A Remarkably Dangerous IPO You Should Avoid

Four years after a private equity buyout, Avaya will be respun out to investors in an IPO set for April. Pundits may soon hail the opportunity this fresh slate of equity represents, especially in light of good results from primary competitor Cisco Systems (Nasdaq: CSCO  ) . Please don't buy the hype. This is a sucker's bet, and I'd rather you didn't get taken.

I'll go into why in a minute. First, let's talk details. According to Bloomberg Businessweek, Avaya, which is owned by Avaya Holdings, is hoping to raise $1 billion in a new offering while cashing out at least some, if not most, of the interests of buyout firms TPG Capital and Silver Lake Partners.

There's reason to hold the IPO soon. Yankee Group predicts the market for telecommunications equipment will grow roughly 10% to $302.2 billion by 2014. Meanwhile, AT&T (NYSE: T  ) and Verizon (NYSE: VZ  ) have combined to spend more than $30 billion on capital upgrades in each of the past three fiscal years.

So why not buy? Several reasons:

1. Avaya is still unprofitable. Though net losses narrowed to $26 million from $180 million in last year's fourth quarter, history doesn't give much reason for optimism. Earnings have run consistently negative since 2007. Revenue is up 5.5% over that period.

2. The business is structurally weak. Avaya has one of the worst balance sheets you'll see for a tech company. Liabilities are now 128% of assets, meaning Avaya owes more than it has in assets for funding growth. But the ratio is actually worse than that if you exclude the 74% of assets related to intangibles and goodwill.

3. Cash isn't flowing. After several years of shrinking cash flows, Avaya burned through $300 million in fiscal 2011 to keep the lights on. That number fell to a better-but-still-awful $223 million through the 12 months ended in December.

We don't yet know what valuation Avaya would seek, but it couldn't possibly be cheap given reported aims to raise $1 billion in fresh capital. Peer Cisco is valued at roughly $108 billion, and Avaya is second only to Cisco in selling telecom gear. I can't imagine this company coming public at a reasonable price.

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