AVAYA HLDGS CORP AVYA
July 08, 2021 - 11:17am EST by
Saltaire
2021 2022
Price: 26.38 EPS 0 0
Shares Out. (in M): 96 P/E 0 0
Market Cap (in $M): 2,523 P/FCF 0 0
Net Debt (in $M): 3,072 EBIT 0 0
TEV ($): 5,595 TEV/EBIT 0 0

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Description

AVYA – Investment Thesis

July 2021

All figures presented in US$ millions, except for per share data.

All share price data as of market close, 7/6/21.

At <8x 2021 EBITDA, AVYA trades like a legacy, on-prem hardware asset with limited prospects for revenue growth.  Low investor expectations create an attractive risk/reward profile given AVYA’s participation in high-growth end-markets with multiple areas where AVYA is well-positioned to accelerate revenue growth, combined with a valuation and FCF profile that limits downside from here.

 

Situation:

Avaya (“AVYA” or the “Company”) is globally the largest contact center (“CC”) vendor and second largest unified communications (“UC”) supplier.  Avaya is in the process of converting its existing on-prem customer base into subscription and cloud customers which will drive accelerating revenue growth. 

We believe Avaya is well-positioned to capture a meaningful percentage of its customer base’s migration to the cloud given: an entrenched position with enterprise customers; limited competition amongst large enterprise customers, particularly in private cloud; and a partnership with RingCentral (“RNG”) that provides Avaya with the leading Unified Communications as a Service (“UCaaS”) platform and added ability to capture small and medium-sized business (“SMB”) customers.

While this transition occurs, Avaya’s top-line growth remains muted, which is where we believe the opportunity for the stock lies.  AVYA is trading at 1.9x 2021 Revenue and 7.9x 2021 EBITDA, which compares to its cloud competitors 8x8 (“EGHT”) at 5.5x 2021 Revenue and RNG at 19.0x 2021 Revenue. 

Avaya is targeting $1bn of ARR by 2023, which can be achieved by converting just 4% of existing UC seats to a subscription or cloud offering[1].  If we ascribe a multiple of 4x to Avaya’s $1bn ARR target, we arrive at an enterprise value of $4bn, which compares to Avaya’s current EV of $5.6bn before ascribing any value to the remaining ~$2bn+ of revenue the Company generates.[2] 

From a risk/reward perspective, we believe Avaya’s stock today presents an attractive re-rate opportunity.  Consensus is forecasting decelerating revenue growth and ascribing minimal credit to Avaya’s ability to succeed in the cloud despite strong execution to date (ARR in the most recent quarter increased +31% sequentially and 5x YoY) and multiple areas where we believe Avaya is uniquely positioned to win, creating a dynamic where not much has to go right for the stock to appreciate from here.

We recommend Avaya as a long with a target price of $40.00 (~50% upside), which represents a free cash flow yield of ~9%.

 

 

Company and Industry Overviews:

Avaya offers UC and CC solutions, across on-prem, private cloud, public cloud, and hybrid cloud offerings.  The Company is a market leader in both the UC and CC markets, with a 25% and 40% market share, respectively.  

 

Unified Communications (UC)

Contact Center (CC)

Description

-    Business communications platform to enable a company’s employees to communicate across various mediums (phone, text, video, conference) through a single interface

-    Platform to enable a company’s call center with capabilities such as: automatic routing when a customer calls, automatically calling the customer based on use case, call recording and analytics, chatbots

Avaya Size

-    100mm seats (25% market share)

-    50% Enterprise / 50% SMB mix

-    70% of seats no longer pay maintenance, largely concentrated in SMB customers

- 6mm seats (40% market share)

- 65-70% Enterprise / 30-35% SMB mix

Industry TAM and Growth Rates

(2019-2023)

-    Private Cloud: $2.6bn à $5.3bn (+19% CAGR)

-    Public Cloud: $12.8bn à $19.7bn (+11% CAGR)

-    On-Prem: $6.7bn à $5.0bn (-7% CAGR)

-    Total: $22.1bn à $30.0bn (+8% CAGR)

- Private Cloud: $0.6bn à $1.9bn (+33% CAGR)

- Public Cloud: $2.9bn à $7.1bn (+25% CAGR)

- On-Prem: $2.1bn à $1.4bn (-10% CAGR)

- Total: $5.6bn à $10.4bn (+17% CAGR)

       

 

The UC and CC markets largely consist of on-premises (“on-prem”) deployments acquired through a perpetual license (often with a maintenance revenue stream attached).  Vendors are focused on the market share and monetization opportunities as customers evaluate their future deployment options, which include:

On-prem subscription: customer retains the on-prem seat but receives the latest hardware and software, along with free ongoing software updates, which customers are finding increasingly valuable given the pace at which additional features are being introduced.  This solution is particularly appealing to enterprises, as they can access the latest feature set without the friction of moving to the cloud.

