Mitel, Shoretel’s just not that into you

After weeks for not talking to Mitel, it looks like Shoretel’s Board has managed to stay independent, as Mitel announced they are withdrawing their bid to acquire Shoretel. Reaction is pretty muted in the scant press that serves our industry, though some consultants that have historically worked with Shoretel were happy about the outcome.

Shoretel is a cruel mistress

Mitel will be curling up to watch this over the weekend (in German, because they are No.1 in W. Europe, see)

Key takeaways from this episode:

  1. No one is dying to get into enterprise telecom. No one else put a bid out for Shoretel.
  2. Competitors were not interested. As we mentioned in prior posts, competitors were not going to materialize as bidders. Avaya is up to its ears in debt, Cisco walked away from the small-to-medium business market Shoretel and Mitel are fighting over, and the Asian brands (NEC, Toshiba, Samsung) tend to pick “make” over “buy” no matter how bad their product turns out.
  3. Mitel continues to exercise Canadian prudence. Mitel was put in a position of bidding against itself, gamely upped the bid 40c a share, and walked away when Shoretel wouldn’t come to the table. The real risk for Mitel dealers is that Mitel made a bad deal to knock out a competitor and become saddled with debt, which fortunately did not happen.
  4. Wall Street gave a big shrug. Stocks for both companies barely moved, with trading volume for Shoretel off a third from the average.
  5. The hate between the two companies burns bright. Shoretel’s Board choosing to decline the offer is one thing, but refusing to discuss either offer with Mitel leadership is a sign of continued enmity between the two firms.

I am a little disappointed because I would have liked Mitel to capture some of the Shoretel magic when it comes to marketing their products. I am sure Shoretel dealers would have liked the SIP, contact center, security and virtualization capabilities Mitel brings to the table.

Mitel, Shoretel Merger Drama Continues

Mitel and Shoretel will merge... or won't they?

The drama continues to unfold, and this is playing out as many in the press predicted. Mitel CEO Rich McBee has reframed the offer Mitel (MITL) made for Shoretel (SHOR), and that Shoretel rejected, as an opening bid. So far, there are no white knights on the horizon coming to save Shoretel, so Mitel begins the bidding war against… itself.

Mitel and Shoretel will merge... or won't they?

An awkward courtship between two rivals

Taking a look at the recent earnings out for dear Mitel, and you have a lot of bright spots. Mitel’s cloud business is taking off with over 800,000 seats sold. Year over year, recurring cloud revenue is up 50%, to 21.7M a quarter.  The quarter’s loss of 5.1M is actually small beans now that the Aastra merger is complete, amounting to 1.9% of over a quarter billion in quarterly revenue. Cash burn was 12M, leaving $120M in the bank. And another $25M of debt was retired in the last quarter, as the company continues to hack away at the debt burden that went up a sixth following the Aastra merger. 50 people were laid off following the merger, so there does not appear to be a wave of cost consolidation. All in all, Mitel’s story of incremental improvement and shift to a cloud-based business continues apace.

Having seen the product roadmap for Mitel following the Aastra merger, we can say conclusively that the Mitel MiVoice Office 250 (the branded Mitel MiVoice Office that was once the Mitel 5000 after it was the Mitel 5000 HX and the Mitel 5000 CP and the Inter-Tel 5200/5400/5600 systems) is here to stay. It will not be virtualized – that is where the Mitel MiVoice Business comes into play – but it is the Mitel system for the small to medium sized business of up to 250 users. There will be a new Mitel system from Aastra – the Mitel MiVoice Enterprise – that will support up to 500,000 users. Give us a call if you know of any Fortune 500 companies and small countries

If we look at Shoretel’s recent financials, we see an interesting moment in time – GAAP profit! Yes, Shoretel has made some money, though a paltry $366,000 on $90M in revenue for the most recent quarter. Top line revenue is up, they are keeping a lid on costs (snarky competitors will note: marketing is just about 1/3 of revenue and costs), all to be commended. Mitel has pissed all over their parade because this was the quarter Shoretel was waiting for, as they finally achieved enough scale to turn a profit. They are still sitting on a nice pile of cash ($57M).

