Mercator Capital is a privately-held investment bank focused on mergers & acquisitions, private placements, and strategic advisory services. Mercator's IP Communications Newsletter is a monthly analysis and commentary on the major business stories impacting the convergence of voice, video, data, and wireless communications.

1. Fall VON 2006 Preview

Pulvermedia’s VON conference marks its 10 th anniversary in Boston, and the Fall show runs from September 11-14. Ten years is a very long time in the IP world, and this particular show will be notable for both looking ahead and reflecting on how far things have come since the very first VON in 1996. Jeff Pulver is a leading bellwether and advocate of all things IP, and he’s had ongoing success in his many ventures and initiatives that cover the gamut in this space.

The VON conference is Pulver’s anchor event, and Jeff recently noted on his widely followed blog (http://pulverblog.pulver.com/) that both Spring VON and Fall VON made the list of the fastest growing trade show in Tradeshow Week magazine. Aside from VON, Jeff has built a mini-empire with various media properties, including regional VON events around the world, VON Magazine, and budding enterprises such as podcasting and videocasting.

Aside from marking VON’s 10 th anniversary, Fall VON 2006 is also important for its updated focus. To date, VON conferences have been built around Voice over IP, and over the years, VON has become the premier event for VoIP. Recognizing that VoIP has evolved from fiction to fact, Jeff has been introducing more content related to video and broadcasting in recent shows. Fall VON 2006 marks the debut of their first show with a full program of content focused solely on video. In addition to the regular VON program, Video on the Net will have its own program that looks at the disruptive impact that IP is having on the broadcasting sector.

So now, the “V” in VON appears to be just as much about video as voice. VON is still the go-to show for VoIP, and Video on the Net is hoping to do the same for its space. Video has been a minor component of previous VONs, but in the past year it has become clear that IP is starting to impact broadcasting much the way it has already done for the telecom sector. If anything, the impact is going to be greater since the stakes are high for both the transport channels and the content. Voice is a fairly one-dimensional application when compared to video, and the issues are far more complex, especially on the content side.

There will certainly be much to explore at Video on the Net. With IP being a more mature technology today, the groundwork has been laid and things are evolving now at a rapid pace. One need look no further to how quickly YouTube has become a household name in just a few months, and already, media companies have sprung up to produce content that is exclusive to the Internet. Conventional broadcasters and content producers are waking up to the fact that changes are coming quickly and that the Internet is posing the same kind of threat – or opportunity, depending on your view – that television posed for the film industry in the 1950s.

And if voice and video are not enough reason to follow this conference, Fall VON also presents a number of other tracks that are highly relevant in their own right. While Video on the Net addresses the overall broadcasting sector, it is not just about IPTV, which itself is an important movement just gaining momentum. Video on the Net will look at television, but as one of several elements of broadcasting. IPTV is really a separate topic because it pertains to the path telcos are taking to compete against the bundles being offered by the cablecos. On this front, the Pulver organization has partnered with Telephony Magazine to produce an IPTV Summit.

Moving further out, Fall VON has three additional tracks that focus on more vertical aspects of the IP communications space. Expo Plus targets enterprise IP, so this is the place to see how both large and small businesses are deploying the various flavors of IP. Drilling down a bit further, they have partnered with Wainhouse Research to bring their Collaboration Service Providers Summit under the VON arena. Collaboration and conferencing applications are becoming important productivity tools with IP, enough so that VON feels it warrants a dedicated focus. And finally, we have Open Source, which seems to have become a staple of all IP shows in the past year. Pulver has done a lot to build ties with this community, especially Asterisk, and has developed a standalone track on Open Source IP PBX.

VON usually attracts big names and bright lights, and the Fall show has a full roster of thought leaders from both Tier 1 service providers and leading edge disruptors. One could argue the show is trying to be too many things to too many people, as VON has never covered such a broad range of topics. There may be some truth to that as it will be impossible to take in everything unless you’re sending a large team. You won’t be able to take in the totality of IP communications this well anywhere else, and if there was ever a time to explore the IP community, this is it.