Private cloud: customer receives access to cloud-based capabilities through software hosted on the customer’s infrastructure.  The offering tends to be highly customized and generates a higher LTV customer as additional services are consumed in the cloud.  Private cloud enables enterprises to retain the security, privacy, and control of on-prem systems, with the enhanced capabilities and flexibility of the cloud.

Public cloud: customer is hosted through a multi-tenant cloud solution with access to the functionality, consumption-based pricing flexibility, and outsourced security and server management offered in the public cloud.  Public cloud offerings are well-suited for SMB customers, as they typically lack the scale to manage security and server maintenance requirements provided in the public cloud, and prioritize the enhanced pricing flexibility and capabilities of the public cloud. 

Avaya’s ability to capitalize on these evolving market dynamics lies is in management’s ability to:

Convert on-prem enterprise customers to a subscription or cloud-based offering.

Enterprise customers, which account for the majority of Avaya’s customer base, are principally focused on private/hybrid cloud given their security, implementation, and complexity needs.  According to the Nutanix Enterprise Cloud Index, 86% of enterprises consider hybrid cloud their “ideal operating model”.[3]

Most Avaya’s CC customers are also UC customers[4], which puts Avaya in a unique position to serve the customer with a custom private cloud offering that includes both offerings, in addition to migration tools, implementation, and ongoing support. 

Enterprise customers are expected to move slowly to the public/hybrid cloud.  In the interim, we can track Avaya’s success in transitioning enterprise customers to a subscription or private cloud offering as a proxy for the Company’s relevance to customers’ longer-term cloud strategy. 

The transition generates a 10%+ uplift in revenue, guarantees a multi-year contract renewal, shifts the customer to a cloud-like consumption model, and positions Avaya well for future hybrid cloud conversations. 

Convert on-prem SMB customers to a public cloud offering.

Avaya is targeting its legacy SMB UC customers with a public cloud UC product based on RingCentral’s offering, which is widely considered best-in-class. 

Avaya also offers an internally developed public cloud CC offering and has committed to deploying >2/3 of its ongoing R&D budget to enhancing the product[5].

Management has cited impressive early progress across both opportunity sets, claiming win rates of 90%+ with installed base customers moving to a subscription or cloud offering.

Unified Communications

UC vendors offer tools which enable the connection and integration of enterprise communications across devices and modes of communication – including voice, video, text, and conferencing – through a single interface for users that is not device or location dependent.

The UC market consists of 400mm total seats, almost all of which are on-prem seats.  UC seats in the public cloud (UCaaS) account for 3.5% of the total seats.[6]

Key players in the on-prem market include Cisco, Microsoft, and NEC.  Public cloud (labeled as UCaaS in the pie chart) players include RingCentral, 8x8, Microsoft, Cisco, Mitel, and Fuze.

UC Market

Source: Craig Hallum equity research, 1/8/21.

Our channel checks suggest that ~20% of UC seats are likely to remain on-prem for the foreseeable future given idiosyncratic end-market needs; for instance, hospitals and hotels with individual local site requirements.  Craig Hallum estimates that over 50% of the UC market will remain on-prem or in private cloud.[7]

Avaya’s UC market forecast (based on Gartner) indicates that by 2023, over 1/3 of the market will remain on-prem or in the private cloud.  Of note is growth in the private cloud, expected to grow at a 19% CAGR through 2023.

UC TAM and Growth Rates ($ in billions)

Source: Avaya FQ2 21 (3/31/21) Investor Presentation.

Avaya holds 100mm UC seats, comprised of 50mm enterprise and 50mm SMB seats.  Just 30% of Avaya’s UC seats generate a revenue stream; the remaining 70% of seats are perpetual licenses with a break-fix fee structure.  Non-revenue generating customers are largely concentrated in SMB seats. 

