Win or Lose, Oracle Bid for PeopleSoft Could Revamp the Software Sector

While Oracle Corp.’s $6.2 billion hostile bid to buy business software vendor PeopleSoft Inc. promised to be a three-ring circus for some time, technology experts say that the fallout from the high-profile battle is likely to determine the shape of future deals in the sector, and perhaps the landscape of the sector itself. Prospects are, they say, that Oracle, win or lose, has become a forerunner of consolidation in the industry, much of which could be executed through hostile bidding. “This is the first major hostile acquisition in software since IBM bought Lotus,” says Laurie Orloff, a software analyst at Forrester Research. She points out that unlike the way International Business Machines Corp. and Lotus Corp. brought together complementary businesses, Oracle and PeopleSoft have overlapping product lines. In fact, that provided fuel for added hostility when Oracle CEO Larry Ellison initially said that his company would not maintain or support PeopleSoft products if the buyout succeeded. Subsequent statements by Oracle, best noted for database management software, have backpedaled from this stance, but Orloff says that the remark stung PeopleSoft customers. She notes that Oracle is trying to buy a customer base, and in her estimation those customers have been seriously alienated by the acquisition process. “PeopleSoft has 5,100 customers, most of whom chose it after a bake-off that included Oracle’s products, so Oracle’s statement about not supporting PeopleSoft products is sure to raise their hackles.” Breaking the taboo against hostility Whether Oracle’s bid will open the door to more hostile deals in the software industry is the subject of speculation spawned by Oracle’s move on PeopleSoft. “I’m 90% sure that Oracle’s bid will break the taboo against hostile bids for software companies,” states Richard Davis, an analyst at Needham & Co. If the Oracle hostile bid succeeds, it would increase its clout in enterprise applications. Oracle’s first offer for PeopleSoft was $5.1 billion. The bid subsequently was raised to $6.3 billion after complaints that the original offer was too low and contained a tiny premium. Davis says that in the two-plus years since the “tech bubble” burst, working conditions for software developers have changed substantially. The big hitch in launching hostile takeovers was the fear that developers and other critical intellectual property workers would take a hike if they disliked incoming management. That kind of exodus isn’t as likely now, Davis adds, because software has become more modular. This means that individual developers are less vital to the creation and upgrading of products. In addition, an increasing amount of software development is being done abroad. Both developments lessen the clout of developers. However, Pat Mason, a software analyst at Pacific Growth Equities, projects that hostile takeovers won’t ever be commonplace in software. “The integration is too daunting,” he says. The chain of events that led to Oracle’s bid for PeopleSoft kicked off with the announcement of PeopleSoft’s plan to buy competitor J.D. Edwards Inc. Mason notes that Oracle will have to swallow both PeopleSoft and J.D. Edwards, assuming that the two firms ultimately combine. This would double the already tricky integration process that companies face in the aftermath of a successful hostile deal. As a result, Mason expects to see Ellison walk away from the bid. But regardless of how the battle for PeopleSoft turns out, the contest seems likely to set off a new round of consolidation among smaller enterprise application software companies. In fact, the sector is flashing some classic signs of a consolidating industry. Davis says he’s sure that people in the sector will be talking to each other about potential combinations during the next few months. He reasons that because the enterprise applications sector has been flat for two-and-a half years, a lot of underfunded players are just scraping by. Another deals driver is the lack of corporate spending on software that the industry has seen since 2000, according to Orloff. She points to sub-sectors such as business intelligence, analytics, financial services software, and supply chain management as the areas that will see more concentration because of market conditions. Mike Barnacle, an analyst at Pacific Crest Securities, notes that all of the smaller, best-of-breed applications providers will be open to consolidation in the wake of the m&a activity among the industry’s major players. He mentions companies such as i2, a provider of supply chain management software, Brio Software Inc., a maker of a suite of business intelligence tools, and Hyperion Solutions Corp., a producer of business management tools as second-tier providers that could be prominent targets. In fact, the day after the announcement of the PeopleSoft bid for J.D. Edwards, an investment group consisting of Cerberus Capital Management and General Atlantic Partners bought Baan NV, a provider of enterprise application software for industrial enterprises. Over the next several months the consortium, which also owns SSA Global Technologies, intends to combine Baan with SSA, which provides enterprise solutions for process manufacturing, discrete manufacturing, consumer, services, and public companies worldwide. Among the larger software companies, industry leader SAP AG was seen as a likely beneficiary of the turmoil caused by a prolonged battle between Oracle and PeopleSoft. “The uncertainty for PeopleSoft and J.D. Edwards customers will help SAP maintain and attract new users,” Barnacle says. Even if the Oracle acquisition of PeopleSoft goes through, he adds, SAP still will control 35% of the market. “It won’t matter to them that the No. 2 and No. 3 providers have combined,” he states. Another beneficiary of the industry’s realignment could be Salesforce.com, which makes customer relationship management (CRM) software. It would complement some of J.D. Edwards’ products in the sector, Orloff notes. Its particular niche is CRM software that runs the applications for the customer without installing it at the customer’s site. “If PeopleSoft can’t complete the acquisition of J.D. Edwards, it would make a lot of strategic sense for a company like Edwards to acquire Salesforce.com,” she says. Another underlying factor that could drive consolidation in the second tier of enterprise software is the need for companies to have alternatives to their primary suppliers of software. “A lot of corporations don’t want to have to rely on a single vendor for pieces of mission-critical software so it is in their interest that the smaller firms survive. One way for them to survive is to combine with producers of complementary products,” Mason remarks. That offers the prospect of more diverse companies offering multiple lines to the same customer base. Antitrust action as a potential chiller Technology experts say that one possible roadblock to consolidation in enterprise resource planning software would be a thumbs-down verdict from the U.S. government on the Oracle/PeopleSoft deal. Antitrust expert Steven Newborn, a partner at the Washington, D.C., office of Clifford Chance, says that if the Department of Justice defines enterprise resource planning as a narrow market rather a part of the broader software industry, it is hard to see the agency approving Oracle/PeopleSoft. He adds that in any antitrust proceeding market definition is crucial and difficult to predict. However, if the government decides that SAP is the No. 1 provider with Oracle at No. 2 and PeopleSoft in third place, it is unlikely that the deal would pass muster. In addition to killing off the Oracle bid, experts say, an antitrust division rejection would discourage consolidation among smaller players. “The thing that could stop a lot of deals is if PeopleSoft were successful in persuading the government to kill the deal on antitrust grounds,” Davis says. But if the merger gets past regulators, Davis adds, he sees the deal as a healthy thing for the industry. “If Oracle wins the battle for PeopleSoft, it will put more money in development, which should result in better products,” he states. An alternate road for Oracle However, if Oracle does not complete the PeopleSoft acquisition, Davis says it might be well served to pursue an alternate path – that of getting out of applications altogether. His thesis holds that if it can’t get PeopleSoft, Oracle should aim to become the dominant player in software infrastructure by buying a company like BEA Systems Inc. or Tibco Software Inc. This would allow Oracle to stop competing with their customers. SAP, for instance, runs its enterprise resource planning applications in some cases on top of Oracle databases. That, of course, would represent an abrupt change of strategic direction. But as the launch of the Oracle bid proves, the industry has come to expect the unexpected from the mercurial Ellison. Copyright 2003 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com