As always, Mercator will be present at VON, meeting with current and prospective clients. If you’d like to get together at the show to discuss M&A, funding requirements, company strategy, or just industry trends in general, please contact Mike Myshrall at mmyshrall@mercatorcapital.com to arrange a meeting.

2. Mobile VoIP

It was only a matter of time until the VoIP services that are becoming commonplace on landlines and PCs shift to the mobile arena. Toll bypass and arbitrage were early drivers of VoIP, but as long distance rates continue to decline, these have become secondary considerations, at least in North America. Mobile VoIP has a different set of challenges, but roaming and long distance charges remain high, creating an attractive market opportunity. Perhaps more important than the economic appeal is the simple fact that mobility is a bigger and faster growing market than landline VoIP, especially on a global basis.

Mobile VoIP can mean many things, and we view it simply as the ability to divert voice calls off mobile networks and to route them – in whole or in part – over IP networks. Much of the current focus on IP is video-centric, as this represents a better revenue opportunity than voice. However, VoIP still has a lot of growing to do, and the mobile market is largely untapped.

The first thing we find interesting about this market is the fact that all large operators behave the same way. Not surprisingly, the ILECs and PTTs have been the last to embrace VoIP. Their sunk costs in TDM infrastructure are too great to move away from, especially when they’re amortized and working very well. Being rational entities, they resist VoIP because it cannibalizes the traditional services that have served them so well for over 100 years. It turns out that mobile operators are no different. Despite having more modern networks and fast growing markets, they are not in a hurry to move to VoIP either. With demand booming, there is little incentive to cut prices or margins for voice services.

As a result, mobile VoIP applications have focused on IP-based operators, and August saw some key developments and offerings that lead us to believe this market is becoming real. To provide further context, it must be noted that if the existing mobile operators are not ready for mobile VoIP, there are basically two options. The first is to route mobile calls over a PC-based IP connection, and the second is to do it over a fixed line connection. In short, Skype versus Vonage. By extension, Skype includes other IM platforms like MSN, Google and AOL, but Skype is the clear market leader for what one might call VoIM – Voice over Instant Messaging. Similarly, among Voice over Broadband (VoBB) operators, Vonage is dominant, but others could just as well be doing this, such as 8x8, SunRocket or VoicePulse.

What we find most interesting is the fact that virtually all of the recent mobile VoIP offerings and applications are built around Skype, or emulate the Skype model. The inherent nature of Skype’s platform – especially presence, user simplicity and peer-to-peer communications – make it more attractive than VoBB. Of course, Skype also has the largest user base, so it is the de facto standard, but we feel this speaks well to the future of all VoIM platforms. Conversely, VoBB offerings face additional challenges, though mobile VoIP is a market any pureplay VoIP provider would want to add to its offering.

Two particular August announcements are notable in this regard. First is iSkoot, who announced their partnership with Skype on August 8. The iSkoot Mobile service is a downloadable software application that enables mobile users to make or take VoIP calls via Skype. Not only does this broaden Skype’s footprint, but also it drives handset sales, and boosts the ARPU of mobile users by increasing mobile traffic. Initially, the service will only be offered only on U.S. GSM networks, and is supported by Nokia, Motorola and Ericsson Sony handsets. Support for other handsets will come, and iSkoot plans to extend coverage to other IM networks like GoogleTalk.

We see this service potentially having strong appeal, but it is too early to tell how successful it will be. It is interesting to note that the software can only be downloaded from iSkoot’s website. There is no mention of it anywhere on Skype’s website, and we suspect Skype is being cautious with this for now. Clearly, such offerings will have much more visibility when available through Skype’s website. One reason may simply be that iSkoot is only available in the U.S., and the majority of Skype’s users are elsewhere. Another factor may be that Skype is still working through how best to handle other applications that support mobile voice as well as IM. Two examples of this include EQO and Voxlib, both of whom offer Skype applications with a few variations on iSkoot.