Cloud though is not such a great facet of the business for Shoretel. Since buying M5, we have not seen a really good cloud story from the brand, since the two lines are not really integrated at this stage. Hosted revenue is up from a year ago, up $4M from $20M to $24M.  Competitors like RingCentral and 8×8 are showing massive growth every year. Vonage has leveled off – perhaps due to their large residential service component – but has close to $900M in annual sales.

Diving into the revenue numbers, we see flat product sales. The increase in revenue year over year at Shoretel is the $4M in cloud and $2M in support contracts and services. Support contracts are profitable for manufacturers but also limited as to how large they can grow – they are driven by product sales. You can only jack the price up on your support contracts so many times.

As far as the merger is concerned, Shoretel might want a more dynamic partner than Mitel, and definitely wants more money, but Mitel has shown that they have figured out a way to share a single software stream between premise and cloud, something we are still waiting on with Shoretel. I am not in a position to say whether this hurts Shoretel and accounts for their relatively sluggish growth, but the story with brands like Mitel and Zultys is much easier to tell – customers can just pick the way you want to deploy your system and not think about differences in how things work.

I can also report as a Mitel dealer that there is reluctance from the dealer channel to sell cloud, but no matter, as Mitel has a small army of direct sales reps. Shoretel is more reliant on their dealer channel, so if their dealers look at cloud the way our dealers do (they hate it, more or less) then the slow growth makes sense. Just as Mitel benefited from Inter-Tel’s US & UK sales machine when that merger took place, so Shoretel could start to look at their acquisition by Mitel as leveraging a Mitel sales channel that is already pretty familiar with their product, without hurting their loyal base of dealers who are stuck on premise anyway.

Shoretel’s cloud phones use SIP, their premise phones use MGCP, and until they update their core phone business to the SIP standard they will be at a disadvantage as the days of buying a phone to match your phone system fade into history. Mitel’s new SIP phones are out on the market and will probably make it very hard to compete now that Mitel can leverage Aastra’s scale for production and experience with SIP.

The premise system market is far from dead, but no one is dying to break into the industry, either. Shoretel and Mitel are far more nimble than the large companies competing against them in the SMB marketplace, and have better technology than the hosted-only companies in the space. As feisty as both companies are, it might be time to think about the possibilities a combination affords.

Mitel’s Shoretel Offer

Exciting times to be a Mitel dealer in Los Angeles. With a crowded marketplace full of Shoretel dealers banging into each other on every deal, many IT VARs, MSPs, IT and Telecom Consultants, and Telecom VARs and Interconnects are eagerly awaiting what shakes out, if anything, from the Mitel bid for Shoretel.

On October 20, 2014, Mitel (MITL) offered $540M for Shoretel (SHOR), an offer Shoretel’s board rejected. In fact, Shoretel has publicly scorned the offer as financially inadequate and tooted their own horn regarding their recent successes, giving every indication that they were fiercely independent and going to stay that way. Mitel sued them over intellectual property on the eve of their IPO, so this announcement, on the heels of a quarter where Shoretel managed to eke out a positive GAAP (Generally Accepted Accounting Principles) net income could be seen as part and parcel of Mitel habitually raining on a competitor’s parade.

Except, for one, Shoretel hired Blackstone to advise them. This offer comes on the heels of last year’s executive exodus at Shoretel and a wave of insider selling over the last 12 months – all signs that there is something odd going on. We are looking at some weird execution problems at Shoretel lately too – it took about a month to patch the HeartBleed problem on their core systems, and this is still going on – different protocols and phones for premise and cloud.

Odd choice of Phone

Cisco SIP for Shoretel Sky

 

 

 

 

 

 

 

 

This blog post takes a pretty tough stance, noting that the telecom equipment market is consolidating as businesses shift to the cloud and that Shoretel has run at a loss for 16 years in a row. I would argue that the numbers clearly show that Shoretel’s cloud business is getting some traction. The counter to that is that SHOR’s cloud business is of insignificant size compared to 8×8 (EGHT) or Vonage (VG), who combine for a billion dollars in cloud telephony revenue a year. I would add that Vonage has a gross profit margin of close to 69%, and 8×8 runs at nearly 71%. Premise manufacturers like SHOR (59%) and MITL (55%) are going to face some challenges supporting a large premise base while they pursue cloud. I think combining to wring efficiencies and scale out of their operations is going to be crucial if these old-line companies are going to compete with firms with that big of an advantage.