We estimate that Avaya’s on-prem UC base is churning at a rate of 8-12% annually, most of which is moving to an Avaya subscription or private cloud offering. 

Private Cloud / On-prem Subscription

Avaya offers its on-prem customers the ability to shift from a perpetual license to a subscription or cloud-based revenue model. 

The conversion is a straightforward sell: in exchange for a ~10% increase in spend, the customer receives new hardware and free software upgrades, along with cloud-capabilities if migrating to the private cloud.

Craig Hallum estimates that each on-prem seat generates $168 of ARPU.  Assuming no incremental uplift in revenue from the conversion, converting 1mm seats (of 100mm total) to a subscription-based model drives an incremental $168mm of ARR, which compares to $344mm of ARR at 3/31/21 and management’s 2023 ARR target of $1bn.  While there will be some offset to revenue from displaced maintenance revenue, from an ARR perspective – which excludes maintenance and is the higher-valued revenue stream – converting just 4mm UC seats to a subscription model pushes the Company past its $1bn ARR target.[8]

Subscription ARR Opportunity in Enterprise Base

Source: Craig Hallum equity research, 1/8/21.

UCaaS

In October 2019, Avaya announced a partnership with RingCentral for the launch of Avaya Cloud Office (“ACO”).  ACO is built on RingCentral’s UCaaS product, which is widely recognized as the industry’s leading offering. 

The strategic benefit is two-fold: 1) Avaya can minimize competitive churn from SMB customers moving to the public cloud by offering the leading UCaaS platform with Avaya-branded migration tools and 2) Avaya is able to focus its R&D efforts on the private cloud and CC.

Though ACO’s economic terms were not disclosed, below are Craig Hallum’s estimates of revenue to Avaya: $100 up-front per seat plus $21.60 of annual commissions per seat.  We believe this math is directionally accurate, based on conversations with industry participants.

Recurring ACO Commissions

Up-Front ACO Commissions

ACO is targeted at SMB customers, who are less likely to be paying maintenance revenue, and as such ACO revenue should largely be incremental revenue for Avaya. 

Based on the math above, every 1mm ACO seats added generates $100mm of up-front commissions and $21.6mm of ARR for Avaya.  RNG paid Avaya a $375mm advance for future commissions, suggesting that RNG expects Avaya to sell millions of ACO seats. 

Contact Center

Contact center tools cover a range of customer service, sales, and marketing functions for companies to engage with their customers.  Through a single platform, companies can interact with customers across channels including voice, chat, email, web, video, social media, and mobile.  Enterprises are increasingly focused on service capabilities as a strategic asset and competitive differentiator, and the role of the agent is expanding from historically mundane tasks (e.g., password resets) to a focus on brand building and driving incremental revenue streams through upselling.  A Salesforce Service survey found that 70% of call center agents say their jobs are more strategic in nature.[9] 

Salesforce Survey Results

Source: Evercore equity research, FIVN, 8/19/20.

 

With customer service support tickets increasingly arriving through digital channels, and the introduction of AI-enabled tools to enhance efficiencies, the CC market is expected to remain a critical area of business investment. 

Avaya’s CC market forecast (based on Gartner) indicates that by 2023, over 30% of the market will remain on-prem or in the private cloud.  The private cloud is expected to grow at a 33% CAGR through 2023.

CC TAM and Growth Rates ($ in billions)

Source: Avaya FQ2 21 (3/31/21) Investor Presentation.

Avaya serves 6mm CC agents, comprised of ~65-70% enterprise agents and ~30-35% SMB agents.

According to the Company, a CC customer generates 3-6x the value of a UC customer, across all deployment vehicles (on-prem/private cloud/public cloud).

Private Cloud / On-prem Subscription

Similar to its UC offering, Avaya offers its on-prem CC customers the ability to shift from a perpetual license to a subscription or cloud-based revenue model. 

Our customer calls indicate that Avaya’s CC on-prem customers are very sticky, a function of how embedded within an organization the contact center is (just think of the number of touchpoints across customers and employees the support organization reaches). 

Avaya appears to face virtually no competition in the CC private cloud, as competitors have focused almost entirely on the public cloud.  Private cloud CC customers require significant customization and implementation support.  Avaya’s multi-tenant, cloud competitors seek to avoid providing customization and significant implementation support.

