The telecommunications equipment niche known as “enterprise telephony” is a US$8.7-billion-a-year business that appears to be going nowhere. Global sales fell 7% in 2005, following a 9% drop in 2004. Yet the decline in the business of selling phone systems to businesses disguises a dramatic rebirth — and opportunities for investment.
There are now two enterprise telephony markets. One involves a set of older products based on voice-friendly, “time division multiplexing” (TDM) technology. The second features next-generation gear that transmits data and voice signals using Internet protocol technology, a growth segment known as “voice over IP” (VoIP).
This year, for the first time, IP gear sales will overtake those of TDM products. And there’s no going back.
The ascendancy of IP has been a long time coming. Many companies that invested in Y2K-compliant, mainly TDM-based networks in the late 1990s are finally replacing them. And VoIP, which offers more flexibility and runs more cheaply, is becoming competitive in terms of capital costs.
The cost of manufacturing VoIP gear will soon be comparable with that of TDM products, noted Francis Shen, co-CEO of Concord, Ont-based Aastra Technologies Ltd., recently. Yet, when Aastra — which develops and markets products and systems for accessing communications networks — first evaluated how much to spend on VoIP research six years ago, it determined the cost of manufacturing VoIP gear was five times that of TDM products.
As a result, VoIP has acquired considerable momentum. By the fourth quarter of 2005, 48% of communications systems sold to corporations were IP-based, according to a global survey by Synergy Research Group Inc. of Reno, Nev. By comparison, only 14% of products sold in the first quarter of 2003 were IP-based.
The bottom line: TDM sales in 2005 fell 25% to $4.7 billion, while the VoIP segment jumped 31% to $4 billion. (All figures are in U.S. dollars unless otherwise indicated.) Synergy predicts a 25% jump in IP equipment sales this year to $5 billion and expects growth in each of the following three years to average 28%. By 2009, this would produce a $10.7-billion IP niche, accounting for more than 90% of enterprise telephony equipment sales.
For investors, there are two ways to play the market in enterprise telephony gear. One is to focus to TDM leaders, which are shifting toward an all-IP world. The other is to invest in firms that have largely chosen to ignore TDM products.
In the first group, industry leaders Avaya Inc. of Basking Ridge, N.J., and Nortel Networks Corp. of Brampton, Ont., look best placed to take advantage of the IP boom. Although neither rates a “buy” from the majority of analysts tracked by Bloomberg LP, both have the advantage of long-time customers that are gradually shifting to IP technology.
Avaya has developed hybrid TDM/IP products that allow corporations to add IP networks without having to toss out their older TDM systems. The strategy has made Avaya the leader in the hybrid niche, which last year had sales of $1.7 billion, up 29% from almost $1.3 billion in 2004. Avaya’s share of that market was 42%, representing sales of $695.1 million in 2005 vs $589.7 million in 2004.
But Avaya’s hybrid growth is lagging the segment’s average; it was only 18% year-over-year. In addition, last year it relied on sales of pure TDM networks to contribute $477 million to revenue, accounting for about one-third of its total telephone systems sales. The net result: Avaya’s top-line growth slowed to 6.7% in its first quarter ended Dec. 31, 2005. Product sales, which make up almost half its total sales, were $591 million in the quarter, vs $554 million in the same period in 2004. This less than exceptional growth is one reason only eight of 21 analysts rate Avaya a “buy.”
But some analysts like Avaya’s position — it was the No. 2 supplier globally of VoIP enterprise gear in 2005, just behind Cisco Systems Inc. Significantly, the Synergy survey showed Avaya reclaiming the lead from Cisco in the second half of 2005. As a result, Manuel Recarey, an analyst at New York-based Kaufman Bros. LP, earlier this year rated Avaya “an attractive investment for value-oriented investors,” citing the company’s low valuation (slightly more than one times revenue) and strong balance sheet.
@page_break@Nortel is a solid competitor in VoIP and TDM-only markets, ranking highly in both categories in the Synergy survey. But last year, TDM provided 58% of its sales to enterprises, suggesting customers are taking their time moving to IP.
Canadian investors searching for a purer play in VoIP networking can acquire shares of Aastra, which was rated a “buy” by three of six analysts. Aastra has spent three years acquiring smaller developers of telephone systems. Last year alone, it purchased the enterprise telephony unit of Munich-based EADS NV and the telecommunications systems division of DeTeWe Deutsche Telephonwerke AG & Co. of Berlin. As a result, its 2005 sales more than doubled to C$522.6 million from C$256.1 million in 2004, while earnings per share jumped almost 6% to C$1.46 from C$1.38 in 2004.
Aastra investors should take heed of its relatively slow earnings growth. The big risk is the company’s ability to integrate its new properties. Greg Reid, an analyst with Toronto-based Wellington West Capital Inc. , noted in March that the EADS acquisition, the first of the two, was breaking even, but the DeTeWe unit was “behind plan and has been R&D starved.”
He maintains a “buy” on the stock but, he adds, “The easy money has been made” — referring to the rapid run-up in Aastra’s share price following the DeTeWe purchase last July. Reid’s 12-month target is C$41 a share, up from C$36.93 when he wrote the note. The new target is based on his 2006 earnings estimate of C$2.36 a share — assuming Aastra gets DeTeWe in shape.
Another option for playing enterprise telephony is Kanata, Ont.-based Mitel Networks Corp., which is expected to launch a cross-border initial public offering soon. When Terence Matthews took control of Mitel in 2001, he transformed the TDM firm into one offering only IP networks. This was risky; Mitel’s TDM sales fell considerably before IP revenue could take their place. According to Synergy, TDM sales at Mitel plummeted 82% to $23 million last year from $125.7 million in 2004, while IP gear generated sales of $237.4 million, up 31%.
Mitel now relies almost exclusively on products with growth potential. Looking at the $812-million global market for IP-only networks, excluding hybrid systems, Mitel’s potential is impressive. Its sales of IP-only networks jumped 58% last year to $134 million. That was double the average growth for the niche and enough to rank Mitel third globally behind Nortel and Cisco.
Last year, Mitel nipped ahead of Cisco for top place in the IP-only market for small and medium-sized businesses, according to InfoTech, a unit of the Telecom Intelligence Group. Mitel secured a 12.6% share of the niche, vs Cisco’s 11.7%. Investors now have to wait for the prospectus to see if Mitel shares are worth the price. IE
VoIP plays finally ready for prime time
Next-generation enterprise telephony market has emerged — and a few players offer investment opportunities
- By: James Bagnall
- May 2, 2006 October 31, 2019
- 13:24