Finally Private Equity won the battle for Avaya

On Monday, private-equity firms Silver Lake and TPG Capital agreed to pay $17.50 in cash for each share of Basking Ridge, N.J.-based Avaya. The buyout represents a 28% premium above Avaya's closing price of $13.67 on May 25, the last day prior to initial reports about a potential sale. Other companies in the telecommunications-equipment industry, such as Cisco and Nortel, also showed an interest in acquiring Avaya, but the high price offered by TPG and Silver Lake pushed them to the sidelines. Analysts say those companies might eventually renew interest if TPG and Silver Lake succeed in making Avaya more profitable.

By going private, Avaya executives say they'll be able to move faster to improve the company and worry less about meeting the short-term concerns of public investors. Yet the acquisition does nothing to diminish competition in what's a very tough market. Avaya has been battling Cisco Systems Inc. for the right to supply corporate customers with Internet-based phone systems. Other major rivals include Nortel Networks Corp. and Siemens.

So, what did Silver Lake and TPG see in Avaya that was so attractive? If they can work their financial and operational magic again, the equity firms should be able to reinvigorate the company and perhaps resell it at a profit. However, such a process could take three years or longer. Avaya’s business is very complicated to manage, that’s why equity firms have asked senior management to stay on to run the company. But there will have to do some tough restructuring.

First, the new owners have to fix Avaya's lower margin and less predictable service business and reduce the company's 20,000-strong workforce, even though no major layoffs are expected. Secondly, Avaya has to continue to invest significantly to retain its leadership in the corporate phone market. Actually, competition is intensifying in this space as a lot of players are trying to get into it. Aside from operational issues, Avaya and its new owners need to figure out how to generate faster sales growth, boost market share and improve mid-single-digit profit margins. Stronger growth is expected because of an anticipated global upgrade cycle. Corporations want to combine separate phone and data networks into one system to trim costs and take advantage of the new features offered by Internet technology. Let’s see whether management is up and around for the monumental challenge.

And it finally happened: Alltel goes private

On a much expected deal, TPG Capital LLP and the private-equity arm of Goldman Sachs Group Inc., agreed to purchase wireless operator Alltel Corp. for $27.5Billion, in the largest venture of private-equity money into the wireless business. The buyers will pay $71.50 per share for the company, which represents a price of about 10% higher than where the shares traded last Friday. The buyout group will put $4Billion of its own equity, while banks led by Citigroup Inc. will make “equity bridge” loans of greater than $600Million.

Now, let’s see the strategy behind this deal. Alltel has 12 million subscribers mostly in the Midwest, West and South. The company became an attractive target after spinning off its wireline unit last year to put more focus on the faster-growing wireless telecom business. From the finance standpoint, Alltel shares trade around 9 times its cash flow, an attractive multiple to private equity buyers who are increasingly paying in the double-digits as competition for deals grows tougher. So far, so good.

There are two key points that trouble me a bit. How about the strategic questions that new buyers will face? First, it is unclear how the company will approach the bidding in a coming Federal Communications Commission auction of radio spectrum for wireless broadband communications. This new spectrum and the building out of a new high-speed wireless network would be very costly; however, it might be necessary as larger competitors, such as AT&T, Verizon Wireless and Sprint Nextel are all increasing the speed available on their networks to offer new applications. Up to now, management said the company is willing to invest in its network. However, it seems to be very difficult to predict which direction the company will take, but this is a key fact or to consider moving forward.

I think the Alltel deal is just the beginning of a huge wave of telecom deals. Private-equity investors are showing strong interest in telecom companies. Just to mention a few deals, in Canada, Kohlberg Kravis Roberts & Co. and three pension funds have been in discussions to buy BCE Inc. In the U.S., Sprint-Nextel has also been a rumored target during the last month. So, let’s expect more deals and action to come in the always exciting telecom sector.