Day of the Big Sharks

Research firm Gartner regularly brings out their much vaunted four quadrants

where different companies are placed depending on factors ranging from their

business maturity levels to service performances. For the software sector, the

quadrant might soon lose its raison detre; it perhaps becomes meaningless to

track which companies belong where, especially if only a handful of software

vendors remain in the scene. Quibble if you want about the nitty-gritties but

one thing is clear, that software is going the way of the PC, auto, lighting

fixture, consumer goods, and other mature manufacturing industries: ruled by the

giants.

The march toward consolidation by the software industry has been in full

swing for quite a few years now2007 only saw the momentum reaching a crescendo.

Leave aside the multi-billion dollar giants; there remain very few independent

best-of-breed vendors who are holding their own. SAS, Adobe, Autodesk, Dassault,

i2 Technologies, and Ariba could count themselves among these lucky handfuls.

But how long they can maintain their independent status is the moot question.

Many analysts believe that for many of them, and even for a handful of tier-2

software vendors like CA and BMC Software, its just a matter of time. Maybe,

even 2008 could turn out to be the D-Year for many of these vendors.

When it comes to acquisitions, software dominates all technology sectors,

accounting for 40% of the $298 bn in tech M&A deals done in 2006, and half of

the $306 bn in deals in 2005, according to Thomson Financial. The runner-up:

Internet companies, which accounted for just 18% of 2006s tech M&As.

While software always has been an acquisitive industry, the deals are getting

bigger and more complex. In 2006, 1,726 software companies were acquired, the

highest number since 2000, according to investment firm Software Equity Group.

But more impressive was the size of some of those deals: HPs $4.5 bn

acquisition of Mercury Interactive, EMCs $2.1 bn purchase of RSA Security, and

IBMs acquisitions of FileNet and Internet Security Systems, both of which

exceeded $1 bn.

These deals came on the heels of Oracles big-bucks, high-profile

acquisitions of PeopleSoft, Siebel, and Retekas well as forty-one other

companiesover the past four years. IBM is not far behind, with twenty-two

notches on its belt over the same period. Microsoft has bought more than

twenty-five companies in that time, though most of them were tiny startups

acquired under the radar. 2007 proved to be an even more eventful year with top

three global BI firmsCognos, Business Objects, and Hyperiongoing under the

hammer.

Consolidation Drivers



For many analysts, the trend at consolidation in the enterprise software

industry began in right earnest following Oracles acquisition of PeopleSoft.

There have been isolated instances of mergers previously too, especially the

consolidation of a wide range of startups into more moderately-sized companies

following the dotcom bloodbath, but the Oracle-PeopleSoft alliance (accompanied

by all its hostilities) was the landmark; not just did it signal the beginning

of the consolidation frenzy, it also marked Oracle as one of the chief

protagonists in the game.

Incidentally, analysts like Jeff Nolan believe that the enterprise software

industry goes through periods of expansion followed by periods of digestion. The

expansion stage lasts 5-6 years and is marked by significant market growth and

dramatic technology transformations that create new leaders. The digestion

period lasts 5-7 years and is marked by low to moderate overall market growth, a

couple of points above GDP, and declining prices.

In this environment, in which the industry has been for almost four full

years, the scenario is ripe for vendor consolidation... declining prices in a

low growth market is not exactly an exciting condition for new entrants or weak

players. So, in effect, this period of consolidation is very predictable, and

indeed desirable. With the consolidation wave that has started for sometime now,

it looks like independent software vendors would soon become a relic of the

past.

Theories typically center on industry maturity, vendors in search of new

growth and market opportunities, or a combination of the two. Some view

consolidation as the natural progression of an aging industry, invariably

dredging up a comparison to the global auto industry. But consider that both

software suppliers and buyers have more cash to spend than in years past.

IT budgets have increased steadily since bottoming out five or six years ago,

and its universally forecast that spending on software will continue to rise

this year, as long as something unexpected does not derail the economy.

Meanwhile, software companies, which were under pressure from the bourses to

focus on profitability several years ago, have shifted back to revenue-growth

strategies to capture more of those rising IT budgets. So, they are buying

companies with technologies that either complement their own or drive their

businesses into new areas.