Even as the on-prem CC market churns to the cloud, Avaya’s SoW with its customers should increase as the transition to a subscription or private cloud offering drives higher spend and another refresh cycle.

CCaaS

Avaya has developed its own first-party UCaaS offering for the public cloud, where it mainly competes with Five9 and Genesys.  

CCaaS Competitive Landscape

Source: Jefferies equity research, FIVN, 3/1/21.

CCaaS represents a small portion of Avaya’s business today. 

Our initial channel checks suggest a gap in functionality between Avaya’s CCaaS product and Five9 / Genesys.  Management believes they can achieve feature parity with Five9 and Genesys by year-end and is deploying substantial R&D resources to product development to do so. 

Given limited disclosure, it is difficult to gauge traction in CCaaS and progress will need to be evaluated in the coming quarters.

 

 

 Investment Thesis:

1)   Avaya is transitioning its base of legacy on-prem licenses to a more durable set of recurring revenue streams in the cloud.  While this transition occurs, reported revenue growth is muted but will inflect as subscription and cloud revenues increase in mix and drive accelerated revenue growth. 

Avaya’s revenue growth has been muted as the business mix transitions from on-prem perpetual licenses to a subscription-based revenue model.  The revenue headwind is consistent with other companies making the transition to a SaaS-based model and should naturally abate as the business mix shifts.

Below are the economics of a new booking under a perpetual vs. subscription license:

Illustrative $300 booking under perpetual vs. subscription license

Source: Avaya FQ2 presentation, pg. 30.

In year 1, each subscription license sold is a -9% headwind to revenues compared to a perpetual license.

This dynamic is reflected in Avaya’s financials: in fiscal 2020, the Company’s reported revenue declined by -0.5%, but the losses were concentrated in UC hardware, which was a -5.3% headwind to overall revenue growth.[10] 

We expect hardware revenue to remain a headwind to reported revenue growth for the next several quarters, but we disagree with consensus on the trajectory of future revenue growth.  Consensus for F2021 revenue growth is +2.7% but decelerates to +1.8% in F2022. 

As perpetual licenses move to a subscription or cloud-based offering, the reduction in the hardware-related headwind should result in accelerating total revenue growth; increased traction in ACO (which is still ramping) and CC (with 3-6x higher ARPU vs. UC) will further drive an acceleration in revenue growth.   

Management has guided to 2-4% long-term revenue growth, with prospects for MSD+ revenue growth beyond 2023. 

We believe MSD growth is achievable.  In addition to the transitory nature of the hardware headwind, Avaya is only beginning to transition customers to the private cloud; not only do customers tend to spend more in the cloud, but pricing power is enhanced given higher customer stickiness and switching costs.

The following catalysts have the potential to enable the Company to beat consensus, change investor perception, and catalyze a re-rating: Avaya achieving its $1bn 2023 ARR target, which would place the Company’s ARR between EGHT and RNG[11]; enhanced segment disclosure, particularly around cloud-specific metrics; the Company’s December 2021 Analyst Day; demonstrated progress towards the Company’s 2-4% long-term revenue growth target. 

 

2)   Despite the narrative that the world is moving to the cloud, private/hybrid cloud deployments are growing in the mid-teens and will account for the majority of enterprise spend moving forward.  Avaya carries an incumbency advantage in this market as there is virtually no competition for its enterprise customers’ deployments, particularly in the private cloud.

With industry reports forecasting that “90% of the market will be in the cloud in 10 years”, investors have adopted the narrative that the UC and CC markets are moving to the cloud and Avaya as an on-prem vendor will not be a participant in the industry’s future. 

But overlooked is the distinction for private and hybrid cloud, which will be the primary deployment vehicles for enterprises.  From BTIG equity research:

The fallacy in the argument that everything is moving to cloud-based subscription is evidenced by the fact that hosted instances of traditionally on-premises solutions are expected to grow in the mid-teens, with the line of demarcation between UCaaS and Hosted quickly blurring as enterprises demand all offerings be subscription-based regardless of deployment location.[12]

Enterprise customers account for 50% of Avaya’s UC seats and 65-70% of Avaya’s CC agents; the Company’s UC SMB seats are largely non-revenue generating and have been addressed with ACO.  As such, the white space for Avaya largely resides with enterprise customers.

