Disruption is not a new concept. We all get that Amazon disrupted Circuit City, the advent of the MP3 reduced sales of CDs and digital photography wreaked havoc on filmmakers like Kodak. But what of companies who develop new technologies which disrupt multibillion-dollar markets – only to see these innovations turn on them, causing their own product line to become legacy in short order?

Dialogic is one such example and they recently announced replacing CEO Nick Jensen with Kevin Cook (pictured). The company is legendary for those of us who have been in telecom for a while as much of the technology that enabled computer telephony and pioneered VoIP came from their engineers. Companies like Interactive Intelligence have leveraged off-the-shelf PCs and DSP resource boards made popular by Dialogic to build contact center solutions to disrupt proprietary solutions from the likes of Avaya.

More importantly, a slew of CLECs and other new communications providers providing services such as calling cards have relied on technologies pioneered by Dialogic to disrupt the incumbent carriers of the world. Without these boards in fact, telephony might still be a proprietary and closed technology where office phones are not interoperable and Skype didn’t exist.

It is indeed ironic that the same innovations which made the world of telecom dramatically more competitive have turned on the company’s leading-edge products to make them considered “legacy.”

Some History

As mentioned above, the core business at Dialogic was once DSP resource boards you would need to enable a PC to record and playback voicemail. These products had huge markups and competitors like Aculab, Rhetorex and NMS fought tooth and nail for marketshare by appealing to developers – like Interactive Intelligence who would place these boards in their systems. The good news is once a product win was achieved, you rode the wave of the product’s success without having to do very much. After all, it would be a herculean effort to rip-and-replace a DSP resource board.

This once margin-rich business evolved over the years as the processors in typical computers became powerful enough to handle what once needed proprietary DSP-based solutions. In other words, over time you could purchase software allowing the host processor to handle the media processing (HMP) which helped commoditize the market and pushed prices lower. In addition, a new competitor emerged last decade in the form of open-source/Asterisk coupled with lower priced boards from Sangoma and Digium.

As a result of the pressure on margins, Dialogic looked to new forms of revenue and moreover thought it made sense to consolidate the market purchasing Cantata, NMS and others.

The Focus on Video

At the leadership of Nick Jensen, Dialogic not only went on an M&A tear, it devoted a tremendous amount of energy to the video market. Nick was a major evangelist for getting service providers to provide video-based services which consumers would pay for. In fact these enhanced services have been the holy grail of the communications space for as long as I can remember. As you may know, some new service ideas fail spectacularly and others like music-based ring tones and SMS have become multibillion dollar markets few saw coming in advance.

Video is much more processor-intensive than voice so if there was a way for Dialogic to help carriers profit by providing such services it would have been spectacular for the company’s sales. And it’s obviously a rapidly growing market – just one that’s been tough to monetize effectively. After all, consumers have fast broadband connections in much of the world and don’t need the carrier to do much. Then there are app stores and Skype which make it more challenging for carriers to add any value they can charge for.

For parts of the world where bandwidth is constrained, consumers will pony up some money for video services but the challenge is, these parts of the world are generally poorer by definition meaning less revenue is to be gained by providing such enhancements.

The Financial Reality and Helm Change

Dialogic’s combined assets at the peak of their worth would likely command a value north of $1.5B but the market cap as of this writing is under $20M. The company combined wstith Veraz Networks in October 2010 and from the chart, between the arrows you can see the entire value of Dialogic has been eliminated since the merger.

 

The company was proactive in restructuring its debt and as a result, $39.7M owed to Tennenbaum Capital Partners, LLC has been converted into stock. Typically, these are the sorts of situations where companies change management and this explains part of the reason Kevin Cook has taken the helm. I spoke with him recently and the story he tells points to a future where the company’s new solutions are beginning to sell at a sufficient rate to offset the reduced sales from legacy businesses.

On a related note, company execs tell me additional shares due to debt conversion are likely to increase Dialogic’s market capitalization in the near future.

Streamlining Everything

Kevin spent time explaining that the elimination of the Tennenbaum debt also reduces interest payments to the tune of just under $10M per year. Moreover the company is spending its energy consolidating areas of redundancy and slowing R&D in areas which won’t provide a return while investing more in growing areas.

These changes have resulted in the company lowering its quarterly breakeven point from a cash flow perspective from $60M six quarters ago to roughly $40M today.

But What’s Next?

Since video has been the company’s obsession for many years we’ll start there. They will still focus on mobile video but watermarking and analytics will be spun off or discontinued. The areas of focus going forward will be PowerMedia HMP, softswitching, optimization and SBCs among others.

But What of The SBC?

