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Tech firms get urge to merge

June 15, 2003

Tech firms get urge to merge

Sam Zuckerman, Chronicle Economics Writer

Sunday, June 15, 2003

Oracle chief executive Larry Ellison might not be the only big-game hunter in Silicon Valley these days.

Now that the technology sector has finally found firmer ground after a three-year slide, a pack of other valley chieftains is on the prowl, looking to bag their rivals, analysts and executives say.

Technology merger and acquisition activity, at a low ebb the past few years,

is poised to heat up, they say. And Oracle's $5.1 billion hostile bid for rival software maker PeopleSoft could just be the match that lights the takeover fire.

"The market window is open again for mergers and acquisitions," said Tom St.

Dennis, chief executive of Alameda's Wind River Systems, which makes software embedded in a wide range of devices. "As the industry emerges from the downturn, I don't think there is any question that you're going to see consolidation."

Throughout its history, the tech sector has seen repeated waves of mergers. There once were, after all, more than 50 computer-makers, including such memory-lane names as Kaypro and Packard-Bell. Almost all of them folded or were swallowed by competitors.

"Technology has always been a business where winners kill the losers," said Tim Dattels, retired manager of the Menlo Park office of the investment bank Goldman Sachs.

But the hard times of the past few years produced a deal drought, with a few notable exceptions, such as Hewlett-Packard's takeover of rival computer- maker Compaq.

The number of tech sector mergers and acquisitions dropped from 3,063 with total value of $363.7 billion in 2000 to 1,421 worth only $35.2 billion last year, according to Thomson Financial. Activity continued to drop this year, with only 536 transactions worth $17 billion announced to date.

Despite the low numbers of the past few months, analysts say the merger market is stirring behind the scenes. For many of them, the signal of a market pickup came not from Oracle and PeopleSoft, but late last year when IBM agreed to buy Cupertino's Rational Software for $2.1 billion.

For the year and a half prior to that, most acquisitions had been been opportunistic takeovers of distressed companies at bargain-basement prices. But IBM paid roughly 30 percent above Rational's stock market value, a healthy premium.

"I mark that one as the turning point," said Ken Marlin, managing partner of the New York boutique investment bank Marlin & Associates. "It showed that there were people in the market willing to do strategic deals and pay reasonable multiples."

Oracle has initially offered only a tiny 6 percent premium to PeopleSoft's market value. Most observers believe it would take a lot higher price to get a deal done.

Whether or not Oracle nabs PeopleSoft, the drama of a high-profile hostile takeover bid has electrified Silicon Valley, putting pressure on other players to consider merger options.

The move came just a few days after handheld computer-maker Palm of Milpitas agreed to buy Mountain View's Handspring in a stock deal valued at $195 million. And last week, Sunnyvale business software maker Mercury Interactive said it was purchasing Kintana, a maker of technology project management software, for $225 million.

"It's a little like chess. Once somebody makes a move, you have to make your own move," said Bill Burnham, managing director of Mobius Venture Capital in Palo Alto. "It's like, 'Maybe my competitor knows something I don't know.' "

Investment bankers say the logical buyers are the tech sector's largest players that have remained profitable and amassed huge cash hoards, including IBM, Intel, Oracle, Microsoft and Hewlett-Packard.

One company that has been the subject of takeover talk is Sun Microsystems. The Santa Clara maker of server computers has been walloped by the slump in corporate technology spending, but has one of the best brand names in Silicon Valley. The company has declined to comment.

Other attractive targets are well-run companies that have commanding positions in important market niches. According to Marlin, that might include such high-profile players as San Mateo's Siebel Systems, the leading seller of customer relationship management software; EMC, the Massachusetts maker of data storage systems; and Sunnyvale's Hyperion, which makes business performance software.

For its part, EMC has said it intends to do acquisitions itself to make software sales a bigger part of its business, a spokeswoman said. A Siebel spokesman referred to Chairman Tom Siebel's recent statement that the company is more likely to be a buyer than a seller. A spokesman for Hyperion declined to comment.

