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'Big Bang' Software Mergers

Already this year 11 public software companies have been acquired, with Netegrity becoming the latest victim when it announced last week that it was going to be acquired by Computer Associates. While this year’s acquisitions have each been interesting in their own way, there have still not been any “big bang” acquisitions that involve true household names or seriously threaten to disrupt the existing status quo in the software industry.

With that in mind, in an effort to stir the pot I have put together a list of what I consider to be a few of the most strategically plausible “big bang” acquisitions that have yet to happen. I have no idea if any of these deals will actually come to fruition, but in each case there are compelling business and financial reasons that suggest there’s at least a small chance they may actually happen.

Deal #1: HP acquires BEA
HP Rational: In 2002 HP made a humiliating exit app server market when it decided to shut down its BlueStone app server group (which it had purchased for $470M just a couple years earlier). At the time, HP appeared to believe that the app server market and the infrastructure market in general would remain relatively fragmented and that customers would be willing to buy services from HP to help them stitch together “best of breed” solutions from multiple vendors. Since that time however, IBM, SAP, Oracle, and Microsoft have all not only dramatically improved their app servers, but have embarked on strategies to integrate their app servers with not just other middle ware products, but with infrastructure monitoring tools and development tools. These integrated software “stacks” are making it much more compelling for customers to choose a single software stack from one vendor rather than try to piece together several “best of breed” products. If HP does not develop its own integrated stack it risks further marginalization of its software business and an inevitable decline in its OpenView franchise. With the addition of BEA, HP would not only get an app server that has about 50% of the market (but is losing ground to IBM), but it would also get a good stable of complimentary infrastructure products such as portal and EAI products. Equipped with a robust middleware stack, HP will thus be able to better leverage its strong network and operations management product lines. Luckily for HP, it has been “dating” BEA for awhile. The two firms struck up a strategic partnership to sell WebLogic following the Bluestone disaster and by most accounts this partnership has been a reasonable success. With HP’s $58BN market cap, it can easily afford to pay a reasonable premium above BEA’s $2.6BN enterprise value and still make the numbers work. For just 5% of the company, HP has the opportunity that in one fell swoop takes it from “also ran” to “serious contender” in the enterprise software space. It’s a no-brainer.

BEA Rational: Five years ago BEA looked like it might take over the world. As the #1 enterprise app server vendor, BEA sat atop a rapidly growing market with little competition from established vendors and a market cap of $30BN+. That all quickly changed though in the ensuing years as most of the major enterprise software vendors, including IBM, Oracle, SAP and Microsoft developed their own app servers and began to drive them through their formidable sales and marketing channels. By most estimates, IBM is now the #1 vendor of app servers in the enterprise market and appears to be gaining steam. Oracle and Microsoft are also methodically improving their products and leveraging integration points with their established platforms to win converts. BEA now finds itself in the unenviable position of having to wage a tactical sales and marketing battle against the biggest (and many would say the best) software sales and marketing organizations in the world. What’s more, these gorillas can not only amortize their sales and marketing expenses across broader product lines, but each company also has highly profitable core businesses that can support massive “investment” in the app server space thus driving down prices and raising marketing costs. In addition, open source solutions, such as JBoss and TomCat are rapidly being adopted by many of BEA’s core Dot Com customers. Clearly BEA’s employees appreciate their dilemma, with several high profile BEA executives recently hitting the exits, including their CTO and head of sales. With its stock price down 40% this year, the market also clearly senses a problem. A merger with HP would give BEA the sales and marketing heft it needs to compete with the big boys overnight. It would also give BEA access to HP’s management and monitoring franchise creating a true “stack” that would rival the best that any competitor could throw at it. While BEA may feel that it would be selling at a “depressed” price if it sold now, it can count on a real depression if its app server market share keeps slipping and if customers keep defecting to rivals or open source solutions. They can’t make this deal fast enough.

Deal #2: IBM Acquires Sun Microsystems
IBM Rational: IBM’s software group has “bet the farm” on the viability of Java and J2EE software stack. Both of these technologies just happen to be owned and still marginally controlled by Sun Microsystems, a company which increasingly appears as though it may wander of a cliff. IBM simply can not afford to have Java impaired by a sick and/or clueless Sun Microsystems. Keeping Java healthy by itself probably doesn’t justify acquiring the mess that is now Sun, but there are other parts of Sun that clearly fit well with IBM and play to its strengths. For example, IBM has perfected the art of profitably and happily maintaining legacy customer bases while constantly selling them select upgrades to new technologies. In this way, IBM is ideally suited to take on the task of managing Sun’s SPAR/Solaris customer base and figuring out ways to keep them happy, paying, profitable, customers. On the semi-conductor front, IBM has the scale and experience to figure out what to do with SPARC and to make sure that it pays its own way. It may even be able to figure out a graceful way to simply transition the whole SPAR/Solaris line to its POWER/Linux line. More important than bits and chips though, IBM knows what to do with Sun’s customer base. Not only will these customers likely be happy to have IBM take over the reigns (and establish some much needed stability), but IBM will be able to sell these customers a far broader array of software and services than Sun currently can. Finally, if IBM controls Sun, it will also control the platform currently running a large % of Oracle’s licenses giving it some real leverage over its bitter enemy. With time and some integration, many of these customers may likely see the light and migrate to DB2. With an enterprise value of just over $8BN (and $5BN in free cash) BEA would cost IBM just 5% of its equity. In return IBM would get complete control over Java (and coverage under Sun’s deal with MSFT), a large legacy customer base to milk, and the ability to grab Oracle by the balls and apply lots of pressure. What’s not to like?

