20 Mar Avaya Chapter 11 filing
As experienced technology analysts and consultants we spend a great deal of time tracking and analyzing a broad range of telecom, network and IT players. We also work with many end user government and enterprise organizations in a broad range of industry sectors. This enables us to look at things from both the industry and customer side of things.
Bill Elliott (who is a long time member of the Fox Group team) brings more than 30 years of direct telecom industry technology and management experience to his NG9-1-1 role, plus ten years of consulting as enterprise practice leader with us at Fox Group. I asked him to provide his perspective on what the recent Avaya announcement means from his unique viewpoint.
Bill Elliott, ENP commentary
On Jan 19, 2017 Avaya Inc. announced that they were seeking Bankruptcy under the protection of Chapter 11 of the United States Bankruptcy Code. This has been expected for several months, and was not a surprise to Fox Group or most other people in the industry.
The culminating incident leading to Avaya’s decision appears to be a deadline with its creditors at the end of January to restructure its debt. In addition, Avaya also faced a balloon payment of approximately $600 million in October 2017. This was all part of their total debt load of approximately $6 billion and an annual interest expense of $400 million.
CEO Kevin Kennedy clearly stated that the filing for Chapter 11 affects Avaya in the United States. Canadian and other worldwide business interests are not included. Therefore, in Canada there should not be any significant changes in the short term; however, the long-term structure of Avaya and its associated business units is less clear; and, therefore, some actions taken during the process may well have an impact on Canadian customers.
There is always a level of uncertainty when businesses act to reorganize, particularly when Chapter 11 protection is included as part of the process. Organizations that still have traditional Nortel/Avaya equipment need to be vigilant during this Avaya reorganization. Of interest to us at Fox Group are the short and long term effects on the healthcare industry and 9-1-1 services. First, however, a deeper understanding of the Avaya announcement itself is necessary.
How did this Happen?
Over the past 10 years, Avaya has been accruing a high level of debt due to acquisitions, including parts of Nortel Networks in 2009. In addition to the debt issue, is also in the middle of a significant business transformation as it moves from being a hardware telecom provider to a software and services communications technology company.
The restructuring costs of this transformation and the change in the types of revenue stream, discussed below, can also be considered as contributing factors to the recent announcement. The business transformation has also resulted in Avaya maintaining intellectual capital for both types of technologies.
Why the Change from its Traditional Roots?
This new strategic direction is a result of significant change in the essential nature of the industry. Voice communication is no longer a separate and distinct environment from the data network; in fact, voice, video, and messaging are now software applications residing on the IP Network.
Instead of selling large business PBX systems with large one-time payments, the business has evolved to where Avaya installs servers with operational and application software that has associated multi-year revenue from licensing and support. This evolution dramatically changes the corporate finance model.
This is a reminder to telecom users that the days of “big iron” PBX’s is effectively over. When the voice services and the associated Unified Communications are migrated to the IP Network, they are subject to the same software assurance, server renewal programs and associated timeframes that the IT department has for the rest of the technology investments.
How does Business Transformation affect the Balance Sheet and Revenue Streams?
As Kennedy pointed out, the financial arrangements for Avaya were made 10 years ago when they were effectively operating in a world of large cash influxes which would support (almost as large) cash outflows.
In an environment where revenues from a single sale are recognized over five years rather than six months (as in the past), the capital structure of corporate debt would be different. The process of restructuring of the balance sheet could well realign revenue and debt in an appropriate way that allows Avaya to move forward.
In addition to the mis-match of cash flows, the amount of R&D expense, sales overhead and market development costs for the new products are also being incurred with the intention that they will drive revenues for future years.
This convergence of factors resulted in the January announcement.
Kennedy announced that a branch of Citibank will be providing $750 million of debtor-in-possession financing. This approach was approved on Friday, January 20 2017 by a U.S. bankruptcy court judge.
This is a special type of financing designed to provide liquidity to companies undergoing restructuring; to keep it operating as a going concern until the process is completed.
In the case of Avaya, this financing is for a maximum of one year. The stated objective is to recapitalize the company including “monetizing assets”. It was also stated that sale of the Contact Center business would not maximize value for Avaya’s customers and stakeholders; therefore, it seems that Contact Center, Networking and Unified Communications will form the centerpiece of the business plan moving forward.
The remaining, non-core, business processes and assets would seem to be on the primary target of the “monetizing assets” activity. As was seen during the liquidation of Nortel Networks, there were significant assets such as patents and non-core business operations which generated a substantial amount of capital.
It is unknown which parts of Avaya may be in this category but clearly Contact Center and Unified Communications are now considered to be core operations and are unlikely to be on the chopping block.
Who or What is at Risk?
When asked about headcount reductions, the answer included comments that they were still hiring for openings in sales and other key positions. The answers focused on references to growing the Contact Center and Unified Communications business and the associated support and Service Level Agreements.
One can assume that business operations outside of these core businesses may be scrutinized for additional revenues, reduced costs or sale (monetizing assets).
Those organizations that still have older Nortel/Avaya equipment should be closely monitoring Avaya’s business re-organization to determine how support may continue to be offered, by whom and for how much. In addition, special attention should be given to the Product Life Cycle Matrix published by Avaya.
How does this news affect NG9-1-1/E9-1-1 and Health Care?
These industries are not only dealing with “life and death issues” but the process to update and replace the information communication technology is typically a challenging multi-year process due to complexity, budgetary limitations and the intricacies of the overall deployment. Based on risk analysis, having a communications partner with a stable long term financial outlook and product line is a key component when selecting a communications vendor.
In the past, Avaya has been very actively involved, both at a technical level and a lobbyist/activist for legislation to improve 9-1-1 services in Canada/US. This valuable support to the NG9-1-1/E9-1-1 industry has been recognized and appreciated.
Health care organizations including hospitals, health care help lines, extended care facilities and community outreach along with NG9-1-1/E9-1-1 need to be particularly vigilant during the Avaya reorganization process to protect their daily operations.
For example, one possible outcome of the reorganization might be that Avaya sells the service contracts to all traditional telecom equipment. In this case, cost of service could skyrocket or be discontinued suddenly for any equipment at or near “end-of-life”.
Although the local dealer may make every effort to continue providing service, without manufacturer’s support, service would become, at the least, expensive; and at the most, extremely difficult. This could leave organizations that provide life-saving services in a very difficult position.
Roberta J. Fox Commentary and Guidance
What does this all mean for telecom channels and enterprise customers?
Since the announcement, we have had numerous discussions with Avaya channel partners of varying sizes asking for our thoughts and opinions on the impact of the Avaya corporate announcement.
We believe that the Avaya contact center technology is the crown jewel of value for both clients and the industry, and will continue to be important, particularly for those large government and other enterprises that rely on contact center technology solutions.
Avaya also has a significant number of patents from products that they have developed over the years that are used in hundreds of hardware and software products. These too have residual value.
One last point that many folks have not commented on is the human capital of both the Avaya employees and the channel partners throughout the world.
Yes, we agree that telecom is evolving to be applications oriented and moving from customer premise based to cloud. Yet, there is still the need for experienced people who know how to design, install and support the various applications that make sure communication work, whether voice, voice mail, ACD, IVR, text, chat, or within contact centers.
The human capital value of Avaya and their channels may in fact be the most valuable asset they have for their future, in whatever form it takes.
Our guidance to enterprise and government clients
We have been advising our Canadian clients to remember that Avaya Canada Corp. is not part of this announcement, and has had good financial performance, and is able to continue to support its client base in the future through their Canadian channel partners. We believe that their technology products and services will continue to have long term value in solutions, whatever form they take, and whoever delivers their solutions.