We offer two observations: 1) Avaya enjoys an incumbent position with enterprise customers (90% of the Fortune 100 are Avaya customers), and given the complexity and scalability required to service this segment, we believe Avaya will retain a meaningful percentage of its enterprise customers moving to the private cloud.  2) On-prem is expected to remain a core part of the market, and Avaya is well-positioned to retain and enhance monetization of this customer set through its on-prem subscription offering. 

Enterprises are slow to make significant capital decisions; those that do require large-scale implementations, data security provisions, significant support resources, and customized cloud solutions that create complexities and can be highly disruptive – just think of the scale of resources required to rip-and-replace a contact center solution with 100k+ agents.

We believe the current set of public cloud vendors are at a structural disadvantage when competing for Avaya’s on-prem enterprise customers moving to the cloud.  Avaya has a natural advantage as the incumbent vendor, given the institutional knowledge built over years and its perceived ability to smoothly transition its customers to the cloud.  Our diligence calls also indicate that above 1,000 seats and certainly above 10,000 seats, Avaya faces minimal competition; at this scale 8x8 and RingCentral lack sufficient implementation resources and the expertise to build customized private cloud solutions.

Avaya delivers a seamless implementation process and is able to get private clouds deployed in hours.  Avaya is also able to create a custom private cloud with both UC and CC consolidated, a solution increasing in demand.  From RingCentral:

[With] the pandemic…customers want to make strategic decisions for UCaaS and CCaaS together. …they also want to have one single [platform]. – BAML Global Technology Conference (6/8/21)

[Employees at companies] which made [the UC / CC decision]…are almost 30% more productive. And we see that validated in companies trying to now make those decisions jointly. Contact center and UC…we see it starting to go hand-in-hand. – MS TMT Conference (3/2/21)

Avaya claims that they face limited competition in the private cloud, which was validated on our diligence calls.  We repeatedly heard that CC enterprise customers are very sticky and unlikely to churn. 

Most of the enterprise market is serviced through master agents, system integrators, and value-added resellers (VARs).  Avaya’s long-standing relationships with its 4.7k channel partners should further support Avaya’s incumbency with enterprise customers. 

For enterprise customers not yet ready to move to the cloud, Avaya is focused on enhancing monetization through a migration to a subscription model.  Given Avaya’s outsized exposure to government (one channel check estimated government could represent 30% of revenues) and financial services end-markets, we expect a meaningful portion of its customer base to fall in this bucket of slow-to-migrate to the cloud.  In the interim, successful execution in moving these customers to a subscription model should drive an uplift in revenue in the near-term (10%+) while further entrenching Avaya’s position with the customer in the long-term.

Avaya’s offerings appear to be resonating well with enterprise customers.  Management claims a 90%+ win rate with its installed base of customers who choose to move to a subscription or cloud offering.  Customers generating >$100k of ARR account for 97-98% of Avaya’s total ARR; by contrast, enterprise ARR represents 37% and 21% of total ARR for RingCentral and 8x8, respectively.[13]

3)   ACO provides Avaya with the industry’s leading UCaaS offering and is already paying dividends through an increase in SMB logos.

We believe partnering with RingCentral was an astute strategic decision for Avaya as the SMB seats ACO targets are the least likely to be generating a recurring revenue stream, but most likely to churn to a public cloud product.  Through ACO, Avaya is able to generate largely incremental revenue and expand its share in the SMB market.

Early traction has been positive as Avaya added 1,500 new logos in each of the past three quarters, most of which were ACO logos.  Based on the following commentary from RNG, we expect ACO momentum will continue:

Solid growth in Avaya Cloud Office seats, new accounts and transaction volume. ACO has proven to win deals in all segments, including upmarket. We are seeing strength across multiple verticals, including continued traction in education and health care…Avaya [continues] to build strength every quarter. This quarter, again, we saw multiple million-dollar deals…We will continue to see the benefits way beyond 2021 – RNG Q1 21 call, 5/4/21

In 2020, we had some contribution from Avaya…but it's not material to the growth rates…Avaya will be fully ramped in 2021. Fully ramped meaning it will be ramped in earnest, but multiple years to come – MS TMT Conference (3/2/21)

Avaya does not disclose ACO revenue, but from the commentary above it is reasonable to assume ACO is not a driver of its current overall revenue growth.  As this business scales, Avaya should benefit from the incremental revenue, while adding numerous new customers to which the Company can up-sell products to over time.

