ConvergeOne (C1): When Majority Control Meets Judicial Constraint

Welcome back to the 197th Pari Passu newsletter, 

Today’s write-up explores a restructuring where intra-class dynamics took center stage. The Bankruptcy Code states that a plan must provide similarly situated creditors, or creditors of the same class, equal treatment. Thus, intra-class creditors should share recoveries proportionally and without favoritism. In practice, Chapter 11 is rarely that simple. When liquidity tightens and negotiating leverage shifts, economic incentives, backstop fees, side agreements, and strategic positioning prepetition can quietly reshape what “equal” really means.

With an economic incentive to achieve higher recoveries, a subclass of similarly situated lenders in ConvergeOne (C1) attempted to receive enhanced economics through exclusive rights offerings and backstop premiums. We will later explore the competing legal arguments surrounding these economics, particularly the extent to which compensation for new risk becomes unequal treatment of old debt.

Without further ado, let’s dive into how a legacy value-added reseller tumbled into bankruptcy with a stressed capital structure from untimely acquisitions, rising floating-rate debt, and supply chain disruptions exacerbated by vendor concentration. This petition will explore a contested rights offering and the doctrine of equal treatment in bankruptcy. The C1 writeup is the first of an exciting three-part write-up series that will connect NPR economics in bankruptcy.

ConvergeOne (rebranded to C1) was founded in 1993 as a telecommunications reseller headquartered in Bloomington, Minnesota. Over time, it evolved into what is known as a value-added reseller (VAR) and systems integrator for full-service cloud solutions, unified communications, and customer experience (CX) technologies. Original equipment manufacturers (OEMs), which are manufacturers who develop the hardware and software for larger systems, such as Cisco, Avaya, Dell, and Microsoft, build networking equipment, unified communications platforms, collaboration software, and contact center infrastructure. Enterprise customers (C1’s customers) rarely deploy these systems on their own. They require architecture design, migration from legacy systems, cybersecurity integration, implementation, and ongoing management. [2]

C1 sits between the OEM and the enterprise customer on the value chain. It purchases hardware and software from OEMs, installs and configures those systems for clients, and then layers on professional services and recurring managed services. Rather than selling simply hardware boxes, C1 sells modernized networks, secure collaboration systems, cloud migration, and managed infrastructure bundled with higher-margin professional maintenance services. You can think of this almost like a razor-and-blades business model. Later, we will discuss the consequences for C1 when its customers aren’t able to buy more “razors”, implying that they don’t need as many “razor blades.” 

By 2018, the company had grown to approximately $1.8bn in annual revenue and established long-standing customer relationships with a diversified end-market base of 10,800 customers. Its top 10 customers accounted for approximately 10% of total revenue and maintenance renewal rates were 90%, which refers to C1’s service offerings such as hardware monitoring, software updates, replacement parts, and security patches following the initial product installation. These managed services contracts typically exceeded two years. In terms of revenue composition, approximately 48% of revenue, or about $864mm, came from product sales. These were hardware and software licenses purchased from OEMs and resold to customers. Approximately 17%, or $306mm, came from professional services: design, installation, implementation, and other maintenance services. The remaining 35%, or roughly $630mm, came from managed services, cloud offerings, and recurring maintenance contracts. Together, the professional services and managed services segments account for 52% of total revenues, which represent recurring and higher-margin service-based offerings, although the exact margin of these offerings is unknown given the limited financial data, as C1 is a private company. [1]

Management had a clear long-term strategy to shift toward higher-margin recurring services revenue and reduce reliance on transactional product sales. As mentioned, services revenue carries higher margins and greater predictability. Once an enterprise outsources its network management, switching providers involves risk and operational friction. Nevertheless, as we will discuss, by 2021, services still represented 52% of total revenue. By mid-2023, services had declined to roughly 47% of revenue, an unfavorable mix shift away from the higher-margin services segment.