The second August announcement comes from a Dutch startup called Nimbuzz. On August 24 the company launched a service offering similar to iSkoot, but focused initially on mobile text messaging. Nimbuzz is first addressing mobile IM for MSN and GoogleTalk, and will soon add Yahoo! and AIM. Each of these are large addressable markets, and the company’s strategy here seems to be one of establishing themselves as the mobile IM enabler of choice, and later launch the Nimbuzz Voice offering to support mobile VoIP services. Between iSkoot and Nimbuzz, all the VoIM platforms will have some mobile VoIP capability, and collectively, this represents a powerful alternative to mobile operators.

As an aside, there is a Skype connection worth noting. Nimbuzz is funded by Mangrove Capital Partners, who were Skype’s first funders. No doubt they did well with the eBay acquisition, and given this success, their support of Nimbuzz gives this venture additional credence.

Finally, there is Rebtel. The company had no specific news in August, but during the month there were a number of signs they were attracting attention outside their core market in Europe. Their service formally launched in Stockholm on June 27, and since then they have been gaining a strong following. One cannot help but notice that Rebtel is yet another Scandinavian telecom startup with an unusual name, proving that good ideas can come from anywhere, and in the world of IP, these ideas can become adopted very quickly.

Rebtel is similar to Skype in many ways, but is just for mobile users. It is the purest form of mobile VoIP, and they have taken the best of the Skype model, especially the low cost and ease of use. Unlike offerings like iSkoot, there is no software to download and there is no need to involve the PC. The service is easy to understand and use, and is especially attractive for mobile calling between countries. While they lack Skype’s user base, they are addressing a much larger market, and one that will find their value proposition attractive.

It remains to be seen how they will grow beyond their viral buzz, but the underlying idea is compelling, and we think they are moving in the right direction at the right time. Certainly, other offerings exist that work on the same principle of reducing your mobile long distance costs, but these are largely dial-around plans that essentially provide cheaper minutes. Companies like Mobile Miser and Mino are good examples, but are not really mobile VoIP. While these services may provide good value to their users, they are not game-changers, at least in the way we have been discussing the other companies in this article. We will continue to follow mobile VoIP, and will revisit this in a future issue to see which model becomes the next winner.

3. Spotlight on Fixed Mobile Convergence

FMC – fixed mobile convergence – is one of the major trends in telecom, and while there was no particular news of note last month, we have been following the space closely for some time. Among carriers, FMC is often intertwined with IMS, which is also a key trend but a much broader topic. IMS is really a reference architecture, and by virtue of its scope will take much longer to deploy and become a reality. FMC is timelier to discuss, as there are live deployments today, which makes it a better barometer as to where carriers are investing now for nextgen services and applications.

The basic value proposition of FMC is straightforward – it enables carriers to manage calls across fixed and mobile networks, opening the way for new services and a closer relationship with subscribers. Initially, FMC supported limited integration between networks, but with separate numbers for cellular and wireline phones. From there, FMC evolved to a single number service, but incoming calls could not be handed off to another network. Today, FMC has become a truly converged solution, supporting a single number across dual networks, along with a seamless handoff between networks. There is definitely value in having this capability, and vendors are reporting good traction across the board.

A key reason for FMC’s appeal is that it offers different things for different types of operators. Traditional ILECs are turning to MVNO deals to enter the mobile space. Cablecos and ISPs are looking to do the same, not just to resell minutes, but also to offer a single number service that covers home and mobile phones. And of course, mobile operators are looking at FMC to enable them to enter established landline markets.

