The Lippis Report

It’s been over a month that Avaya has acquired Nortel and in that little time it has produced the most extensive product rationalization and roadmap the industry has seen. Kevin Kennedy, Avaya CEO and long time industry veteran known for execution and operations clearly has his hands all over the New Avaya as it consolidates product and organizational lines and expands a global channel ecosystem all the while striving to make Avaya easier to work with for both channel partners and customers. During times of rationalization it’s often easy to get mired in details, but Avaya maintains a key focus on unified communications, collaboration and contact center. Like a laser it’s focused on financials. It purchased the Nortel Enterprise Business for slightly more then $900m and reported FY09 revenue of $4.2B while projecting an initial proforma FY10 combined revenue of $5.5B! Its net debt to EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization, a measure of profitability, is 5.9 with a goal of driving it below 4 by year-end 2011. While Kennedy’s hand is on operations his eye is on profitability as Avaya’s EBITDA is in the mid teens to lower 20 percent of revenue with a goal of being industry leading at 25% by year-end 2011. In this Lippis Report Research Note I review the “New Avaya” and provide an assessment of its going forward strategy.

Avaya now employs some 20,000 and supports over 100 products that it sells through an ever-increasing global ecosystem of channel partners. Its goal is to drive over 85% of sales through this channel by year-end 2011. Before the Nortel acquisition it earned approximately 50% of revenue through its channel. But beyond revenues, employees, channel, etc., is a strategic vision and synergy it gains from being a new corporate entity of Avaya plus Nortel. That synergy is a common culture that has navigated the communications industry for over 100 years. At one point in time both Nortel and Avaya were AT&T and with that they have earned the skills to transition the industry through huge technical evolutions in call control/routing that created multi-billion dollar plus size spending over decades. Call control has migrated from analog to digital, then TDM to IP telephony and now IP telephony to SIP. From a technical point of view, it’s in SIP that the New Avaya is building upon to rationalize products, provide customers with a migration and transition plan and innovate new features and capabilities. From a business plan perspective the New Avaya offers the most extensive communications portfolio in the industry, surrounded by global services and channel partners who promise to take complexity out of doing business with it from envisioning, designing, implementing and managing its real-time communication solutions.

There is an excitement within Avaya that seems to be rooted in the knowledge that they are a new major industry force equipped with a new business plan that’s being executed by an experienced executive management team who possess both networks and communications experience from Cisco. Their CEO, Dr. Kevin Kennedy ran Cisco’s IOS Technologies Division and Service Provider Line of Business. Charlie Giancarlo, Avaya’s Chairman was Cisco’s CTO; Dr. Alan Baratz, Sr. VP and President of Avaya’s Global Communications Solutions was the Sr. VP for Cisco’s Network Software and Systems Technology Group while Todd Abbott, Avaya’s Sr. VP of Global Sales and Marketing & President of Field Operations ran Cisco’s global sales and marketing. This executive management team knows how to create value and change industries and it seems like the employees understand it and are energized to be a part of this New Avaya.

As job one, Avaya set out to communicate a roadmap for its Unified Communications, Contact Center, Small and Medium Enterprise Communications, Data Solutions, Government and Industry Solutions businesses. Being sensitive to both Nortel and Avaya customer’s existing investments the New Avaya provides a well thought-out and generous support program for when and if they notify product end of life. We’ll touch on just a few of the roadmaps here, in particular Unified Communications, SME and data networking. To deep dive into any of these areas there is a set of webinars here.

Avaya Aura Is The Integration Point for UC and Legacy Voice: The Unified Communications (UC) portfolio roadmap provides a migration from today’s integrated voice-based PBX systems to a future world of open, flexible, modular real-time communication systems that support voice, video, and real-time data. SIP is the fundamental building block to deliver this vision and it’s the Avaya Aura product that makes it a reality. Aura possesses two components to its value proposition: 1) Aura connects legacy PBX and IP telephony voice communications systems via SIP reducing communications cost through consolidated SIP trunking plus operational efficiencies; and 2) Aura offers an application environment where communications can be injected into business processes removing system and human delay, speeding workflow and increasing productivity.

