Is this a Good Time for an IPO in the Communications Market?

On December 22, Mitel announced it had filed for what seems to be a record (Ottawa’s largest) $230 million IPO. The filing was somewhat surprising (at least, to me) because I typically assume a recessionary economy is not the best time to go for an IPO. The communications industry does not seem to be in any better shape than the rest of the market either. However, I can see some reasons why Mitel would wish to do it right now.

Firstly, Mitel has been determined to raise more equity for some time now. It filed for an IPO back in 2006 but then withdrew its application as it chose to pursue the acquisition of Inter-Tel. It then had to streamline its portfolio and organization before it could file again.

Secondly, Mitel has a significant amount of debt and the large interest payments are hurting its profitability and ability to re-invest capital into the business. As it states in Form F-1, Registration Statement Under the Securities Act of 1933, it intends to use the proceeds generated through the IPO primarily to pay off its debt:

 “We intend to use the net proceeds of this offering as follows:

• to repay $30.0 million of borrowings outstanding under our revolving credit facility. As of October 31, 2009, the principal amount outstanding under this credit facility was $30.0 million. This credit facility currently has an interest rate equal to the London Interbank Offered Rate, or LIBOR, plus 3.25% and has a maturity date of August 16, 2012; 
• to repay $             million of borrowings outstanding under our first lien term loan. As of October 31, 2009, the principal amount outstanding under this loan was $289.0 million. This loan has an interest rate equal to LIBOR plus 3.25% and has a maturity date of August 16, 2014; and
• to fund working capital and for general corporate purposes, which may include acquisitions. 

While we currently anticipate that we will use the net proceeds of this offering as described above, we may reallocate the net proceeds from time to time depending upon market and other conditions in effect at the time. Although we occasionally evaluate potential acquisition and investment opportunities, we have no current arrangements or commitments with respect to any particular transaction. In addition, to the extent the net proceeds of this offering are greater or less than the estimated amount, because either the offering does not price at the midpoint of the estimated price range or the size of the offering changes, the difference will increase or decrease the amount of net proceeds available for general corporate purposes. Pending their application, we intend to invest the net proceeds in short-term, interest-bearing, investment grade securities.”  

While Mitel’s net income of $12.6 million in FY 2008 and net loss of $193 million in FY 2009 (its Fiscal year ends in March), seem to paint a gloomy picture, a couple of factors need to be taken into consideration when evaluating its performance. In FY 2009, Mitel reported an Impairment of Goodwill charge in the amount of $284.5 million, which is not likely to impact its profitability in future years. Further, its adjusted EBITDA ($50.2 million in FY 2008 and $78.7 million in FY 2009) shows that, should Mitel be able to eliminate a portion of its debt, it will be able to generate a healthy return for its shareholders.

Thirdly, in spite of the bad economy and the dismal state of the communications market today, there appear to be signs of an imminent recovery. The U.S. department of Labor just announced that the number of unemployment claims dropped to 452,000 for the week ending on December 19, 2009, which is 28,000 less than the previous week. Further, most communications and technology vendor are now reporting stabilizing of demand, which remains weak compared to a year ago but is the same or better compared to the first half of 2009. Some industry pundits are suggesting the stock market is in a new bubble, which could be creating a beneficial environment for IPOs and other investment opportunities.

Fourthly, Mitel has made some significant investments in technology development to position itself more competitively in the evolving unified communication and collaboration marketplace. In addition to greatly enhancing its applications portfolio, it has also virtualized certain elements of its architecture looking to deliver further cost-efficiencies to its customers. As virtualization and cloud computing appear to be among the top 2010 priorities for technology executives, solutions addressing these customer needs are likely to generate growing revenues over the next few years.

Finally, Mitel continues to be one of the strongest SMB vendors worldwide, and especially in North America. In 2008, Mitel held about 9.6% market share of North American telephony revenues, placing it in fourth position along with NEC. In the highly fragmented SMB marketplace, Mitel is probably the largest market participant with a portfolio of software, devices and services that are targeted specifically at this customer segment. This is a significant competitive advantage given that customers are likely to have some concerns about the portfolio roadmap of the newly merged Avaya-Nortel and maybe shy away from getting locked in an end-to-end Cisco environment. Certainly, Mitel faces competition from some other agile SMB vendors including open-source providers (e.g. Digium), consumer solutions (e.g. Skype), ShoreTel, Interactive Intelligence, etc., but their current market shares are significantly lower.

We will have to wait a few months to see the outcome of the IPO. I am personally hoping to see Mitel emerge financially healthier in 2010 in order to be able to continue to provide its customers with the value of its advanced communications technologies.