaya's self-definition as "a leading provider of next-generation business collaboration and communication solutions." While Avaya is certainly, as indicated in the S-1, in the Leaders quadrant of Gartner Magic Quadrants for Corporate Telephony and for Unified Communications, Avaya is not even shown as a participant in Gartner's Magic Quadrants for Enterprise Content Management (e.g. collaboration products such as Microsoft Office SharePoint and IBM Lotus Quickr), Unified Communications as a Service, or Social Software in the Workplace.

Reliable system maintenance

This is always a primary customer expectation for enterprise voice telephony. Expectations in other communications categories are generally not as stringent.

S-1 Response: Avaya recognizes this expectation and emphasizes their leadership in this area, as well as highlighting their "product portfolio has been designed to be highly reliable, secure and scalable and is backed by an award-winning global services organization with services support tools to help our customers monitor, troubleshoot and manage their infrastructure."

Commentary: There is broad industry agreement with Avaya's claims in this category. However, the S-1 also points to the risk that, "Business collaboration solutions are complex, and design defects, errors, failures or 'bugs' may be difficult to detect and correct." It is reasonable to expect that Avaya core telephony solutions will continue to be reliable and maintainable. However, the Avaya emphasis on being a leader in business collaboration solutions may impact on reliability when those new features are included in the customer solutions.

Clarity of sales and maintenance relationships via channels

Customers expect a seamless relationship with Avaya, whether they are buying from Avaya and Avaya Services on a direct purchase relationship or via an Avaya authorized channel Partner. This is especially true if the customer has multiple locations or has multi-national operations and does not wish to have separate contracts, terms and prices with Avaya or with Avaya Partners for the multiple locations.

S-1 Response: The S-1 does point to Avaya's intention to "leverage our sales and distribution channels to accelerate customer adoption and generate an increasing percentage of our revenue from these new high value software solutions and user experience-centric applications." Also, the stated risks include, "If we are not successful [in maintaining, expanding or developing relationships with channel Partners (from prior sentence in S-1)], we may lose sales opportunities, customers and market share." Some of the planned channel actions mentioned include, "we must further monetize the NES installed base by increasing the services attach rate for the Nortel customers we acquired." Against that goal, Avaya states the risk that, "Our financial results could be adversely affected if our contracts with channel partners were terminated, ..., if our maintenance pricing or other services strategies conflict with those of our channel partners..." Avaya does indicate that developing skills in and relationships with the channel Partners will be an area of attention and investment.

Commentary: Recent experiences by our consulting clients indicate that the sales and services relationship between Avaya and its channel Partners is far from seamless. Avaya seems to leave the negotiating of a global services program up to the customer and whatever set of channel Partners the customer may have access to or may choose. Also, there is little transparency of Avaya's services offers, terms and conditions through the channel Partners, leaving the client with an inability to clearly establish service level agreements (SLAs) from Tier 1 through Tier 4 and leaving the impression that both Avaya and the channel Partner(s) are taking advantage of this lack of transparency to offset the low margins of competitive pricing in the software and equipment markets. This area may, in our opinion, be one of the riskiest areas highlighted in the S-1.

Reasonable pace of innovation

Customers expect their solutions provider to maintain consistent levels of investment in R&D and innovation at a pace that is appropriate to the markets. In core telephony, that may be more focused on adaptation of new Internet technologies such as Session Initiation Protocol (SIP). In unified communications and 'next-generation business collaboration,' the customers may expect more investment in innovation in selective areas defined by customer inputs, market demand and competitive pressures. However, most customers expect that the costs of such innovation in new markets will be borne by the prices assigned to the new solutions and services, not buried in the price of the core, mature products. Also, most customers do not want the solutions provider to be overly aggressive with those development investments, since the impact of major mistakes could impact on the health of the core business on which the customer relies.

S-1 Response: The S-1 shows Avaya's R&D investment at 8.5% of revenue in the six months ending March 31, 2011. Clearly, based on the S-1 statements, Avaya is focusing this R&D on SIP-based solutions, claiming major development efficiencies by using SIP-based technology. Also, within that 8.5% R&D spending level, the S-1 points out that Avaya is investing aggressively in the "next-generation business collaboration and communication solutions."

Commentary: The level of Avaya investment in R&D seems appropriate for their core telephony products and is comparable, say, to the R&D rate of 8.4% at Mitel. However, the level of investment may not be commensurate with a program that would produce market redefinition and leadership in 'next-generation business collaboration and communication solutions." Competitors in that category are able to spend at average R&D rates (it is not possible to determine the rates for only UC, collaboration and communication) of 13.7% (Cisco) to 17.0% (Microsoft) in the same time periods. Customers should be proactive in expressing their opinions to Avaya senior management as to how Avaya allocates R&D funding in response to the customer's desired outcomes and tolerance for risk and change.

Vendor financial strength, market leadership, and acceptable direction

Almost all customers wish to buy from the market leaders, since that leadership should translate into long-term supplier stability, into sustained competitiveness of the product lines in the relevant markets, into competitive pricing based on the scale of production volumes, and into Sales, General and Administrative (SG&A) expense efficiencies as a percentage of total revenues. Also, most customers prefer that their suppliers not be hindered by financial constraints nor constantly distracted by changes in leadership or ownership.

