Deals of the Year: Mitel’s acquisition of Inter-Tel got off to a rocky start

By KRYSTLE CHOW
Published in the Ottawa Business Journal newspaper and website.
Dec. 31, 2007 (Jan. 2, 2008 on OttawaBusinessJournal.com)

The players: Mitel CEO Don Smith; Steve Spooner, Mitel’s CFO and chief integration officer; Alexander Cappello, chairman of Inter-Tel’s board of directors; Steven Mihaylo, Inter-Tel’s founder and ousted chief executive; private equity company Vector Capital Corp.; Mitel’s financing partners Francisco Partners and Morgan Stanley Principal Investments; Genuity Capital Markets (Mitel’s financial adviser); UBS Investment Bank (Inter-Tel’s financial adviser)The deal: Mitel Networks Corp. announced on April 26 that it was offering about US$723 million, or $25.60 per share, to buy Arizona’s Inter-Tel Inc. The deal, which closed in August, is expected to boost Mitel’s revenues to more than $800 million and give it the number-one spot in the U.S. small- and medium-sized market for business communications systems. Inter-Tel had annual revenues of $458.4 million in 2006.

How the deal was done: In 2006, Mitel had been preparing to go public with an offering valued at up to $150 million and to reposition itself as a major Internet protocol (IP)-based telephone systems and services provider, after years of on-again, off-again talks. Then in the summer of that year, the company got wind of the fact that Inter-Tel’s founder and major shareholder, Steven Mihaylo, had been trying with the help of private equity firm Vector Capital to put together a deal to take Inter-Tel private. However, the plan narrowly failed to obtain shareholder support.

“When we saw that coming, we discussed the merits of hooking up to emerge as a leader in the space,” says Mitel CFO Steve Spooner, pointing to Inter-Tel’s strength in the U.S. market and unique managed service portfolio as some of the reasons why Mitel thought Inter-Tel would be a complementary fit.

So, Mitel put its plans for its IPO on hold, and in April 2007 made a play for Inter-Tel.

“There was a sense of urgency … you can’t assume you’ve got time to move when a company comes into play, and we decided we needed to get on with (the acquisition) instead of doing our IPO first,” says Mitel CEO Don Smith.

It looked like the acquisition would sail through, with Mitel managing to partner with California-based investment firm Francisco Partners and Morgan Stanley Principal Investments to put together funding for its bid, and Inter-Tel chairman Alexander Cappello voicing the board’s approval of the deal.

But barely a month later, a monkey wrench was thrown into the works with the emergence of a rival bid from Vector Capital worth $26.50 per share. This offer was then retracted in June with the announcement of a leveraged recapitalization plan from Mr. Mihaylo, which involved a $375-million self-tender offer to be funded by $200 million in cash from the company’s holdings and another loan of $200 million.

Mr. Mihaylo owned a stake of roughly 18.5 per cent in Inter-Tel at the time, but lacked the support of the company’s board after being ousted from his CEO position in February 2006. He urged shareholders to reject the Mitel deal in a letter in which he touted his plan as presenting a greater value for investors.

However, Mr. Mihaylo’s recapitalization strategy was rejected by the special committee of Inter-Tel’s board of directors, citing the concern that shareholders would get less overall value because the plan would only pay cash for 60 per cent of their shares. Shareholder adviser Institutional Shareholder Services also changed an earlier recommendation to cast aside Mitel’s offer in favour of waiting for a better deal, after Inter-Tel reported lower-than-expected revenues in its second quarter.

In the face of the weak quarterly results and outlook, Mr. Mihaylo withdrew his plans for the recapitalization deal at the end of July, just a week before the pivotal shareholder vote. The deal received shareholder approval on Aug. 2 and wrapped up on Aug. 16.

Why the deal is significant: Proponents say the merger means all kinds of good things for the two companies. Minimal product and channel overlap means there won’t be too much pruning at either firm. Only 200 people of the combined workforce of 3,400 are expected to lose their jobs.

“This really is a ‘1+1=3’ story, and the opportunity bodes for us to drive ahead with the depth of solutions and the bench strength of our combined offering,” says Mr. Smith. “It’s really just about taking the best practices from both to build a highly competitive company.”

“It’s a sign of confidence that we can produce competitive, world-class companies,” says Jon Arnold, principal analyst at Toronto-based J. Arnold & Associates. “Most startups ultimately want to market to the United States because (Canada) doesn’t have as strong a competitive sector as the U.S., and there are very few markets to sell to here. To get to critical mass, you have got to compete in the U.S. market, and this deal is a good example of how to do this.”

He notes the merger puts together a company with a 20-per-cent market share with “enough overlap and synergy to help them stay in the race” and fend off competition from the big guns such as Microsoft and Cisco.

Mr. Arnold says the deal to take Inter-Tel private is also intriguing because it allows Mitel to buy some time out of the public eye to rationalize the acquisition and then go public as a much bigger company with all its paperwork done.

“It bakes a bigger pie for the Mitel IPO,” says Ronald Gruia, principal telecom analyst at Frost & Sullivan. “The tide was not at the best level at the time so they decided to wait, and this transaction will give Mitel a better balance sheet, expanded sales channels, and they’ll be able to leverage Inter-Tel’s strong experience in the managed services market, which will provide a new revenue stream for Mitel.”

IntelliCom Analytics senior analyst Mark Ricca says Inter-Tel’s managed services offering, which allows customers to pay for IP communications services for a monthly fee instead of buying the systems outright, is becoming very attractive and is expected to see its markets double in size over the next four or five years.

Meanwhile, Zeus Kerravala of Yankee Group speculates that Mitel could even become a greater influence in the local markets in the years to come than even the great granddaddy of Canadian telecom companies, Nortel.

“Mitel has a good vision of where it’s going, and over time I think we’ll see it play a much bigger role in the evolution of the telecom sector than Nortel, which has tied itself closely to Microsoft but hasn’t really differentiated itself,” he says.

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