Want a sure bet? How about this: There will be plenty of vitriol aimed at Oracle (NASDAQ:ORCL) CEO Larry Ellison during today's annual meeting of PeopleSoft (NASDAQ:PSFT) shareholders.
Now that the Justice Department has sued to block any potential merger between the two, the chances of "OracleSoft" coming to life look slim. Not many observers appear too broken up over Ellison losing his grip on PeopleSoft. Given his pugnacious reputation, that's understandable.
But as I wrote last month, Oracle's fight with the Feds serves a purpose beyond feeding Ellison's desire for victory. Indeed, the case should force clarity in U.S. antitrust and merger standards. That would be a good result, no matter who wins the suit. But it's also not enough. In sifting through the hyperbole, it seems we've forgotten to ask that most basic of questions regarding this merger: Is a combined Oracle-PeopleSoft good for shareholders?
No longer. Ride along, dear Fool, as we rewind history, review some numbers, and take a look at what Oracle and PeopleSoft could be together.
Vinyl records, Atari, and databases
To understand Oracle's plight, and the business reasons behind its bid for PeopleSoft, it may help to rewind the clock. So, hike up that tab collar, pull out a couple of vinyl records, and fire up the Atari (NASDAQ:ATAR) 2600, we're sashaying on back to the '70s, baby.
Oracle was founded in Silicon Valley in 1977. Its databases were designed to take advantage of an innovation called the relational data model, created by EF Codd earlier in the decade. Relational databases allowed information to be stored in easily organized columns and rows.
Fast-forward to now. While still built on that groovy relational technology, today's Oracle databases are far more sophisticated than their disco-era ancestors. And with the Web and e-commerce, they have become more important than ever.
That being said, database technology is no go-go growth market. Industry researcher Gartner Group (NYSE:IT) says growth in the $8.55 billion database market will slow to an average of 4.3% annually from 2002 to 2007, down from a recent high of 18% in 1999. Oracle's recently reported fiscal third-quarter results bear witness to this prediction.
Oracle derived 75% of its $9.9 billion in revenue for the trailing 12 months from database technology. Impressive, right? Sure, but consider the context: 46% of database-driven sales came from maintenance fees such as license renewals, upgrades, and support. Professional services accounted for another 17%. That's likely because most firms already have a version of Oracle's database or something comparable from rivals IBM (NYSE:IBM) and Microsoft (NASDAQ:MSFT).
No wonder Ellison is chasing acquisitions. Robust organic growth may simply be out of Oracle's reach, which is what makes targeting PeopleSoft appear somewhat bizarre.
The joy of maintaining the status quo
Founded in 1987, PeopleSoft began by selling software for managing human resources. It has since become the world's second-largest maker of software for overseeing other business functions such as accounting, manufacturing, and purchasing, trailing only Germany's SAP (NYSE:SAP). Oracle, too, sells such software, often called enterprise resource planning, or ERP, suites.
An acquisition of PeopleSoft would bolster Oracle's offerings and, as the DOJ points out in its lawsuit, create a two-horse race in the business applications market.
But that's hardly the whole story. In fact, it gets very interesting once you take a close peek at the numbers. According to Forrester Research (NASDAQ:FORR) analysts interviewed for this story, ERP is on the downswing, with total annual license revenue in 2003 down to $5.4 billion, a full 10% drop from the market's 2000 peak of $6 billion. PeopleSoft and Oracle both have diversified into other higher-growth software-driven functions such as managing supply chains to offset the ERP downtrend.
Still, PeopleSoft's financials are strikingly similar to Oracle's, with sales of new software dwarfed by maintenance fees. New licenses accounted for 24% of PeopleSoft's total revenue during 2003, down from 27% the year before. Like Oracle, PeopleSoft is competing in a mature market. So is Ellison crazy? Are the conspiracy theories that say Ellison wants PeopleSoft because he is bent on destroying it true? Maybe. Or maybe Ellison is just crazy like a fox.
Even though its core market is rapidly maturing, PeopleSoft has a major growth engine in maintenance revenue. Check the numbers. During 2003, support fees accounted for $904 million, up 29% from 2002's $703 million. PeopleSoft executives have said they expect maintenance contracts to generate close to $1.2 billion for 2004. That would be another33% gain.
Oracle, too, is seeing big growth in support revenue, recording average sequential growth of 7% since the beginning of fiscal 2004. At that rate, Oracle could generate nearly $4.6 billion in maintenance-related sales this year, most of which would come from database customers.
Now mix together each firm's support business and you'll see the potential genius. For 2004, "OracleSoft" could book $5.8 billion just on maintaining the software status quo for customers. Were that business to continue growing at 20% annually, the support alone would annually account for more than $10 billion in sales in less than three years. Imagine the possibilities if Oracle continues to pull more than 20% of revenues into its coffers as free cash flow. Maybe the $9.4 billion price tag for PeopleSoft isn't that steep after all.
The Foolish bottom line
OK, back to reality. It is incredibly unlikely that the Feds will let Oracle go through with its bid for PeopleSoft. And even if they did, regulatory bodies for the European Union and Australia have already expressed concerns. Then there's PeopleSoft's customer assurance program, which would add roughly $1.5 billion to the acquisition cost by guaranteeing reimbursements to customers should there be a change in ownership. At that price, a victory starts to look Pyrrhic.
Fortunately, these setbacks are unlikely to diminish Ellison's appetite for acquisitions. He appears to know that Oracle must to do something, and soon. His shopping list could include any number of companies, but now that we have a better idea of what he could be looking for, we may be able to narrow the field. Certainly BEA Systems (NASDAQ:BEAS) with its popular, high-margin infrastructure software still qualifies. So, too, could mid-market business applications maker Lawson Software (NASDAQ:LWSN) or privately held customer relationship management software providers Salesforce.com and NetSuite. But I'm no merger prognosticator. I'll leave that job to the talented Fools at the Oracle discussion board, including exoracle and zoningfool, whose informative posts made important contributions to this story.
Besides, I'm still having fun enjoying the sound of OracleSoft.
Fool contributor Tim Beyers has decided he's done with mergers. He'll keep his wife of six years, thanks. Tim has no stake in any of the companies mentioned, and you can view his Fool profile here. The Motley Fool has a disclosure policy.