Since Shoretel shares are 83% held by institutional investors, it looks like the barrier to a purchase may be more about price than stubbornly independent Shoretel leadership. This article features shareholders explicit about wanting a price in the $10-12 a share range, versus the $8.10 price of Mitel’s first offer. The stock has been flat for some time, so I would imagine shareholders are excited to see some movement.

So what does it all mean for our customers? If you are considering a Shoretel system, be aware that underneath the tough talk in the press releases, Shoretel hired investment bankers and Wall Street might like to see the company sold, so they can cash out on a stock, and a sector, that has been pretty flat. I imagine Shoretel is hoping for a bidding war to drive the price up, which would be a Pyrrhic victory for Mitel if they take on too much debt, though it is hard to imagine who would want to get in the game ahead of a huge technology refresh cycle about to sweep the industry.

Two CLECs, One Cup of Consolidation

Industry consolidation continues as another player is snapped up.  tw telecom purchase price of $5.7B as reported by the NYT, who capitalized the spelling of ‘tw telecom’ like a bunch of barbarians.

As tw telecom is a Local Exchange Carrier in the grand tradition of ye olde AT&T and Verizon, (the cable TV and internet assets stayed with TimeWarner Cable in the spinoff), we won’t be seeing anything too radical come out of this merger such as a combination of cable and telephone network connections in a billing package.

Level3 is better at long haul internet and companies with large, distributed footprints, and tw telecom is in the trenches providing smaller companies with phone and internet service in US cities. If you were with Level3 for a corporate internet and WAN plan, maybe you can get a more consistent menu of services across locations with tw telecom provisioning in the future. If you were with tw telecom, you were probably too small to care about Level3 getting you MPLS connectivity across an ocean.

On a personal/anecdotal note, we like Level3’s responsiveness when we worked with them on a 60+ location telco rollout, and we find that tw telecom’s local sales and service staff are very polished and responsive.  In our home market of SoCal, we bump into tw telecom more than we do Level3, which is the local/national split that is going to result in oodles of synergy as per this Marketwatch article.

Now, some random comments on the numbers.

  • So total EBITDA will increase by $200M from synergy. tw telecom currently makes $125M a quarter in EBITDA ($500M/yr).  So 11x earnings (8x earnings counting synergy) and assumption of $2B in debt. Level3 loses money every year.
  • tw telecom net income is $36M on $1,560M in revenue in 2013. 2.3% margin. That is pretty stellar in telecom. Again, Level3 loses money every year.
  • Combined market share is 6% per the WSJ. Not bad, but still small in a commodity business with shrinking margins.
  • Level3 says they can cut costs by $2.2B in the WSJ article… not sure if that is over 10-11 years to get your $200M/yr savings number or if we have very different stats popping up. Level3 is spending on average $699M on interest expenses on its own debt.
  • WSJ says that savings on cross-connect fees is the big win here, where Level3 won’t have to farm out local connections as often if they own a CLEC like tw telecom. I’d think tw telecom’s fiber rollout is another huge part of this, as they can offer end-to-end fiber that would be a real differentiator over other carriers that are making a network of copper and fiber connections.
  • Level3 CFO has said corporate data prices have stabilized.  Interesting, but we think fiber rollouts will keep putting downward pressure on data prices. Maybe not so much at the league Level3 plays in, though I would think those are the smartest, toughest customers.
  • Important to note again that Level3 does not really make any money. At least not Net Income by GAAP standards.  In terms of cash flow, they are all over the place.
  • The budget for R&D for both companies is zero.  Not one penny put into research. In case you were wondering if they are utilities or high tech companies.
  • Looking at Level3’s balance sheet, you have $8b in debt offset by $8b in property. This explains why anyone would lend them money, I suppose. The new entity will have $10B in debt and $800M in interest payments a year assuming things hold steady.

If I was looking at either company, I might be a little nervous, because sometimes mergers in telecom are messy.  That said, there is not all that much overlap with these two, at least in our market. Who knows, maybe Level3 will benefit from working with a more efficient operator.