Mizuho forecasts that ACO will add 12.7mm seats by 2025[14], which would equate to ~$275mm of ARR and ~$1.3bn of upfront commissions to Avaya.  Applying a 4x multiple to the ARR stream and 1x to the upfront commissions equates to ~$2.4bn of value to AVYA, or an NPV of $16.00 per share – this alone covers >60% of AVYA’s current share price.[15] 

4)   Avaya generates EBITDA margins of ~25% with a FCF yield of ~13%, enabling equity appreciation even in the “do-nothing” case.

Though investor focus remains on Avaya’s revenue growth prospects, the Company’s 25% EBITDA margins and strong FCF characteristics present an attractive risk/reward profile across a range of outcomes. 

By contrast: 8x8 is not profitable on an Adjusted EBITDA basis; RNG consensus forecasts model a sub-15% EBITDA margin in 2023, which assumes revenue grows by 50% from current levels. 

Management is guiding to FCF of $332.5mm in 2021, which this year will be burdened by an additional $25mm of restructuring costs.  While it is not our underwriting case, margins may expand further as hardware mix is reduced (hardware generates 10-15% margins[16]).

Source: Management guidance.

Irrespective of the Company’s ability to execute on its cloud strategy, management can drive double-digit annual equity appreciation through debt paydown and share repurchases.  While it is possible that the market ascribes a lower multiple to the stock, at <8x 2021 EBITDA Avaya is already being valued as a legacy hardware business with limited prospects for improved revenue growth (consensus is modeling decelerating revenue growth in 2022), thereby limiting downside from here.

If Avaya proves successful in executing on its cloud strategy, the Company has the potential to transform into a consistent MSD grower with leading share positions in UC and CC, and EBITDA margins >1,000bps ahead of its public competitors.

   

Valuation:

AVYA appropriately trades well below peers in the UCaaS and CCaaS markets.  We are not making the case that AVYA should trade in-line with the peers below.  However, we have included them to highlight the magnitude of upside should AVYA make progress in the UC and CC cloud markets and successfully migrate its revenue growth rate from flat to mid-single digit growth over the next three years. 

Comparable Companies

Note: CPaaS comps (TWLO, ZM) were excluded given the minimal portion of Avaya’s business mix the segment represents.

For purposes of our valuation, we have assumed an EBITDA multiple range of 9.0-10.0x.  We believe a re-rating of this magnitude may occur as early as the Company’s Analyst Day in December, where we expect management to provide additional cloud disclosure along with granularity on its path to MSD+ growth rates.

Below we have valued AVYA based on a FCF yield target of 8%, which equates to a share price of $43.46, +65% above the current trading price.  

Avaya’s FCF profile should also continue to improve as the Company de-leverages (cash interest represents >50% of FCF). 

We have also valued AVYA using a sum-of-the-parts valuation, valuing separately the Company’s $1bn 2023 target ARR and residual $2.3bn of revenue.  We have valued the ARR stream at 4.0x, a discount to RNG’s 5.5x Revenue multiple, and the residual revenue at 1.5x, a discount to AVYA’s 1.9x Revenue multiple:

Note: Residual revenue based on $2,938mm 2021 revenue guidance less $656mm revenue converted to ARR ($1bn 2023 ARR target less $343mm current ARR) = $2,281mm.  For simplicity, calculation assumes zero revenue growth through 2023, despite forecasted LSD revenue growth.

Below we have sensitized a range of multiples and ARR targets.  The principal takeaway for us is the dramatic upside to the equity if AVYA can execute on its ARR targets. 

 

 

  

Risks:

1)   Avaya’s on-prem customer base migrates to a competitive cloud-based offering.

The principal risk to our thesis is that Avaya’s on-prem customer base churns to competitive offerings.  Our thesis is predicated on Avaya’s ability to retain a meaningful portion of its existing customer base, particularly enterprises.   

Avaya competes in a highly competitive market with numerous participants directly targeting Avaya’s customer base.  Five9’s stated strategy is to move upmarket by expanding its channel partners (Avaya’s sweet spot).  8x8 often cites Avaya’s on-prem customer base as targets for competitive wins. 

The most vulnerable area is CCaaS, where Avaya’s feature set does not appear to be competitive with Five9 and Genesys.  Although CCaaS is primarily an SMB-focused market and represents only a small portion of Avaya’s business today, a failure to reach feature parity may lead to elevated attrition over time. 