Another interesting trend often visible during this period of consolidation

is that many vendors want to claim the platform vendor title, and with it the

underlying assumption that in order to be a platform player you need to have

account control. Many enterprise software vendors believe that they have to own

an account in order to reap future rewards from it, so consolidation is a

natural strategy to employ in order to accomplish this goal, asserts Nolan.

Its not just about acquiring an all encompassing account, most of the big

platform vendors like IBM, SAP, and Oracle need to take over new markets as

growth in their own businessesdatabases and applicationsdries up. Buying

companies with mature products and a lot of customers gives them a fast and safe

way to do that. Oracle, with forty-one acquisitions in the last forty-five

months, has been the master of this trend. However, IBM and to a lesser extent

Microsoft and SAP too have learnt the tricks of the trade.

A host of acquisitions during the year, like Pilot Software and OutlookSoft

by SAP, Telelogic by IBM, and Agile Software by Oracle, were aimed toward this

platform expansion. And its not just software giants, even storage vendors like

EMC (acquisitions like VMware and RSA Security) and networking vendors like

Cisco (acquisition of Webex) have joined the consolidation bandwagon with an eye

on expanding their platform.

The commoditization of key software sectors, including middleware and

business intelligence, has also started driving this wave of consolidation. This

has been especially true for the business intelligence segment in 2007; this was

a domain where products that once were distinct and innovative started to look

remarkably the same. The year saw the takeovers of Hyperion by Oracle, Business

Objects by SAP, and Cognos by IBM. With these constituting three of the top four

BI vendors, it leaves SAS as the lone independent entity. Maybe the fact that

SAS is the largest privately held software vendor in the world and hence

relatively less vulnerable to investor pressure had more to do with its

independence.

Analyzing the Future



According to former Oracle president Ray Lane, there is a large no mans

land of smaller software makers trapped between Microsoft, IBM, Oracle, and

SAP, which consume nearly 90% of the available revenue, and start-ups such as

Salesforce.com that carry no baggage. Such software makers may seem strong with,

say, $300 mn or so in market capitalization, but they are really just waiting in

line at the chopping block. They do not have the might to compete against the

big three or the cost structures capable of defeating new stars like Salesforce.

According to analyst Bill Burnham of Inductive Capital, it is the relatively

ageing middleware crowd that is ripe for preys by the hunters in this

consolidation frenzy. More so, considering that both Oracle and IBM are going

the full hog in expanding their middleware portfolio; notwithstanding, Oracles

abortive bid for BEA Systems (the premier middleware vendor still independent),

the latters ultimate capitulation sometime in 2008 looks to be a fait accompli.

And keeping in mind Oracle chairman Larry Ellisons never-say-die predatory

instincts (rewind to the PeopleSoft saga), Oracle looks likely to be BEAs final

destination.

BEA and Tibco Systems could be the likely takeover targets in the middleware

space; even CA (a re-branded Computer Associates) might prove to be vulnerable.

The irony of the consolidation frenzy in the middleware space could be gauged

from a couple of acquisitions in 2006. Business Objects acquisition of

Firstlogic for approximately $69 mn and Informaticas acquisition of Similarity

Systems for approximately $48 mn added information quality pieces to the

acquiring vendors middleware puzzle. However, within a year, Business Objects

is all set to become history (acquired by SAP) while most industry observers

believe Informatica to be on the chopping block too.

Another votary for consolidation, in fact a dark horse, could be HP.

Traditionally, in the software game, especially the middleware space, HP has

lagged behind not just the software giants like Oracle, Microsoft, and SAP, but

even IBM. However, as recent quarters showed, HP is betting big on software and

services in devising a turnaround in its fortunes. And the acquisitions of

Mercury Interactive and Opsware leave no doubt that HP, too, has thrown its hat

into the consolidation ring, especially the middleware muddle.

In fact, HP CEO Mark Hurd also believes that the software industry is in the

cusp of another consolidation wave. In the end, math wins, he said during a

keynote address at Oracles recent OpenWorld conference in San Francisco. If

you look at the math right now in the tech industry ... only a handful of

players have more than $100 bn in cash. Hurd said those reserves are likely to

go toward just a few different things: dividends, stock buybacks, or

acquisitions. In many cases, potential merger and acquisition cases will rise

to the top of that list, he argued.

