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IBM Files Another Big Deal

Like other enterprise-software companies, FileNet (Nasdaq: FILE  ) has had a static stock price over the past couple years. But things changed abruptly over the past few weeks as buyout rumors propelled the price from $25 to $35. The Street's hunch was right -- IBM (NYSE: IBM  ) announced on Thursday that it will shell out $1.6 billion for the company. It's likely not an isolated event, so expect the dealmaking to continue.

Founded in 1982, FileNet develops software to help companies manage "unstructured content," which includes things such as Web pages, spreadsheets, PDFs, images, emails, and word-processing documents.

Having built a full-featured content management system to deal with the proliferation of unstructured content, FileNet has created many advantages for its customers, including increased efficiencies; analytical tools; integration with industry-standard applications, such as from Microsoft (Nasdaq: MSFT  ) , Oracle (Nasdaq: ORCL  ) , and IBM; and better compliance, such as with Sarbanes-Oxley requirements. The company has more than 4,000 customers.

In the second quarter, FileNet posted revenues of $117.1 million, up from last year's $104.6 million. Because of its reliable maintenance income and new licenses, the company generates significant amounts of cash flow. The cash balance increased from $392 million at the end of 2005 to $451.8 million by the end of June.

Software is a critical part of the IBM business model -- it accounted for $15.7 billion of its revenues last year and has pre-tax margins of 27%, much better than its services business, which has pre-tax margins of 9%. To keep growing the software business, IBM realizes that content management is a must-have, and FileNet is certainly a good choice to meet that need.

But FileNet would also be a good choice for IBM's fierce competitors, such as Oracle, Microsoft, and Hewlett-Packard (NYSE: HPQ  ) . These companies would not be reluctant to pay premium dollars to snag a company, nor are they afraid get hostile. In other words, we could see a bidding war for FileNet.

In the meantime, given the difficulty of building solutions and meeting customer needs, it makes sense that some of the other attractive content-management companies out there -- including Interwoven (Nasdaq: IWOV  ) , Vignette (Nasdaq: VIGN  ) , and Stellent -- could become potential buyout targets, too.

I talked with Reid Conrad, the CEO of Web-based content-management firm Near-Time, about the current atmosphere in the sector. "Over the past five years, consolidation in the software industry has been driven by vendors of structured business applications," he told me. "With this [FileNet] deal, the unstructured space is in play. Driving the sector are new approaches that bring collaboration, content, and knowledge management together."

Does this mean investors should buy Interwoven, Vignette, and Stellent, or even pick up some FileNet? Not necessarily. Speculating on takeovers is really a game for the pros, who can constantly monitor the players and afford to take quick losses.

What about buying IBM? While it is filling a gap in its product offering, FileNet is not big enough to move the needle of this massive company. Keep in mind that it has revenues in excess of $90 billion.

However, you may want to consider Fool colleague Brendan Mathews' contention that IBM does have world-class assets that are trading at values discounted to those of its competitors. What is critical is that Big Blue continues to build its software business, which not only provides higher margins but also brings more value to its services business. The fact that management has spent more than $2 billion in the past couple of weeks on software deals shows that the company is certainly willing to make the moves to protect its software franchise.

Related Foolishness:

Microsoft is aMotley Fool Inside Valuerecommendation. To read about more great stocks trading at a discount, try out Inside Value with a free, no-risk trial subscription.

Fool contributor Tom Taulli does not own shares of companies mentioned in this article.

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