It’s no secret that the SBC space was one of the hottest areas of telecom for a number of years and although the performance of the publicly traded companies may not show it, the future of the market is expected to be quite good. Dialogic seems to agree and Cook says he has reinvigorated the R&D in the SBC space with an addition of 25-20 heads. The company’s BorderNet 4000 SBC is doing well in the peering space and works quite symbiotically with the company’s softswitching solutions he says.

Cook believes the performance of this product line is ahead of the competition and expects to be a more potent threat to Acme Packet and Sonus in the future as more features will be added. The company’s BorderNet 2020 SBC plays in the access market on the border of carrier networks and the sales funnel for this product are ahead of projections he explained. He believes the company’s transcoding and multimedia capabilities will be a differentiator as the product moves upstream.

This product line also has potential to expand into the enterprise especially with IP based contact centers.

Who is Dialogic Now?

For most of its history Dialogic was a building block company then a video enabler for carriers. I asked, what should the company been known for now? Cook says, “We’ve staked out a claim in an area we call mobile experience management.” He went on to say the company has a lot more experience in the mobile space as opposed to Genband or Sonus or others who have more experience in the fixed line area.

Moreover there are a few parts to this vision. The first is service creation which is the value added service parts of the business like video gateways and video enabling applications which could for example allow a carrier to provide a social game where users could watch other players over their mobile devices.

Then there is the PowerMedia platform where people are building applications like mobile videoconferencing, roaming and signaling. Moreover, the company’s PowerMedia XMS solution provides a software media server allowing standards-based media control (XML, etc.) in a data center or cloud as part of a carrier’s IMS architecture.

Service delivery is another area of focus – where the company supplies softswitches as well as SBCs. Service optimization is another one and perhaps one of the most important from my perspective. Here the company supplies myriad solutions from the radio tower to the mobile switching center with the I-Gate Session Bandwidth Optimizer Mobile Backhaul which optimizes Abis and Iub data streams, including both ATM and IP-based Iub streams in 2G and 3G networks. Cook says it provides optimization of 70-80%, has customers like Telefonica and other major operators around the world, and sits between the RAN side of the network and the MSC.

Cook said, “The product does more header compression,” and continued to tell me this optimization is pretty unique to Dialogic and incremental to compression already done in switches from companies like Huawei and ZTE.

From there he discussed the company’s core network bandwidth optimization product, the I-Gate Session Bandwidth Optimizer (PDF) used in major networks around the world, which handles traffic optimization in and between VoIP and 3G networks.

The company is making a big bet on a product code named internally as DV which is short for data and video optimization and he says, “There are some very unique things we can do with this product and we’ll do some proof of concepts this December and launch in 2013.” He continued to tell me he the product can optimize 20-30% on top of what all the other players are doing, and that it is targeted for LTE/IMS networks. He invited me for a deep dive discussion which may take place at some point in the future.

The story got better with the addition of a slew of board members who are really well-versed in managing public companies as well as a discussion of customer diversity. No single customer in fact makes up more than 4% of the company’s revenue and North America revenue is less than 40%. The point is the company is more diversified than many of its competitors from a customer and country standpoint.

The Concern

Carriers want to work with companies who are in solid financial shape and this presents a chicken-and-egg problem for a publicly traded company. Dialogic needs to increase its stock price to be more attractive to its customers but in order to do so it needs to sell more products.

Conundrum may be the best way to explain this challenge.

The good news for the company is they already have a solid relationships with so many companies and carriers and they’ve been around for so many decades that they likely get far more leeway than other less-known organizations.

The Future

The takeaway from the conversation is the company is beginning to see traction in its new products. The legacy lines are seeing less investment and there has been large amounts of cost-cutting between office closures and debt conversion making interest payments less onerous.

There is an impending data crisis in the world and mobile carriers are scrambling to provide bandwidth to towers around the globe. The optimist will likely point out it is always cheaper to maximize the bandwidth of existing circuits than it is to dig trenches and shoot new fiber meaning sales growth of products which help in this area should be a given.

Moreover, carriers do want to reduce churn and managing the customer experience is obviously an important part of doing so.

At the end of the day, Dialogic must execute and if they do they could be in solid shape. Of course some of their future is dependent on carriers feeling optimistic enough to spend money improving their networks. Moreover, if legacy product sales decrease more rapidly than anticipated or new product growth stalls, the company will likely have to make more and painful cuts. But again, the optimist will say Dialogic's unique compression solutions will produce a rapid ROI for carriers who will spend more freely. And since mobile broadband growth is predicted for years to come, the company does seem to be positioned to take advantage of some of the investments carriers are bound to make.

See Dialogic at ITEXPO, Oct 3-5, 2012, Austin, Texas in booth #308. Disclosure - I am the Chairman of ITEXPO.