Weakness in the numbers: Why Mitel is going private
It was the day that everything changed for Mitel Networks, the catalyst at the heart of Kanata’s tech industry.
On April 9, 2018, the directors of the 45 year-old firm — led by chairman and co-founder Terence Matthews — logged in one by one to a telephone conference call. Including lawyers and financial advisors, more than a dozen people were listening from offices across North America. On the agenda: a preview of the company’s first-quarter financial results.
It didn’t take much to discern the weakness in the numbers. Rich McBee, the company’s CEO since early 2011, and chief financial officer Steve Spooner, began by telling their fellow directors that revenues overall had grown year over year. But Spooner clarified that currency shifts, not sales of company products, accounted for all the growth and then some.
More importantly, the managers noted, there was an emerging problem with cloud recurring revenue: the company’s most important source of future business.
Unlike Mitel’s traditional revenue streams, which involve the sale of telecommunications hardware and related services, cloud revenue is generated through software apps sold under monthly online subscriptions.
Mitel’s old business has been declining five per cent annually but the company had expected cloud revenues this year to jump close to 20 per cent, enough to produce higher revenues overall.
Except that here was McBee on the conference call saying that first-quarter sales of Mitel’s older products had fallen faster than expected and that, while cloud subscription revenues were OK, bookings were not. There had been a double-digit decline in new orders compared to the fourth quarter of 2017, he said, while Mitel’s competitors — including industry leader RingCentral of California — had posted increases.
McBee told his fellow directors that he didn’t expect Mitel would make up the losses during the remainder of the year. There was more bad news. McBee acknowledged that blending the operations of Mitel and recently acquired ShoreTel of California was not going as smoothly as expected.
The reaction of company directors can easily be gauged by the events that followed. The board’s independent directors, Matthews among them, met separately to consider the company’s options, including whether the board should consider selling out to a larger, better capitalized player. The discussion was not theoretical. Searchlight Capital Partners of New York had been pressing Mitel since 2017 to consider a buyout.
The independent directors agreed it was time to test the seriousness of Searchlight’s intentions and to find out what other potential offers might be out there.
Events moved at breakneck speed. On April 24, Mitel revealed it had a tentative deal to sell its shares and debt to Searchlight for $2 billion (all figures U.S.). Assuming the deal goes through as expected before year’s end, Mitel will once more delist from the stock exchanges and retreat from public view.
“Business to me is business,” Matthews says, “we generally feel good about the strategy for the company but along comes an offer from someone prepared to pay more than where our share price has been.”
Almost certainly Mitel’s shareholders will approve the transaction at a special meeting July 10 in Matthews’ Brookstreet Resort.
Mitel, of course, will not disappear. The company will continue to sell telecommunications gear, services and software to customers around the globe. The Kanata operation, some 550-people strong out of the company’s 3,800, will still manage key aspects of the company’s R&D and operations. And the investment firm has indicated it will keep Mitel’s current management team intact. The idea is to finish the hugely difficult, messy job of transforming Mitel from maker of gear into a telecommunications software company.
Something important is being lost, though. The fate of Mitel will lie entirely in the hands of Searchlight, creating what could be a pivotal moment for Ottawa’s high-tech industry, one of the city ’s most important economic sectors with 50,000 workers.
The strongest tech clusters are anchored by standalone global enterprises, billion-dollar revenue firms that form technology alliances with local startups and force their suppliers to be competitive.
Mitel, which is expected this year to generate $1.3 billion in sales, has played this role for many years. Its influence is also by way of example. It has been rocked by multiple booms and busts, some of its own making. But Mitel survived when its much bigger rival Nortel Networks did not. More importantly, Mitel rarely stopped being ambitious.
After Matthews reacquired Mitel’s telephone systems unit from Zarlink in 2001, he eventually concluded the firm would thrive as a standalone, public firm only if it became much bigger.
The first major step along that road came in 2007 when Mitel paid $717 million to buy Arizona rival, Inter-Tel, closing the deal just before global financing began to dry up and the world tipped into the great recession.