Competitive risk also exists from potential future entrants into the market; for instance, well-capitalized software players (e.g., MSFT, CRM) that may be willing to invest aggressively to compete for enterprise SoW.

Though we believe that the principal driver of value for Avaya’s stock will be in its ARR stream, which will exceed $1bn if Avaya is successful in converting just 4% of its UC customer base to a subscription model[17], nonetheless the markets in which Avaya competes are highly competitive.

 2)   UCaaS loses relevancy to collaboration platforms such as Microsoft Teams.

The enterprise software industry continues to evolve, and it is possible that a collaboration platform such as Teams develops into a competitor to Avaya’s UCaaS offering (ACO). 

 3)   Avaya is unsuccessful in converting its on-prem enterprise customers to subscription or cloud products, resulting in decelerating or declining revenue growth. 

Although it appears that the Company is succeeding in converting its customers’ existing maintenance revenue streams into subscription or private cloud revenue streams, it is possible that Avaya’s outsized exposure to government and financial services end-markets limits the addressable base of customers interested in subscription or cloud-based models. If this were to be the case, it would limit Avaya’s long-term revenue growth potential. 

 4)   Partnership with RingCentral is not renewed.

Avaya’s UCaaS strategy is built around RingCentral’s product, and a failure to extend the partnership agreement would result in immediate customer attrition.  However, RNG seems highly incentivized to continue the relationship – given its economic investment in Avaya and its reliance on accessing Avaya’s customer base / migration tools to win upmarket.  RNG management has also indicated the intention to expand, not reduce, partnerships going forward.

Industry participants have suggested that the initial contract term was 5 years, which would suggest a renewal in 2024.  Beyond the risk of a withdrawal from the partnership, it is also possible RNG seeks a more advantageous economic structure upon renewal.

 

 

 

 


 

[1] Math based on 100mm total UC seats and Craig Hallum’s per-seat ARPU estimate of $168.  100mm seats x 4% converted x $168 ARPU = $672mm of ARR + $344mm current ARR = $1,016mm ARR.

[2] $2,938mm 2021 revenue guidance less $656mm revenue converted to ARR ($1bn 2023 ARR target less $343mm current ARR) = $2,281mm.

[3] https://www.nutanix.com/enterprise-cloud-index#background-and-research-goals.

[4] Source: Craig Hallum equity research, 1/8/21.

[5] Source: Craig Hallum equity research, 1/8/21.

[6] Source: Synergy Research.

[7] Source: Craig Hallum equity research, 1/8/21.

[8] Math based on 100mm total UC seats and Craig Hallum’s per-seat ARPU estimate of $168.  100mm seats x 4% converted x $168 ARPU = $672mm of ARR + $344mm current ARR = $1,016mm ARR.

[9] Evercore equity research, FIVN, 8/19/20.

[10] 2020 United Communications and Collaboration Products & Solutions Revenue of $710mm / $863mm in 2019 = -$153mm headwind / $2,887mm 2019 revenue = -5.3% revenue decline.

[11] Avaya’s reported ARR includes on-prem subscription revenue.

[12] BTIG equity research, RNG, 4/15/20.

[13] ARR based on the most recent quarter, ending 3/31/21.  RNG ARR represents customers generating >$100k of ARR, consistent with AVYA; EGHT ARR represents customers with >$1bn of revenue.  AVYA ARR includes on-prem subscription revenue.

[14] Mizuho equity research, RNG, 10/8/2020.

[15] Math is meant to be directional and does not assume churn or any maintenance revenue displacement.  $275mm ARR x 4x multiple = $1.1bn + $1.3bn commissions stream = $2.4bn / 95.6mm FDSO = $24.76 per share.  For simplicity, NPV assumes that revenue is generated at 12/31/25 and discounted at 10% per annum.  $24.76 / (1+10%)^4.5 = $16.12.

[16] Northland Capital Markets equity research, 2/2/18.

[17] Math based on 100mm total UC seats and Craig Hallum’s per-seat ARPU estimate of $168.  100mm seats x 4% converted x $168 ARPU = $672mm of ARR + $344mm current ARR = $1,016mm ARR. 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Avaya achieving its $1bn 2023 ARR target; enhanced segment disclosure, particularly around cloud-specific metrics; the Company’s December 2021 Analyst Day; demonstrated progress towards the Company’s 2-4% long-term revenue growth target. 

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