What's paved the way for more deal-making can be summed up in one word: stability.

When company sales and stock prices were falling on a weekly basis, no one knew how much to pay for an acquisition. "Companies and directors had no sense of what valuations should be," said Dan Warmenhoven, chief executive of Sunnyvale's Network Appliance, a maker of data storage products.

Specifically, buyers were afraid that if they picked up another company, it would be worth much less in the future. That's a lesson Time Warner learned the hard way when it had to write down the value of America Online by tens of billions of dollars last year. There are hundreds of similar but smaller examples.

Sellers got cold feet because they simply couldn't accept that their companies were no longer worth the giant pot of money they had dreamed about. It was the corporate equivalent of tech stock investors who swooned when they opened their brokerage statements and realized how much money they had lost.

"It was like, 'My friend sold his business for 3 gazillion dollars and I ought to get at least 2 gazillion,' " Marlin said.

Sybase, the Dublin maker of business software, has been an active acquirer in the past few years. Most recently it bought AvantGo, a Hayward maker of business software, for about $39 million.

"Companies like ourselves would like to pick up reasonable deals," chief executive John Chen said.

But, until recently, some of Sybase's potential takeover targets wanted too much money. "Companies had the unbelievable view that Nasdaq was going to bounce back and they would be worth millions again," Chen said.

Now, sales of a wide range of computer hardware and software are rising again modestly. Tech stock prices have rebounded significantly. No one expects a return of boom times, but at least the direction is up.

"Most of us feel that we are definitely near to the bottom, if we have not already found it," Chen said.

It was almost as if a tornado hit and corporate managers are now coming out of their basements to size up the damage. What they are finding is a business climate light years away from that of the late 1990s.

While the market has stabilized, demand remains relatively weak, especially by the tech sector's go-go standards. Sales growth is projected in the single digits for most tech subsectors. The prices tech firms can get for their products are low and profit margins are squeezed.

"Everybody is getting used to the notion that we are looking at fairly slow growth," Warmenhoven said."

Hundreds of new ventures were created during the 1990s. Now there isn't enough business to go around.

"There are too many independent companies, given market conditions," Warmenhoven said. "A lot of the companies created in the late 1990s are not capable of reaching critical mass."

In such an environment, companies naturally look for partners. "This is a time when the strong pick up the weak," said Steve Shevick, chief financial officer of Mountain View's Synopsys, a maker of design software for the electronics industry.

For stronger companies, consuming a competitor is one of the only ways to expand rapidly. If executed skillfully, acquisitions help the bottom line by extending product lines and providing economies of scale. The cost, of course, is lost jobs as duplicate functions are eliminated.

Meanwhile, the prospect of a tech recovery and the rapid run up of stock prices encourage buyers to pull the trigger soon before the prices of target companies rise too high.

"Once it looked as if there was a glimmer of hope in the economy, buyers that had been on the sidelines started saying, 'I'd better go out and do something,' " Burnham said. "It's like they are afraid the Memorial Day weekend sale might be over."

At the same time, slow-growth conditions are forcing weaker companies to shed their illusions of grandeur.

The most desperate are the smaller players that got venture capital a few years ago but have failed to achieve a positive cash flow. Their only option is to sell out, provided they have products or services that would be commercially viable in the hands of a larger company.

"You have people literally up against the wall thinking merge or perish," Shevick said. "The threat of execution focuses the mind."

But even companies that are profitable and have plenty of cash are feeling the heat.

In sector after sector of technology, mid-tier companies are losing ground to larger rivals. Big corporate customers are trimming the number of hardware and software suppliers they do business with, eroding the market positions of all but the most dominant players.

"Companies are tired of the complexity of dealing with hundreds of different vendors," said M.R. Rangaswami, co-founder of the consulting firm Sand Hill Group.

As a result, he said, "The stage has been set for consolidation. The old model of growth can't be re-created. For mid-tier companies, either they buy or get bought."

 


E-mail Sam Zuckerman at szuckerman@sfchronicle.com.

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