On the demand side, the driver for FMC is a simple but powerful reality. Mobile phones have now become the communications device of choice among consumers. Unlike landline phones, which have limited features and intelligence, mobile phones are much more than passive endpoints for voice communications. In today’s on-the-go world, mobile phones allow people to carry their identity with them – this is the first place they expect others to find them, either by voice or text messaging. Mobile phones usually serve as a user’s personal phone directory, and most phone numbers in their directories are typically mobile numbers. Fixed carriers need FMC to remain relevant with their subscribers, and mobile carriers need FMC to extend their reach when subscribers are out of range for coverage.

It is also important to understand the value FMC delivers to two distinct markets – consumer and business. Consumers want the convenience of a single number and a single bill from one provider. This is the anywhere/any time/any device/any content mantra we so often hear about, and FMC is a big step forward for doing so. Businesses want the ability to extend the desktop experience – as well as its look and feel – to employees when they are mobile. With FMC, this capability can be delivered equally well by a fixed or mobile provider, which opens up the market to new entrants.

So who is leading the way with FMC solutions? Several vendors are active in this space, many of which have a singular focus on FMC. Notable vendors include Bridgeport, NewStep, Outsmart, Personeta, FirstHand and LongBoard. Bridgeport has been a leading advocate of FMC and is behind MobileIGNITE, a key industry alliance group. All of these vendors have viable solutions, such as Personeta’s TappS platform, Outsmart’s Smart FMC, NewStep’s Converged Services Node, or LongBoard’s OnePhone. We believe a number of these companies may become acquisition targets for the larger telecom vendors who are also trying to establish their own FMC strategies. Their solutions can complement nicely typical softswitch offerings from companies such as Nortel, Alcatel/Lucent, Ericsson, Motorola, Nokia, Sonus, and others.

Another company worth noting is Ascendant Systems, which was acquired in March by Research In Motion (RIM). They differ from these other vendors in the sense that they are focused solely on the Blackberry market rather than any type of operator. They are mentioned as an example of FMC that is coming from the data world rather than the voice world. Ascendant’s Voice Mobility Suite allows enterprises to extend their PBX out to the Blackberry, providing it with a full set of features that mobile devices do not normally have. Not only does this make the Blackberry a powerful multimedia device, but also it allows RIM an entrée to the fixed line enterprise voice market. We see this as a great example of how FMC opens up the playing field, and as it matures, will have a lot to do with reshaping the communications landscape.

Several challenges remain for the FMC industry. The issue most often discussed by experts is the limitations of dual-mode WiFi/cellular devices, and more specifically power challenges and battery life. More mundane tasks also exist, like how to track usage and billing for calls that are handed off from a wireless network to a wireline network, and vice-versa. These challenges exist in a single carrier environment, but how much more complicated will they become when handing off calls in a multi-carrier environment?

Finally we should note that FMC is really a stepping-stone to IMS, and to varying degrees, all of the above vendors have an IMS story. However, IMS is not a precondition for FMC’s success. We are still in a pre-IMS world, and FMC is gaining rapid acceptance today. This acceptance will accelerate as affordable dual-mode handsets come to market, and we are seeing signs of this now. While today’s FMC applications are compelling, the value proposition will only be stronger with IMS, which will support an even richer integration of services across multiple networks. For those taking the longer view of things, this may be best reason of all to pick today’s winners, as those with an FMC pedigree will be first in line for IMS when that day arrives.

4. Art of the Deal:
Radisys Acquires Convedia

In recent months, we have highlighted interesting deals that have occurred between communications equipment vendors, and this past month gave us the opportunity to witness yet another. Announced at the end of July, and closed on September 1, the $105 million acquisition of Convedia by Radisys serves as an excellent example of a deal that seems like a winner for all parties involved. The deal itself is also notable in that, while Convedia has long appeared to be a potential acquisition target, Radisys was not on the top of the list as the most logical potential buyer. In our view this is an important reality of today’s telecom space, where deals are just as likely to come from unexpected suitors as from the usual suspects.