ConvergeOne’s capital structure began to change materially in the mid-2010s. Clearlake Capital acquired the company in 2014, grew EBITDA by 4x, and subsequently took it public via a de-SPAC transaction with Forum Merger Corp in 2017. After a brief period as a public company on the NASDAQ, CVC Capital Partners acquired ConvergeOne in 2018 through an all-cash $12.50/share tender offer at a 56% premium to the closing price on ConvergeOne’s debut date on NASDAQ (February 2018), valuing the company at approximately $1.8bn. The acquisition, which closed by Q1 2019, was financed with significant leverage as pro forma total debt stood near $1.35bn. The pro forma capital structure is shown below. Moody’s estimated trailing leverage at approximately 7.0x net debt to EBITDA, implying LTM EBITDA of $180mm and a cash balance of ~$90mm. Thus, C1 maintained an interest coverage ratio of ~2.0x based on approximately $89mm of interest expenses. [3]

Nonetheless, seven times leverage is aggressive but could be manageable in a stable services platform, provided EBITDA grows and free cash flow remains positive. However, we will discuss how a series of bolt-on acquisitions failed to improve C1’s top-line or profitability with inorganic growth.

After the finalization of the CVC buyout in Q1 2019, C1’s path to distress was compounded by multiple factors, including a series of untimely acquisitions that significantly levered the business, supply chain challenges, vendor issues that dragged buying cycles, and higher interest expenses when floating rates jumped in 2023 (C1 did not hedge against floating rate exposure). As acquisitions continued to lever the business and supply chain issues lengthened cash cycles, it became increasingly difficult for C1 to delever the business adequately before rising interest rates and further operational struggles strained the company’s liquidity. 

If you have consistently read our write-ups, you may have noticed a strong trend of restructurings (see our coverage of Weight Watchers and Del Monte) stemming from untimely acquisitions that overextended the company’s capital structure with onerous leverage. Although acquisitions aren’t the sole reason, you can add C1 to this extensive list of distressed companies. Before CVC’s buyout acquisition, C1 already had a history of pursuing inorganic growth through a series of acquisitions of smaller rivals at a cumulative purchase price of $190mm since 2017 to diversify its supplier base. Then, between 2019 and 2022, C1 would continue its inorganic growth strategy by pursuing multiple bolt-on acquisitions, including Venture Technologies ($90mm purchase price), Prime TSR ($25mm purchase price), and Integration Partners ($250mm purchase price). The majority of these acquisitions were in the $20-30mm purchase price range, with a cumulative acquisition spend of ~$350-400mm. The full list is shown below in Figure 2. [8]

Through these acquisitions, management sought to broaden capabilities, deepen service offerings, diversify vendor relationships, and drive higher-margin recurring revenue. The main reason C1 pursued these acquisitions was to address one of its key operational issues: high vendor concentration with OEMs. Although the aforementioned diversified customer base mitigated supplier concentration risks, OEMs Cisco and Avaya provided the inventory for sales connected to 60% of total product sales (or 31% of total revenue). We will discuss this in more detail soon. 

Following the CVC acquisition, Moody’s issued a report that expected revenue to approach $1.9bn by 2020, creating a path towards deleveraging by ~1.0x to 6.0x total debt to EBITDA by the end of 2019. However, these acquisitions failed to improve C1’s top-line as revenues declined from $1.8bn in 2018 to approximately $1.5bn in 2019 and further to roughly $1.3bn in 2020. At this point in 2020, the business had a $44mm cash balance and $70mm undrawn capacity under its $250mm revolver due in January 2024, implying $114mm of liquidity. [5]

When the bolt-on acquisition spree halted in early 2022, C1’s pro forma capital structure had grown from 7.0x to 7.8x net debt to EBITDA, illustrated in Figure 3. It is important to note that C1 took out additional leverage, given limited cash, to fund its bolt-on acquisitions, which included a $90mm 1L Kennedy Lewis (KL), a multi-strategy private credit platform with $30bn in AUM (the lender), notes in July 2020 and an incremental $150mm 1L TL in 2021 from its original $960mm 2019 1L TL issuance. [6] [7]

The bolt-on acquisition spree from 2019 to 2022 was funded primarily through debt. Given C1’s pro forma cash balance at the close of CVC’s acquisition was $90mm, FCF was approximately $39mm (based on Moody’s estimated 3% FCF yield on total debt), and the cumulative purchase price for all C1’s acquisitions from Figure 2 was ~$350-400mm, the acquisitions were funded primarily with debt. In fact, by early 2022, total debt had risen to $1.6bn following the seven acquisitions. Leverage climbed to roughly 8.0x, up from 7.0x in 2019. Using Moody’s 8.0x leverage ratio and $1.6bn total debt, implied EBITDA was approximately $196mm in 2022. Ultimately, while C1 had deployed approximately $400mm across its bolt-on acquisition strategy, EBITDA remained relatively flat from $185.7mm at the end of 2018 to $196mm in 2022. Meanwhile, total debt had grown by $225mm to $1.58bn and C1’s $90mm cash balance post-CVC LBO in 2019 had declined to just $22mm by 2022.

