Burnham's Beat

Shotgun Wedding: Is Symantec Afraid of Microsoft's Baby?

The investment bankers marrying off Symantec and Veritas had better not ask Wall Street to “speak now or forever hold its peace” because they are likely to get quite an earful.  Indeed, with Symantec’s stock down almost 23% since the deal was first rumored The Street has already spoken, and from what it’s saying these two lovebirds are going to have a hard time formally exchanging vows.

Conventional wisdom holds that much of this sell-off has been driven by (mostly valid) concerns that Veritas’ relatively lower growth rates will drag down Symantec’s high flying multiple, but underneath these surface issues likely lies a more deep-seated fear that Symantec’s Cinderella story may soon be over thanks to the fact that Microsoft is finally fully pregnant with a new, security focused “baby”.  Viewed from this perspective, Symantec’s surprise merger with Veritas is a shotgun wedding that implicitly acknowledges the fact that Microsoft may shortly make the consumer and SME security software marketplaces a very bloody battlefield leaving Symantec with no choice but to “go corporate” in a hurry.

Waiting For Godot

Pundits, hedge funds, and Pollyannaish anti-trust types have long speculated that Microsoft intends to make security software one of its core business units.  At first such desires were assumed to simply be motivated by Microsoft’s insatiable appetite for growth and their Conan the Barbarian-like desire to crush their enemies, see them driven before them, and to hear the lamentations of their women.  However in the last couple years, thanks largely to Outlook and IE born viruses, Microsoft’s security software ambitions have been transformed from mere sport, into a critical business issue.  With every widely publicized e-mail virus, Microsoft’s reputation takes a heavy hit and its customers become more and more perturbed. As a result, security software has gone from a “nice to have” to a “must have” for Microsoft.

With Windows XP Service Pack 2, Microsoft took its first tentative steps in this direction, but the company realizes that the only way to fully protect its software from security threats it to deeply integrate security technology into the core of operating systems and desktop applications.  This realization set the stage for two small acquisitions by Microsoft.   The first acquisition was of a small anti-virus software maker called GeCAD in June of 2003 and the second was of a small anti-spyware company called Giant in December of 2004.

Collapse of the Confident Facade

Symantec has paid close attention to Microsoft’s moves and has gone to great pains to downplay them and insist that their anti-virus corporate accounts were not at risk even if Microsoft moved with full force into the anti-virus marketplace. Most investors have taken Symantec at its word assuming that the management team had reason to be confident and that Symantec, like Intuit, might be one of the few companies that could not only survive but thrive in the face of full fledged Microsoft assault.

Unfortunately for Symantec, actions often speak louder than words and in this vein its surprise acquisition of Veritas speaks volumes.  If Symantec was so confident that it could survive Microsoft’s antivirus onslaught, why then are they suddenly purchasing a software company growing at half their rate and operating in sectors that have little if any synergy with Symantec’s current security-focused product lines?  In fact, of all the potential companies that the street has theorized Symantec might buy (I actually had my own theory), Veritas was one of the last companies that people expected Symantec to buy.  It’s almost as if Symantec is trying to move away from its core business as far and as fast as possible.

Thus Symantec’s acquisition of Veritas is an implicit admission of two key points:  1) that Microsoft’s entry into the security software market is making that market a much less attractive incremental investment space and 2) that SYMC can’t sustain the growth rates that were, until recently, supporting its lofty PE. In this light, the 23% decline in SYMC’s stock price is not only understandable, but probably less than one might otherwise expect. If Symantec and Veritas can’t counteract these concerns and convince the Street that their merger is the result of mutual love and respect for a viable long term growth strategy, then they had better cut short their romance as shotgun weddings don’t work when the real issue is another person’s baby.

Honey I Bought The Wrong Company!

On Monday December 13^th Oracle announced that it had finally reached an agreement to acquire Peoplesoft thus ending a corporate siege reminiscent of the Roman siege of the Masada. While I suspect many at Oracle are feeling quite triumphant right now, they have a big problem: they brought the wrong company.

The Other Deal

Just two days after the Peoplesoft deal was announced, Symantec announced that it was going to buy Veritas for $13.5BN. Veritas is the market leader in backup, recovery, and high availability software and also an emerging player in the database and application management markets thanks to its acquisition of Precise in 2002. As it happens, Veritas built much of its business by selling back-up and recovery software to Oracle’s customers (much in the same way that Business Objects built its BI business).