Radisys is not a familiar name in the nextgen telecom infrastructure market where Convedia is squarely focused. Radisys is well known among OEM vendors like Nokia and systems integrators, primarily for ATCA, but not so much by Convedia’s core customer base of service providers and large enterprises. This deal is a case where the synergy comes from bringing complementary technologies and customers together as opposed to pooling similar companies to create critical mass.

Over the past several years, Convedia has been one of the best examples of a VoIP startup to emerge as a leader in their sector. Media servers are a core element for nextgen networks, and this has always been the sole focus of Convedia’s business. They have truly evolved into a best-of-breed vendor, and Radisys apparently recognized this value. Convedia has a complete family of hardware-based media servers, catering to Tier 1 carriers, Tiers 2s, and large enterprise networks.

In addition to their strong Tier 1 business, Convedia is also well along the path to IMS compliance, which is fast becoming a table stake for new deployments. Furthermore, Convedia has developed a global presence with over 200 customers, typically through direct wins with North American carriers, and abroad via white label OEM arrangements with majors like Alcatel and Huawei. Convedia’s annual revenues were reportedly in the $20 million range.

Through the acquisition, Radisys obtains a market leader that provides a window into a valuable customer base, along with an IMS story and strategy. That said, Radisys has an even broader global footprint, so they can also help Convedia reach a wider market with their hardware solutions, and conversely, Convedia opens the door for Radisys to sell their embedded software applications.

As IP technologies evolve, software-based solutions are maturing to the point where they can rival many hardware-based solutions. This is important for Convedia as software-based media servers are becoming viable now. Previous or existing software offerings in this space have had limited success, largely because they were too early. In that regard, Radisys provides some insurance for Convedia, allowing them to participate more strongly in this end of the market. As media servers proliferate among smaller carriers and enterprise networks, software-based offerings will become a growth driver for vendors like Convedia, and under the Radisys umbrella, they will have an easier time addressing this opportunity without losing focus on their core business of hardware-based solutions.

Convedia previously raised around $50 million from venture capital investors including Terry Matthews’ Wesley Clover fund. The $105 million purchase price could go as high as $115 million if certain financial targets are met during the next twelve months. At over 5X trailing revenues, the price tag seems relatively high compared to Excel Switching’s acquisition of Brooktrout (2.2X) and Comverse’s acquisition of Netcentrex (3.2X), but is on par with AudioCodes’ acquisition of Nuera. However, the deal is nowhere close to the lofty valuation (15X) that Juniper paid for Kagoor about 18 months ago.

You may recall that Brooktrout’s products included the media server products of SnowShore Networks, who raised a similar amount of capital when these two vendors competed head-to-head for Tier 1 customers back in 2001. Convedia managed to execute more effectively, and SnowShore has long since exited the hardware-based media server space and shifted focus to software solutions, where they have had limited success. SnowShore was sold to Brooktrout in March 2004 for $10 million, whereas Convedia emerged as the dominant pureplay in this market.

From this position of strength, Convedia could have chosen to become a consolidator, but to do this they would have to raise additional capital. That strategy also has risks, since there is no guarantee that they could raise the money, and integrating smaller technology players is always a challenge. There is also no guarantee that a broader product line and more revenues would necessarily result in more value in an exit down the road.

Our overall assessment is that Convedia’s exit represented a good deal for Radisys, Convedia’s investors, and its employees. It’s interesting to note that although Convedia was a Wesley Clover company, it did not follow the path of its sister companies Newport Networks, Ubiquity,March Networks or Sandvine and pursue an IPO on the AIM. Given that Newport has not performed well since its IPO, and the public markets may be tainted by any VoIP-related offering after Vonage’s dismal IPO in May, exit via acquisition seems like the best course of action at this time. This may also send a signal to other companies who have been contemplating IPOs, such as Acme Packet and Broadsoft – good deals are out there if you look in the right places.

5. Financial Highlights