S-1 Response: The S-1 accurately states that Avaya is a leader in the Gartner Magic Quadrants for Corporate Telephony and Unified Communications. Also, the S-1 points to market share leadership in voice telephony, enterprise (voice) messaging, contact centers, and related services. The S-1 shows that Avaya is effectively managing their financial performance, showing cash-neutral operations and positive EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), even though Avaya is losing money on a full P&L basis (i.e. when those EBITDA items are included). The S-1 also shows that over 70% of Avaya stock will still be owned by TPG and Silver Lake, who have a controlling position on the Board of Directors and, therefore, control over high level management selection and business direction. Also, there are some limitations in Avaya's debt financing instruments on Avaya's options for additional financing and on mergers and acquisitions.

Commentary: The corporate telephony market is a very volatile market at this time. Many of the traditional telephony companies have gone through significant restructuring in the past 10 years. Avaya's ability to sustain itself through this turbulent time is a credit to the firm's management teams. Avaya's market share leadership positions in core voice telephony, voice messaging, contact centers and related services, including the move to SIP-based architectures and solutions, can be expected to continue for the foreseeable future. However, Avaya's investments into the 'next-generation business collaboration' markets are far more speculative. It appears the management team is aware of this risk and is investing only as much in that area as could be lost without jeopardizing the core business while simultaneously maximizing the marketing and promotional value of their innovative ideas.

This concludes the list of top customer expectations with relationship to Avaya and a customer-centered evaluation of the Avaya S-1 Registration Statement. Of course, each enterprise will have its own unique set of requirements in addition to these, but almost all enterprises will have this set of expectations.

From our consultant's viewpoint, some suggested actions for customer consideration during the coming 12 months with respect to the information disclosed by the Avaya public stock offering include:

Expectations and Roadmaps

Check your enterprise's list of expectations against the list shown above. You may also want to create or review your enterprise's roadmap plans for voice telephony, for the spectrum of Unified Communications solutions appearing in your industry (see the list of technologies above), and for collaboration solutions. You can inform the roadmap work both with published UC case studies and with consultant support, if appropriate. In the case of collaboration solutions, we encourage you to examine collaboration in the context of the job types and the business processes related to those jobs and use cases. In our experience, most collaboration solutions are focused primarily on information workers in specific jobs and roles and are most often based on information management tools such as collaborative workspaces, with integration of real-time communications as appropriate rather than as a platform for the collaborative work processes.

Communications

If you are already an Avaya customer, determine whether there are any gaps between your expectations and Avaya's directions. If so, communicate your concerns to Avaya management. If you are not already an Avaya customer, but are considering Avaya as a supplier, assess whether Avaya's direction aligns with your expectations more or less than the alternative options and use that assessment as a factor in your decision making.

Negotiations

Avaya management will be extremely interested in enhancing the Company's results following the public offering in order to sustain or increase the price per share. This is especially true in the six months following the public offering since the senior management team, which has options or ownership of about 10% of the Company's stock, has a "lock-up" agreement that prevents them from selling those shares for 180 days following the offering. Avaya's fiscal year ends on September 30, 2011, so that is usually a strong quarter as the sales force seeks to maximize their annual quota performance. However, the first quarter of Avaya's FY12, from October through December 2011, may be a time when Avaya will be very eager to earn incremental revenue. This may be an attractive time to negotiate optimal pricing and terms for system purchases, and perhaps even for maintenance agreements or renewals, since appropriately priced purchases in that quarter will be benefit both customers and Avaya.

Risk Management

If you agree with the commentary in this article (or if you have your own assessment of Avaya's direction), you may want to exercise care in those areas were risks are clearly stated or inferred. For example, if your enterprise is interested in the Avaya Flare experience, you may want to proceed cautiously, as you would with any relatively new capability from any vendor. This might include a prototypes installation or trial, or might involve comparative testing (a.k.a. a 'bake-off') between the Flare experience and other unified communications and collaboration options available to your enterprise. You may want to assure thorough testing of the new SIP-based platforms, as those are new software releases with increased risks of failure or bugs. You may also want to assess your channel relationship with Avaya and assure that your preferred mode(s) of sales and support will be preserved or enhanced as Avaya makes adjustments in their product, solution and services delivery models.

Channel Relationships

If your enterprise is dependent on Avaya channel Partners for your sales and service relationships with Avaya, you may want to consider the risks highlighted in the S-1 as a basis for a review those relationships, updating contracts or letters of understanding as appropriate. Some examples of areas that are always good to assure, but are even more appropriate in light of the S-1 information are: (1) you may want to assure that your Avaya channel Partner(s) are properly certified and are sustaining those certifications from Avaya; (2) you may want assure that all payments made to the channel partner for licenses, multi-year software upgrade protection, and/or maintenance services are flowing through to Avaya and that you have received appropriate documentation of those entitlements; and (3) you may want to obtain written assurances from Avaya of the transferability of your entitlements and serviceability in the case that your Avaya channel Partner were to be acquired by a company hostile to Avaya, or were to lose their certifications, or were to go out of business (it does happen).

In summary, the S-1 Registration Statement associated with Avaya's impending stock sale provides a solid insight into the Company's metrics, strengths, directions and risks. It appears that Avaya has good control on their business metrics, though Avaya must carefully manage the degrees of risk in areas that are unproven as producers of revenue, cash and profit contributions. Enterprise customers can use this information to inform and to optimize their current and prospective relationships with Avaya.