As I have written before, Oracle’s pursuit of Peoplesoft appears to have been based on two main assumptions: 1) Oracle can generate significant scale economies and marginally increase its overall growth rate by acquiring one of its major ERP competitors. 2) Oracle’s belief that its core market, data management, is a mature, low growth space.

It’s hard to dispute assumption #1 (although with the higher price Oracle is paying the deal is inherently less accretive), however assumption #2 is likely flat out wrong. There is a relative explosion of growth and innovation going on the data management business compared to the ERP business. Whether it's unstructured data management, application management, virtualization, or disaster recovery, new opportunities for growth abound in the data management space.

Just look at Veritas. It has made data management (in a broad sense) its core business and has grown revenues 17% between 2001 and 2003 while Peoplesoft has only grown its revenues only 9.4% during the same period. Granted, Veritas isn’t exactly a growth poster child, but it would have grown much faster if it wasn’t for some sales execution and product transition issues (thus its sellout to Symantec).

Moving the Needle … In the Wrong Direction

After I wrote my last piece on Oracle, a few people who claimed to be in the know told me “Hey, Oracle knows that data management represents an attractive long term opportunity, but Oracle needs to make acquisitions that will move the needle in the short term, and there are no comparable companies in the data management space that are big enough to make a difference”.

Unfortunately that statement doesn’t hold much water when one looks at Veritas. While Peoplesoft does indeed have more revenues with $699M vs. Veritas’ $497M in Q3 04 revenues, 77% of that revenue came from low margin services revenue vs. Veritas’ 42%. Given its huge services business, it's not surprising that Peoplesoft is much less profitable than Veritas with only $40M in operating profits vs. Veritas’ $96M in Q3 04. On a trailing 12 month basis this profit differential is even worse with Peoplesoft earning only $107M in profits vs. Veritas’ $500M.

What this means is that Oracle’s $10.3BN acquisition of Peoplesoft, excluding cash, equates to about 81X times operating income while Symantec is getting Veritas for the comparative bargain of about 22X operating income. Even if Oracle can get PSFT’s operating earnings back up to $250M/year (where they were in 2002 … and 2001) that’s still 35X operating income.

When you net it all out, from even an optimistic perspective, Oracle looks to be paying about a 50%+ premium for a business that is growing about ½ the rate of Veritas and producing far less in absolute dollar profits.

Whoops!

It’s hard to look at these numbers as well as the relative long term growth opportunities in ERP vs. data management and not come to the conclusion that Oracle is truly buying the wrong company. The irony of the situation is probably not lost on Oracle’s former product head, Gary Bloom, who just happens to be CEO of Veritas. I can just imagine him sitting back in his chair, shaking his head, and laughing.

Application Management Merger Mania

The game of musical chairs in the application management space just got a bit harder today as IBM announced that it had acquired one of the leading players in the space, Cyanea. The Cyanea acquisition is just the latest deal in the space which has seen Veritas buy Precise , Mercury buy Performant , and ASF buy Dirig. Only two independent companies of note are now left in the space, Wily and Altaworks.

Houston, We Have An Application Problem
Why all the interest in application management? Because, as many companies have unpleasantly discovered, getting distributed component-based applications to work correctly is a major pain in the neck. Unlike traditional mainframe applications, distributed applications are composed of many small pieces of software. What’s more, these pieces of software are often distributed across several servers. Throw in some web services and you can have an “application” that spans multiple computers in multiple locations. This may sound cool, but when something goes wrong in such complex system even if you are a rocket scientist it’s almost impossible to figure out what code is actually “broken”.

By monitoring the inner-workings of applications, often down the method and thread level, application management programs attempt to not only figure out what, if anything is broken in a distributed application, but they also attempt to identify resource and performance problems before they end up taking an application down.

The Great Debate: Horizontal vs. Vertical
One major problem for application management software is that there are a lot of factors that can affect application performance outside of the application code itself. Even if the code is perfect, problems with other parts of the technology stack such as database resources, network performance, message brokers, etc. can still seriously affect application performance.

Given the inter-dependence of all these items, the holy grail of application management (and for that matter systems management in general) has always been to build a holistic map of all the hardware, software, and network resources associated with a particular application and to, somehow, build a management solution that can identify the actual root cause of any particular problem no matter where it lies in the stack.