Margins were compressing at the same time leverage was increasing. In fact, leverage peaked near 10.0x in late 2022 as EBITDA declined further and incremental borrowing accumulated. At 10.0x leverage, the business becomes mechanically fragile. A modest $20mm EBITDA decline meaningfully increases the leverage ratio, and deleveraging requires either substantial EBITDA growth or material debt repayment. ConvergeOne achieved neither, as Moody's notes that the only debt paydown came through the 1% mandatory amortization on its term loans. [1] [7] [8]

In addition to the series of bolt-on acquisitions that increased the leverage of the business, another key factor in C1’s distress story was its concentrated vendor dependence. At various points across 2018 and 2020, OEMs (C1’s suppliers) Cisco and Avaya together represented approximately 60% of product sales (product sales represent ~48% of total revenue in 2018). In 2021, three vendors accounted for roughly 65% of product revenue. Avaya alone comprised roughly 25-31% of total revenue exposure during certain periods. Figure 4 shows the change in vendor concentration across key vendors from 2020 to 2021, likely as a consequence of strategic acquisitions. Importantly, the operational strain associated with vendor concentration coincided with C1’s post-LBO bolt-on acquisition period from 2019 through 2022 and persisted thereafter. [1] [8]

This vendor concentration was not fatal in isolation. C1 could, in theory, shift customers toward alternative platforms/OEMs away from Cisco and Dell. C1 was not legally locked into selling only one vendor's products (contractual captivity), and ratings agencies even noted that vendor concentration was a credit risk but not a very meaningful risk in terms of C1’s total billings (deferred revenue, accounts receivable, and total revenue, which are also all GAAP metrics). Thus, the real risk lies in the timing of the cash cycle. To understand this, one must understand how a value-added-reseller (VAR) generates cash. When C1 secured a contract, it ordered hardware from an OEM, installed and configured the system, and only upon completion, invoiced the customer for cash. Revenue recognition and cash collection depended on successful installation. 

C1 had hundreds of project-based hardware orders sent to its OEM vendors and each shipment order is tied to a specific customer contract. If hardware shipments were delayed, installation was delayed. If installation was delayed, invoicing was delayed. If invoicing was delayed, cash collection was delayed. Meanwhile, operating expenses and interest expenses continued. Therefore, any issues affecting concentrated OEMs like Avaya or Cisco could materially affect cash flow, as product revenues are jeopardized even if the business is anchored by ~50% of the business stemming from recurring and predictable cash flows from maintenance and managed services sales.

Beginning in 2020, C1 faced a few issues that compounded liquidity concerns. The first problem was significant cash delays. With delayed installations from supply chain disruptions and subsequent invoicing, revenue moves forward in time to a later fiscal year, and cash collection is postponed, stretching C1’s working capital and straining FCF. These delays compound immediate liquidity pressure. Then, the second issue stemmed from renegotiation or partial churn, which compresses margins. If a customer pivots from Avaya to Cisco due to concerns over product delivery delays, vendor reliability, or vendor-specific restructuring risks, C1 may need to redesign the solution, retrain personnel, or accept different vendor economics. This will be discussed further later. Even if the revenue ultimately remains within C1’s ecosystem, profitability may decline. The final and most dangerous scenario is outright churn. If customers decide to move the entire contract to another value-added reseller competitor, then the backlog disappears entirely and revenue is lost (not merely delayed). 

By June 2020, Avaya and Cisco's manufactured goods represented 50% of product sales (or 25% of total revenue), down from the 60% of total product sales in 2018. The marginal decrease in vendor concentration was likely due to a secular decrease in customer demand for Avaya products as C1’s organic revenue generated from Avaya’s goods continued to sequentially decline by 3.6% in 2019 and another 7.6% by June 2020. This was a result of competitive pressures from Cisco and other vendors that lowered demand for Avaya-related collaboration solutions and ongoing balance sheet stress/restructuring risk at the operational level for Avaya. Furthermore, two other factors likely contributed to this small decline in vendor concentration of Avaya specifically: Venture Technologies' acquisition in 2019 aimed at reducing vendor concentration and the COVID-19 outbreak that accelerated restructuring risk for Avaya amidst broader weakened tech spending. As mentioned previously, at this point in 2020, the business had a $44.3mm cash balance and $70mm undrawn capacity under its $250mm revolver due in January 2024, implying $114.3mm of liquidity. [5] [6]

