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Little-Known Avaya Tackles Cisco in Internet Calling Gear
By KEN BROWN, Staff Reporter of THE WALL STREET JOURNAL, October 26, 2004; Page B1

Avaya Inc. is hardly a household name. But this unlikely survivor of the telecom bust has emerged as a leader in the surging market for Internet phone-calling equipment.

Today as Avaya plans to report the first annual profit of its short life on revenue of about $4 billion, it finds itself in a rather surprising position. The once-troubled company, which was unceremoniously spun out by Lucent Technologies Inc. four years ago, is slugging it out with some of the biggest names in technology -- chiefly, with computer-networking giant Cisco Systems Inc. -- for major contracts to install this cutting-edge phone gear.

Each has signed up a who's who of customers: Avaya landed Morgan Stanley; Cisco got Bank of America Corp.; Avaya handled the Olympics for General Electric Co.'s NBC; Cisco will install a new phone system for Ford Motor Co.

But despite this string of high-profile contracts, executives say little-known Avaya needs to work on breaking out of telecom circles to establish itself as a big name in technology in its own right -- particularly if it wants to better take on Cisco's legendary marketing clout.

"They're neck and neck," says Manuel Recarey, an analyst at the investment firm Kaufman Bros., adding that the No. 1 slot in Internet telephone equipment now shifts routinely between Cisco and Avaya depending on one or two big orders in a quarter. The two companies "are doing very well in this space, and their competitors are not doing so well."

Even as consumers begin to embrace Internet calling, corporate customers may present a potentially bigger market since they spend billions of dollars on communications annually. Because calls are sent via the Internet as data packets, instead of the dedicated connections used by traditional phones, Internet calling can drastically cut phone costs as well as provide many new features and better control over sprawling communications systems.

Observers say Avaya is doing many things right. In particular, it is taking advantage of its legacy -- stretching back to the days of Lucent and, before that, AT&T Corp. -- of selling equipment that sits in the phone closets of nearly every major corporation in the U.S. With its traditional emphasis on maintaining the quality of voice calls -- the most difficult of all applications on the Internet -- Avaya is going to its established customers and offering to link the new equipment with the old. This allows companies to upgrade their phone systems slowly, keeping costs and stress levels low.

Industry analysts say that Cisco, by contrast, tells customers they must do what's dubbed the "forklift upgrade," meaning all of a company's phone equipment, including the phone that sits on every desk, is removed and replaced with Cisco gear. Avaya's go-slow approach sometimes gives it an edge, especially with companies still leery about Internet calling, analysts say.

Avaya was put in the spotlight last year when Merrill Lynch & Co., which had hired Cisco to build an Internet phone system, decided that it wanted to keep a portion of its traditional phone network. Cisco couldn't provide a hybrid system, so Merrill brought in Avaya to do the job.

"What we've discovered over time, in all manner of service, is rip and replace is not a very well thought-out strategy," says Maribel Lopez, an analyst at Forrester Research, a technology-analysis firm in Cambridge, Mass.

Don Proctor, vice president and general manager of Cisco's voice technology group, says the company purposely doesn't sell a hybrid phone system because it is an unnecessarily expensive step to get to the ultimate goal of an all-Internet phone system. "What we disagree on in the industry is how you get there," he says.

Each company has about 26% of the market for corporate Internet calling gear, according to Synergy Research Group, and the market is growing 30% to 40% a year, according to analysts. Cisco remains a ferocious competitor and still has the advantage of being a big seller of equipment that carries all sorts of other Internet traffic. The growing Internet phone business is likely to provide both companies with healthy growth and profits.

But being such an unknown compared with Cisco is presenting perhaps Avaya's biggest challenge. The Basking Ridge, N.J., company still has a long way to go before its sales and marketing arms catch up with Cisco's. Avaya recently hired a big name to boost its image: Jocelyne Attal, who was the marketing chief for International Business Machines Corp.'s WebSphere software before joining Avaya as chief marketing officer. She is frank about how far Avaya has to come: "I say to my team, we are in the voice business and no one can hear us."

Avaya also is raising its profile by making deals in the U.S., India and Europe. Early this month, Avaya announced its biggest acquisition yet, German equipment maker Tenovis GmbH & Co. from Kohlberg Kravis Roberts & Co. for $725 million in cash and assumed debt and leases. The deal could vault Avaya to the upper ranks of telecom equipment makers in Europe.

Avaya's start wasn't so promising. Lucent spun the unit off in October 2000 so the former parent could concentrate on selling equipment to big telecom companies, which it believed would be a much faster growth industry than selling to general businesses. Investors drove Lucent's stock up 15% on the news of the move, believing that what would become Avaya was dragging down Lucent's growth rate.

Some inside Avaya describe the spinoff as a Viking funeral where the warrior's body is put on a boat that is set ablaze and sent adrift. The telecom meltdown was only one of its problems. Many of its customers had already upgraded their phone systems in preparation for the year 2000 computer-software bug, while others delayed spending because Internet phone calling wasn't yet ready for prime time.

Making matters worse, Lucent freighted Avaya with $780 million in short-term debt, setting the stage for a near-death experience. When business started to slow in early 2001, Avaya executives began cutting costs -- but couldn't keep up with the drop in revenue. The company slashed its work force by more than half to about 15,000 currently and raised cash by selling stock and debt, often on onerous terms. "We weren't quite at the brink, but it didn't feel good being there," recalls Garry McGuire, its chief financial officer.

Avaya's business hit bottom near the end of 2002, a few months after its stock reached its low of $1.15. Today, the company is paying off that debt, its balance sheet is healthy and its stock has rebounded; it stood at $13.22, down 35 cents, at 4 p.m. yesterday on the New York Stock Exchange.

Avaya turned itself around because corporate customers started buying Internet calling gear and many favored the company's go-slow approach. Customers nervous about sending calls over data networks also have been comforted by Avaya's century-old history in the phone business, stretching back to its Ma Bell roots.

Chief Executive Donald Peterson says the company is slowly transforming itself from a phone company to a tech company. When he joined AT&T from Nortel Networks Corp. nine years ago, he says there were dozens of executive assistants running around his department, making "sure I wanted for nothing." He's slashed that and other perks, while also cutting the company's pension plan to better compete with tech companies.

"Have we got a speedboat yet?" he asks. "Probably not, but I think we've moved down to a sleeker battleship."

Write to Ken Brown at ken.brown@wsj.com


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