Unfortunately, like most IT holy grails such as universal object libraries, consistent semantics, and stable Windows machines, the vision of a completely unified application management stack is a long way from reality.

In the interim, vendors have generally decided to focus on either horizontal or vertical management strategies. Horizontal strategies stress the importance of following a transaction “in-flight” as it flows throughout its life-cycle, no matter what platforms it may decide to travel on. To support this strategy, vendors must make their software compatible with as many application servers as possible including modern ones (such as J2EE and .NET) and legacy ones (CICS and IMS). The horizontal view is particularly important inside large companies with complex legacy systems as most of their new distributed applications must still interact regularly with legacy platforms.

Other vendors a pursuing a vertical strategy of trying to link together information from the database, network, and application layers in order to derive a view of all of the technology components that affect a particular application. This strategy is better suited to “self-contained” applications that don’t interact with legacy platforms.

The reality is that for most Global 2000 corporations, horizontal solutions are much more practical given the topographical and political realities in those organizations. Most of those companies still have lots of legacy applications and they generally have very complex IT infrastructures. This means that distributed applications not only have to play nice with other platforms, but managerial and budgetary control over IT resources is often widely dispersed throughout the organization. While it might be nice in theory to instrument all of the databases in a company with a particular application management platform, just try telling the database administrators that they are going to be forced to use the same tool as the application managers. In general, that’s just not going to happen.

Sayonara Cyanea
As it happens, Cyanea was pursuing a horizontal strategy. It had a unique “probe/repository” architecture that makes it easily extensible to multiple platforms and it was the first player in the space to support IBM’s venerable CICS and IMS mainframe “app servers”. Given this, plus IBM’s early investment and reseller relationship it’s really not surprising that IBM decided to bite the bullet and buy the rest of the company it didn’t already own.

For me personally, the acquisition wasn’t surprising because I was actually the first investor in Cyanea and had seen the IBM relationship grow in size and importance first hand. While it’s a bit bittersweet to seen one of my promising investments swallowed up by Big Blue just as it is hitting its stride, I must admit that the ample return on investment provides me with more than a little comfort.

Wither Wily?
One of the big remaining questions following the Cyanea deal is what will become of Wily. Wily was the pioneer in the space and has always been the largest player (though Cyanea was rapidly catching up to them). It’s rumored that Wily turned down a $100M buy-out offer from Mercury in early 2003 before Mercury bought Performant for $22.5M (that may just be some good underground marketing on Wily’s part though).

On the one hand, Cyanea’s sale looks like good news for Wily. Not only does it leave Wily as the only substantive independent player in the space, but it removes a competitor that was increasingly beating it in competitive bake-offs.

On the other hand, with IBM buying Cyanea and integrating it more closely into its product lines, Wily will now face all-out competition from IBM, a platform that supposedly accounts for a majority of their sales. In addition, Veritas recently signed a wide ranging partnership with BEA making Precise the recommended application management solution for WebLogic. Thus with Cyanea at IBM and Precise at BEA, Wily faces the unappetizing prospect of having to face “in-house” competition for every WebSphere and WebLogic sale. In addition, Wily’s core product architecture, which relies on code “wrapping” to instrument it, is dated and not readily extensible outside of J2EE environments.

Despite this, some have suggested an IPO is imminent, but that does not seem likely until Wily figures out a growth story beyond J2EE. Fortunately, on the M&A front there are a few large players that have yet to make a major move in the space, most notably HP, Oracle, SAP, and Sun, so Wily may yet have an opportunity to make it to the alter on time. Whatever Wily decides to do they will have to do it quickly as they are now going from a situation of being top dog to underdog against some of the strongest software sales forces in the business, which is not an appealing prospect not matter how you look at it.

Many Miles Still To Travel
For the application management space in general, the consolidation of the independent players into the major platform players, represents a logical and necessary industry evolution. While the industry is still a ways away from the holy grail of unified management it is making steady progress. Attention will now likely shift towards integrating a few other pieces of disparate infrastructure software, such as business activity management, dependency mapping tools and cluster management tools into the overall application management framework. While each step will take the industry closer to management nirvana, new technologies and corresponding challenges will undoubtedly emerge and thus push the goal further out into the future.