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Krishnan Thiagarajan

SHAREHOLDERS of Avaya GlobalConnect (formerly Tata Telecom) may consider pruning their exposure in the stock. The stock has shed over 10 per cent since the announcement of the earnings performance, for 2004-05, on May 17. However, given the disappointing earnings performance and slower-than-expected growth in its core offerings, there is a possibility of further weakness in the stock price.

Since our last recommendation in end-June 2004 to reject the open offer and stay invested, the stock has shot up by over 100 per cent till the run-up to the results; and even after the recent price weakness is up by over 75 per cent.

The open offer in June 2004 was triggered by Avaya's decision to acquire a 25.1 per cent equity stake held by the Tata Group, the co-promoters of Tata Telecom, at a negotiated price of Rs 220 per share.

The earnings performance for 2004-05 is not strictly comparable with that of the previous year on account of change in revenue recognition policy, but even after some adjustments, the comparable picture is not too encouraging.

Besides this, the modest pick up in expected demand for converged (voice, data and video) solutions market, possible slowdown in the contact/call centre solutions business triggered by consolidation and stiff competition in the enterprise space may dampen growth prospects in the coming quarters.

On the positive side, however, Avaya continues to lead in the communications markets it is operating in, with entrenched presence in the converged and call centre solutions market.

Highlights of 2004-05

For 2004-05, the company recorded gross sales of Rs 332 crore, a drop of 17 per cent, and profit before tax of Rs 37.9 crore, down 18 per cent over the previous year. This, however, does not represent the true financial picture as Avaya had changed the accounting policy for revenue recognition based on project completion instead of billing employed earlier, with effect from April 2004.

This change in accounting policy was also accompanied by a change in organisational focus towards securing projects that can be completed in shorter time frames rather than focus merely on billing, as in the past.

Without this change in accounting policy, gross sales and profit before tax would have been higher by 5.3 per cent and 15.2 per cent respectively. This pales in comparison to the robust growth rates logged in 2003-04.

The company has three key business segments — converged solutions; call centre solutions and services. Of this, the service business, which relates to maintenance and network certification for converged and call centres, is gaining importance.

For the full year, the services segment recorded revenues of Rs 67 crore, logging a strong growth rate of 53 per cent, compared to low single-digit growth rates by the other two segments.

According to information furnished by the management, for the fourth quarter of 2004-05, call centre solutions accounted for 46 per cent of revenues and converged solutions market for about 33 per cent.

While the call centre solutions grew by 19 per cent in the latest quarter over the same period in the previous year, the converged solutions (consisting primarily of IP telephony and video conferencing) revenues fell by 15 per cent. The fall in the latter is attributed mainly to longer sales cycle in the deployment of IP telephony in the enterprise space. In the coming year, the expected growth from IP telephony, one of the key focus areas of Avaya, is likely to be slower than projected.

Buyout, an uncertain variable

As far as valuations are concerned, the key upside may be a decision of its parent, Avaya Global, to buy out the public shareholding using the reverse book-building process and delist the stock. This will be akin to what Flextronics (formerly Hughes Software) proposed recently; it intends to buy out the non-promoter equity of about 30 per cent, involving an investment outlay of over Rs 600 crore.

In the case of Avaya too, since the non-promoter equity stands at over 40 per cent, the investment outlay for buyout will be considerable and timing will be crucial in this case.

Since both the timing and pricing of a possible buyout by Avaya's parent are uncertain variables and there are no indications on this front so far, the price implications of such a move may be hard to factor in.

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