On Monday, the management of unified communications vendor Shoretel (SHOR) rejected a takeover offer worth $8.10 a share or a total of $518 million from Mitel (MITL), a Canadian unified communications vendor. Discussions with several Wall Street analysts suggest that Wall Street thinks the bid undervalues ShoreTel’s potential. Many believe some consolidation would be good for the unified communications industry, but they believe ShoreTel deserves a higher price, either from Mitel or from another competitor.

Both companies compete in the global unified communications (UC) market, which is evolving from the supply of hardware telephone and PBX systems into a cloud or SaaS market where enterprises pay a per-seat rental for a set of services typically including voice, teleconferencing, videoconferencing, instant messaging, and other high-tech IP-enabled communications. In the SaaS model, the vendor typically owns and manages the servers handling the communications, corporate phone numbers are completely portable (assignable to a home phone, a mobile phone, tablet etc.) and so there is a much smaller upfront cost to the customer since there’s no servers to buy. While the UC market has been growing at 20%-30%,that is significantly less than many observers’ expectations. On Wednesday this week, RingCentral (RNG) reported a revenue growth rate of 36% –solid growth but not the sort of hypergrowth many believe a cloud-based technology with clear advantages over equipment-based services ought to generate. Observers attribute the moderate growth to enterprise concern over turning over a precious tool (voice communication) to a technology that is still developing, in a market where the players are still jockeying for position.

Mitel and Shoretel are in some ways similar companies. Mitel is based in Ottawa and reported revenue of $289 million in the June quarter, making it roughly three times the size of Sunnyvale, California-based ShoreTel, which reported revenue of $90.4 million for the September quarter. Both companies are transitioning from their legacy premise-based equipment model to the hosted cloud model, but ShoreTel is further ahead in the transition. In the latest quarter, ShoreTel’s cloud revenue was $24.9 million (28% of total revenue), slightly ahead of Mitel’s $20.9 million (7% of total revenue).

Premise-based vs. cloud-based

“This is a disruptive market,” says telecom analyst Spencer Mitchell of brokerage firm Odeon Capital. “Size and scale is becoming important. It makes sense for the two companies to combine to better compete with the Ciscos and Avayas of the world.” Analyst estimates of the size of the total communications market range from $3 billion to $ 6 billion a year, depending on what you count, and Cisco (CSCO) and Avaya each hold around 30% of the market. According to Mitchell, both companies’ management teams have performed very well since their arrivals at both companies (where results were uneven prior to their arrival.) Mitel CEO Rich McBee has driven Mitel’s growth through acquisition, a strategy he used very successfully at his previous company, Danaher. Last year, Mitel bought Aastra, which brought them a cloud product and a sizeable installed base in Europe. “Six months into the Aastra integration, McBee raised the target for synergies from $50 million to $75 million, so that shows you how well it’s going,” says Mitchell.

ShoreTel’s cloud platform is also based on an acquisition, of M5, but analysts say that ShoreTel has been aggressive about driving that technology forward. According to telecom analyst Barry McCarver of Stephens Inc., ShoreTel has aggressively signed up more than 200 resellers to resell ShoreTel solutions. On top of that, ShoreTel recently announced that beginning in April, they will move to a common software platform for both families of products, which will greatly simplify the transition from the premises-based solution to the cloud solution for existing premise-based customers. “We’re right on the cusp where we’ll see a lot of growth and velocity in ShoreTel’s business in the next one to four quarters,” says McCarver.

Telecom analyst Dmitry Netis of William Blair said Mitel’s cloud product, Telepo, came via the Aastra acquisition. “It’s a very small product, virtually nonexistent in the US market,” says Netis. He says ShoreTel Sky is really what’s driving Mitel’s strong interest in ShoreTel. “This is an opportunity for them to drive consolidation in the market and get themselves a good brand that is seeing a lot of traction in both direct sales and through the channel.”

Mitel strongly disagreed with Netis’s view of the US market. Executive VP of Mitel Cloud Solutions Jon Brinton cited data from Synergy Research for Q2 of this year showing Mitel ranked fourth in US cloud UC revenue, with 8% of the market, ahead of ShoreTel, which was fifth with 6%. Most of Mitel’s US cloud sales are with products branded MiCloud Business and MiCloud Enterprise. “Mitel had the largest percentage change from the previous year’s second quarter, we had the largest move up and we have the greatest velocity of all the competitors,” Brinton said.

On Monday, Oct. 27th, ShoreTel published a press release saying its board “unanimously” rejected Mitel’s offer as “financially inadequate… opportunistic… and not in the best interests of ShoreTel stockholders.” Yet analysts think the deal might yet happen. “There’s a great deal of synergies,” says Mitchell. “ShoreTel is North America-specific, while Mitel has more international exposure.” Mitchell points out that after the Aastra acquisition, the two co-CEOs of Aastra have both stayed with Mitel, arguing that a merger could be arranged where ShoreTel CEO Don Joos and some of his team would remain on board.

Mitel’s Spooner: “cash offer on the table today”

But at Mitel’s first offer price of $8.10, “this deal is dead in the water,” according to another analyst. The analysts have run the numbers on ShoreTel, and come up with a $10-$12 range for the value of its stock, based on comparables with others in the industry, discounted future cash flows, and other financial methodologies. Brian Bythrow, who manages the Wasatch Micro-Cap Value Fund and currently owns 230,000 shares of ShoreTel, is not interested in an offer that starts with an 8. “The new ShoreTel is a transformed company,” he says. “Customers like their product, the new phones are good, and they have good channel partners. Even if there is no buyout, this company will get more respect.”

Mitel CFO Steve Spooner said the company has had no response from ShoreTel beyond Monday’s press release. “We’ve had no opportunity to sit down with ShoreTel board or management and engage in productive discussions relating to the art of the possible,” he told the Daily Cloud. Spooner defended Mitel’s $8.10 offer as a good offer based on a sum of the parts calculation, and a 24% premium to where ShoreTel was trading pre-offer. “ShoreTel shareholders need to evaluate the merits of the certainty of a cash offer on the table today, versus the uncertainties of keeping a stock that was trading at $6.51 and hope that things get better at some time in the future.”

Shareholder Brian Bythrow says he wonders if a ShoreTel acquisition wouldn’t make more sense for a larger company that could combine ShoreTel technology with a large global customer base. Proving that liberal arts education is not dead in America, analyst George Sutton of Craig-Hallum reached for Shakespeare’s help in an Oct. 20th note and asked: “Wherefore art thou Avaya, Cisco or Polycom?”