Sun’s Rational: With revenues down almost 40% from 2001 and increasing price competition against its core server franchise from inexpensive Linux boxes, Sun finds itself in a classic fixed cost death spiral. The three pillars of Sun’s competitive differentiation, SPARC, Solaris, and Java, each require a huge amount of fixed investment to maintain. As revenues decline, there simply isn’t enough gross margin to support these expensive “loss leading” pillars. Underinvestment inevitably follows which ultimately undermines the entire foundation leading, at some point in the near future, to an inevitable and spectacular collapse. While Sun is desperately fighting a rear guard action against Linux in attempt to stem the tide while it figures out a graceful way to transition its business, no matter what path it chooses it faces major corporate surgery which is inherently risky and potentially fatal. By merging with IBM, it gets a partner that has already figured out a graceful way to make the transition from proprietary systems to the new world of Open Source and commodity CPUs. It also gets a partner that has the revenue scale to continue supporting Java and the elements of Solaris that drive true competitive advantage. Without a partner like IBM, Sun faces an uncertain future at best and may well end up like many of the mini-computer companies it once made fun of.

Deal #3: Intuit Acquires McAfee
Intuit Rationale: Intuit has been on an aggressive expansion drive outside of its core finance software space in an effort to diversify its revenue base and leverage its strong distribution channels and customer base. Subscription security services/software represents probably the biggest, most attractive and fast growing SMB-focused PC software segment. It’s also a segment in which Intuit has basically no presence. While anti-virus software may seem a stretch for Intuit, it actually plays nicely to their strengths. Intuit has strong relationships with PCs OEM and a long history of deals with them. It also has very strong retail software distribution channels. Intuit will be able to leverage not just these relationships but its established customer base to aggressively push security software/services to its customer base. Indeed, Intuit would present Symantec with a far more formidable competitor than an independent McAfee. As an added benefit, McAfee likely touches a large number of customers that Intuit does not, thus expanding its market reach considerably. In addition, with McAfee’s enterprise security and network management products now spun off into Network General, McAfee represents a much cleaner “plug and play” fit than before. While McAfee would cost 28% of the company, it would increase revenues by over 50%. INTU could also probably take out a lot of overlapping distribution costs which would probably make the deal accretive even before you figure in revenue synergies. For Intuit, this gives it the mass and breadth it needs to continue fending off the hordes from Mt. Redmond. Go big or stay home.

McAfee Rationale: Free of its enterprise products, McAfee is now able to firmly focus on the consumer and SMB security markets. While this focus is no doubt liberating, it also should squarely confront McAfee with two chilling facts: 1. It is half the size of its major competitor, SYMC, and at a distinct disadvantage to SYMC in terms of channel presence and product depth. 2. If faces the very real possibility of Microsoft moving into the anti-virus market within the next couple years. In the personal finance market, Microsoft’s move into the market set off a huge price war and while the #1 independent player (Intuit) ultimately survived the battle, all of the other competitors were wiped out. A merger with Intuit addresses both issues simultaneously. On the Symantec front, it results in an immediate flip-flop where suddenly its Symantec trying to play catch up to a much larger Intuit that is able to offer OEM partners and retail distributors a wider range of products and services. On the Microsoft front, McAfee gets to fight the battle under the banner of Intuit, one of the few (perhaps the only) PC software vendors that have successfully withstood everything Microsoft has to throw at it and lived to tell the tale. Ultimately, McAfee’s shareholders get to swap a relatively risky bet on the #2 “pure play” software security player for a much more stable and attractive bet on the undisputed #1 non-Microsoft player in the PC Consumer/SMB market.

Deal #4:IBM Acquires Peoplesoft
IBM Rational: While IBM has repeatedly sworn it is not going to get into the applications business, competitive developments are forcing its hand. Not only does Oracle’s bid for PeopleSoft threaten to consolidate a fair amount of the ERP business on an arch rival’s platform, but SAP’s movement down the stack with Netweaver threatens to displace a lot of IBM middleware currently underpinning SAP installations. IBM’s recent partnership deal with Peoplesoft confirms this line of reasoning. Staying out of the applications business made sense when the major ERP players did not compete with IBM’s middleware offerings, but now that they do IBM is almost forced to respond. While getting their other application partners to accept a move into the ERP business will be a tough sell, the truth is that these application vendors have no where else to go as the other major infrastructure providers are also in the apps business. If they play their cards right, IBM gets cast as the reluctant white night. In return they get a well regarded ERP suite that they push through their massive sales and marketing channels. They also get to deprive Oracle of its attempted market share grab. In addition, they get an application platform that generates a tremendous amount of services for IGS. Even at its current take-over inflated valuation of $7.7BN, PSFT would require just 5% of IBM and IBM could likely get a better deal than ORCL due to its white night status.

PeopleSoft Rational: While they have done a good job enduring the Oracle siege, their defenses are gradually giving way. With their CEO now a casualty of War they are now leaderless at the height of the battle. Even if they survive the battle, they have shown themselves to be weak and questions about their viability have been planted in the minds of both existing customers and prospects. IBM offers Peoplesoft a fantastic way out. Unlike Oracle, IBM has no overlapping products, so the Peoplesoft organization and products would continue to exist after the deal. As the #1 enterprise software vendor, IBM would be able to fight mano-y-mano with both Oracle and SAP. Overnight, Peoplesoft would go from independent underdog to odds-on favorite in the ERP war.

October 14, 2004 | Permalink


Legal Disclaimer

The thoughts and opinions on this blog are mine and mine alone and not affiliated in any way with Inductive Capital LP, San Andreas Capital LLC, or any other company I am involved with. Nothing written in this blog should be considered investment, tax, legal,financial or any other kind of advice. These writings, misinformed as they may be, are just my personal opinions.