Nonetheless, vendor concentration remained high into 2021, as seen in Figure 4, and the primary issue surrounding the performance of one of C1’s key vendors, Avaya Holdings, contributed to uncertainty around the industry-wide supply chain shortages in 2021. In 2021, C1 had total liquidity of $165mm ($60mm cash balance and $105mm undrawn from its $250mm revolver). The business maintained a debt-to-EBITDA ratio of 7.5x with total debt of approximately $1.5bn, implying roughly $200mm in EBITDA in 2021. [7]

In June 2022, C1 reported approximately $275mm in backlog due to supply chain constraints. This represented booked business that could not yet be recognized as revenue because installations remained incomplete. Of course, to the detriment of C1, backlog is not cash, and interest expense must be paid regardless of the timing of cash flows. Despite solid bookings increasing by low double digits on a gross basis, the company had many unrealized bookings due to supply chain issues and the backlog of $275mm. Vendor concentration amplified this problem because if one or two concentrated OEMs experienced disruption, a large portion of projects could stall simultaneously (Avaya in this case). The issue was not permanent loss of demand but would nevertheless materially delay conversion of revenue into cash, and caused C1’s customers who use Avaya products to opt for shorter contract lengths. Similarly, this led to higher customer churn from delayed renewals of customer contracts. [8]

To illustrate this dynamic more precisely, let's create an illustrative example with the Jacksonville Jaguars NFL franchise, one of C1’s larger enterprise customers. Let’s assume that the Jaguars sign a $10mm contract for a unified communications and call center solution powered by Avaya equipment for its stadium operations. Once that contract is signed, ConvergeOne records it as a booking and it increases C1’s backlog. On paper, this seems like positive business momentum. However, revenue is not recognized at signing, nor is this typical deferred revenue (no cash yet). C1 typically recognizes revenue once the hardware is delivered, installed, and the system is operational. If Avaya experiences manufacturing or operational issues and cannot deliver key hardware components on time, C1 cannot complete installation. Because installation is incomplete, C1 cannot invoice the Jaguars and, thus, cannot collect cash. The $10mm remains in the backlog as it represents contracted demand, but not realized revenue or cash received.

During this delay period, ConvergeOne still incurred labor costs, interest expenses on $1.6bn of floating-rate debt, and overhead costs. Engineers may have already spent time designing and partially implementing the system. Now, after several months of delay, the Jaguars have a decision to make. If the delay appears temporary and Avaya’s issues seem operational rather than existential, they may simply wait. In that case, ConvergeOne eventually completes installation, invoices the Jaguars, and the cash arrives late (reinforcing the longer cash cycle). That scenario hurts timing and C1’s current top-line. However, if Avaya’s issues escalate (i.e., the OEM enters bankruptcy, raises pricing, or loses credibility in the market) then the Jaguars may hesitate to proceed. At this point, the Jaguars might renegotiate the contract, shorten the duration, reduce the scope of implementation, or even ask to pivot the solution to Cisco or Microsoft instead. In extreme cases, the Jaguars might consider switching to a different integrator entirely, and C1 would lose an enterprise customer.

By the end of 2022, liquidity declined by $43mm from $165mm in 2021 to $122mm in 2022, with a small cash balance of $22mm. The remaining $100mm of liquidity came from its $250mm revolver, which is probably an overstatement given C1 was highly likely to approach covenant thresholds at an 8.0-10.0x total debt to EBITDA ratio on its revolver that would significantly constrain the remaining draw if covenants were breached. As a reminder, the post-LBO bolt-on acquisitions from 2019-2022 occurred simultaneously with the vendor concentration concerns, compounding C1’s cash strain. [8]

To make things worse, Avaya filed for bankruptcy in early 2023. This did not permanently eliminate demand, but the restructuring created uncertainty around Avaya’s long-term operational viability and financial stability. As a result, customers increasingly evaluated alternative OEM platforms over time, which created friction. Consequently, customers shortened contract terms (from 3 years to 1 year), delayed renewals, and professional services tied to Avaya collaboration systems declined. As renewal rates softened and Avaya’s products tied to C1’s sales declined, professional services (expansion projects, platform upgrades) tied to existing contracts fell even faster because customers hesitate to expand a vendor in bankruptcy. [9]