In April 2010, as the economy returned to normal, Mitel raised $130 million in an initial public offering aimed at strengthening the company’s balance sheet.
However, it wasn’t until Matthews hired McBee as CEO in 2011 that Mitel got serious about trying to become an industry consolidator. McBee, a former Danaher executive, was experienced in the art of melding companies together.
Between 2014 and last year, Mitel shelled out more than $800 million to acquire fellow telecommunications firms Aastra of Toronto (which did most of its business in Europe) and ShoreTel of California.
Evidence of Matthews’ ambitions could be seen in two rather spectacular acquisition attempts — a $1.62-billion bid for Polycom, a video conferencing technology specialist in San Jose, and $559-million acquisition of Mavenir, a wireless technology firm based in Texas.
Mitel’s bid for Polycom fell through after a rival was prepared to spend more. Mitel later sold Mavenir’s assets when it became clear it couldn’t compete in the wireless technology market.
Both deals were a sign that Mitel was afflicted with too little heft and insufficient capital. Mitel paid for the majority of its deals with cash, generated by increasing its debt. McBee’s strategy was to pay down the debt as quickly as possible by slimming staff and consolidating company operations following each acquisition.
Mitel’s financial results throughout this period were dragged down by one-time costs related to severance payments and restructuring costs. This, in turn, depressed the company ’s share price, which never again reached the $14 it charged for each share at the 2010 IPO.
Despite this, however, Mitel was clawing its way into contention in the market for cloud-based telecommunications software (a segment known as unified communications as a service). After it acquired ShoreTel, Mitel’s share of this niche was a shade above 17 per cent according to Synergy Research, a consulting group, good enough for the No. 2 spot worldwide behind RingCentral, which had 18 per cent of the market.
In short, Matthews and McBee created a contender by stitching together multiple elements. But it required more time, capital, good management and maybe a bit of luck to see it through.
Indeed, Mitel had been receiving unsolicited calls from a variety of potential buyers as early as 2016, according to a recent filing with the U.S. Securities & Exchange Commission. The company hired a financial adviser, Jefferies LLC, to meet with the interested parties.
In March 2017, four financial firms submitted non-binding proposals at prices ranging from $8 to $9.50 per share (Searchlight is paying $11.15). But after several weeks of due diligence no solid offer emerged.
Mitel turned its attention in June to ShoreTel, which had seeking to find a buyer for months with no takers. The following month, the two rivals reached an accommodation. Mitel would pay $521 million for ShoreTel in a deal that closed last September.
Searchlight contacted McBee in mid-December to discuss Mitel’s business and submitted a nonbinding offer two months later to acquire Mitel for $10.80 to $11.30. That got the board’s attention. Not only was that significantly higher than Mitel’s price at the time — about $8 per share — it was significantly better than the proposals submitted the previous year by the four other financial firms.
Mitel’s board of directors met multiple times to discuss options. Could Mitel do better by separating into two companies, for instance telecom gear and cloud software? Could Mitel still thrive as a standalone company? Could they get a higher price from Searchlight or another firm?
The answer to the latter seemed to be ‘no.’ It was telling that Mitel’s financial advisers had been unable to drum up any interest in an acquisition from another company in the same telecommunications technology niche. If there was to be a buyer, it would have to be a financial group that believed it could squeeze more performance from Mitel.
The board asked McBee early in April to forward some very preliminary data about Mitel’s first financial quarter. After examining it, the directors sought more detail, and they wanted it fast.
This, then, was the context for the April 9 board meeting that tipped everything in favour of selling Mitel to Searchlight.
The dispiriting conclusion, offered by the board in support of the Searchlight deal: Mitel couldn’t get big enough, fast enough to compete in profitability in its chosen industry.
Among the risks cited by the board was this big one: “Significant competition from companies with substantially greater size and resources, and the likely effect thereof on the business, operations, financial condition and prospects of Mitel.”
It is just possible that, under the umbrella of Searchlight’s financial heft, that Mitel will be able to finish the transformation started by Matthews and McBee and reemerge as a standalone public firm for a third time. But there should be no downplaying how difficult that will be.