By connecting legacy and SIP-based communication systems into Aura, Avaya is able to provide customers with a migration path that not only pays for itself with reduced facilities and operational cost but also offers an application development environment that links IT and communications and an innovation inject point for their customers and partners. To meet that end, the Avaya UC roadmap expands the value of Avaya Aura with the addition of the Agile Communications Environment (ACE). ACE uses Service-Oriented Architecture and Web Services to facilitate rapid development of communications enabled applications.

Key point of this strategy is that existing investment in Nortel CS1000 and/or Avaya Aura Communications Manager (ACM) legacy PBX platforms and end-points are preserved, meaning that support, line cards and end-points of both systems are available; however, over time Aura will run on top of CS1000 and ACM while delivering cost reduction benefits. With Aura connecting the CS1000 and/or ACM, customers will have increased choice of end-point devices, which could connect directly into Aura via SIP or existing end-points into CS1000/ACM. For example, consider a CS1000 customer running Aura on top. Avaya will ensure that consistent or identical end-point user interfaces and feature sets are available to end-points connected into Aura or the CS1000 to assure a zero learning curve for users. In addition as SIP and Aura are “session-based” meaning that sessions carry any type of traffic, users are delivered a wide range of communications mode options, be it voice, video, text, etc. The underlining message here is that sessions support and enable any type of communication end-point such as a desktop phones, mobile end-points, a soft client, etc.

Small and Medium Enterprise Migrates To IP Office: The SME business unit possesses the largest number of products that need rationalization including the TDM/Key System Partner, Integral and Norstar products plus the Hybrid IP PBX IP Office and BCM products and the SCS (Software Communication System), a SIP-based UC Software solution designed for IT-centric SMEs. Since the TDM/Key Systems market is in decline by as much as 43% in 2009 and projected to nearly disappear by 2013 it only makes sense to phase these products out over time. As the Hybrid IP PBX market segment is growing double digits in volume with 24% of SME getting ready to deploy it only makes sense to address this market with the current popular IP Office that is used by 6m users worldwide. The SIP client software market is projected to show strong growth in 2012 providing time to integrate SCS into IP Office and Aura.

To its credit Avaya has already consolidated many of the Integral 5 and Partner features into IP Office with a common management environment where IP Office supports Integral 5 and Partner end-points. Avaya will build upon this by converging Norstar and BCM key features, attributes and management into IP Office over the next eighteen months. At the end of this process IP Office will support Integral 5, Partner, Norstar and BCM end-points. Note that all of these products will remain for sale during FY2010 and Avaya has committed to another release of BCM later this calendar year. In total Avaya is providing up to six years of hardware support, which is generous as, most systems are depreciated over seven years. This is a thoughtful migration with a long tail, but the flagship product in the SME space is IP Office.

Real-time Data Networks. This is one area of the product portfolio that is not being rationalized as there is no overlap between Avaya and Nortel in data networking. Avaya did sell ethernet switching under its Cajun brand, then decided to drop these products in lieu of partnering with Extreme Networks and Juniper Networks. Avaya’s history in data networks is dubious. It’s excellent at voice communications and collaboration, but has not been able to deliver competitive data networking products. Avaya Data Solutions currently owns slightly less than 5% of the very large market for ethernet switching which is dominated by Cisco. But Avaya’s data networking customers are unique as they possess a propensity not to buy from Cisco. So the question is, with the executive management of Avaya all from Cisco does it now have the right stuff to compete in this highly competitive market? Avaya seems to be staking out a stance in the area of real-time data networking that enhances Avaya’s real-time communications and collaboration solutions. In short, will Avaya’s UC and CC run better over its data network?

Assessment:
Avaya believes that either the communications industry is at a pivot point toward SIP or it has the wherewithal to influence the industry by creating a flash point of value with a SIP- based product portfolio that’s surrounded by a global partner ecosystem and service organization. Avaya clearly has expertise, products and management to navigate and take advantage of an industry inflection point as big as the transition from analog to digital and its resulting economic opportunity. Independent of pivot, flash or inflection point 2010 will be a year of hard work at Avaya as it executes on the roadmaps. But as it does, little by little the number of products it will be supporting will be smaller, its EBITDA should get larger and if its calculus about SIP is right, then its revenues and market share will surely grow too.