Hurd also said that there is pressure for enterprises to conduct business in

a more standardized manner, dealing with fewer suppliers. The eternal debate

between single vendor and best of breed seems to be currently going in favor of

the former and that could possibly be another reason to accelerate the

consolidation wave.

A Great White Shark



The worlds second largest software vendor and its charismatic chairman

Larry Ellison have been bestowed with colorful epithets ranging from

predatory, to rapacious not for nothing though. Any debate on consolidation

of the software industry you participate in, Oracle is bound to be the first

name up for discussion. Its forty-one acquisitions over the past forty-five

months, including high profile names like PeopleSoft, Siebel, and Hyperion, had

only helped in enhancing its reputation as the biggest shark out in the pool

looking for small fish to feed its insatiable hunger for growth.

Though during the recent OpenWorld conference, Oracle announced new database,

application, and virtualization products, as well as integration products that

ostensibly will help glue together the wares from some of its acquisitions,

Jason Maynard, a software analyst with Credit Suisse Worldwide, feels no reason

to believe that Oracles acquisition frenzy is slowing down. The abortive

attempt to acquire BEA is an example, and most likely we would soon be hearing

more on the matter in the near future. After all, BEA could provide that elusive

glue to bond together all the disparate elements that constitute Oracles

middleware portfolio.

After the BEA saga plays out, Oracle may foray into services: perhaps a deal

along the lines of IBMs $3.5 bn acquisition of PWC Consulting, believes one

industry insider. Most analysts, however, are not buying that one. Oracle is not

interested in the relationship business, they feel, and system integration

profit margins are not nearly as juicy and sustainable as software margins. More

interestingly, it might be SaaS where Oracles next big-ticket acquisition could

be headed for.

Though Ellison and other senior Oracle officials are publicly maintaining

that SaaS does not fit into Oracles strategy (they are adding value for big

customers and SaaS is for smaller businesses) and does not look a very

profitable business currently, the fact remains that Ellison owns a big piece of

NetSuite, the SaaS vendor that is working toward a near term IPO. A piece of

insurance for the future maybe?

According to observers, Oracle is waiting to see how SAP fares on the SaaS

front; SAP has already bet big there with its ByDesign initiative. If SAP

succeeds and SaaS proves to be a sound business even for a large software

vendor, Oracle could simply buy NetSuite and stay with its core business and not

face the pain of SaaS cannibalization otherwise. Meanwhile, it has covered this

bet, and if SAP stumbles, it can rub their noses in it.

Some analysts, however, feel that a carnivore like Oracle cannot be satisfied

only with NetSuite. If SaaS is working out and needs to imminently join Oracles

arsenal, the company would just buy Salesforce.com. After all, Salesforce is the

one that had brought the SaaS paradigm into the software equation. And,

surprise, surprise, Ellison owns a piece of Salesforce too. Thats the SaaS

put-away shot, it makes a heck of a statement, and it further cements Oracles

hegemony over CRM (they already bought Siebel). NetSuite can come along for the

ride too, but the Oracle shark has to find acquisition prey relentlessly, and it

must be of a certain scale to satisfy their appetite.

Big Blues Big Catch?



While Big Blue has not spent as much as Oracle to acquire software companies

over the past few years, it has gradually moved into the neighborhood. It still

might not be the Great White, but its already a voracious carnivore in the

software food chain; its gargantuan services arm provides it almost with a

second alimentary system to digest its acquisitions. If Oracle can boast of its

forty-one acquisitions in the last forty-five months, IBM has not fared worse;

since 2000, it has acquired more than forty software companies.

Besides the $5 bn IBM plunked down for business intelligence vendor Cognos,

in 2007 the company spent $1.6 bn on content management vendor FileNet, $1.3 bn

on Information Security Systems, $1.1 bn on information integration vendor

Ascential, and billions more on many smaller software companies. Until recently,

IBM had maintained that it would steer clear of application vendors, but the

FileNet and Cognos deals reveal a refined approach. IBM is now saying it is

interested in buying apps vendors whose products are extensions of its

information management offerings.

According to analysts, this change of heart is an acknowledgement that IBM

would, otherwise, be left behind Oracle, Microsoft, and SAP in the software

game. More precisely, IBM has little choice but to move into business apps to

keep pace with Oracle, SAP, and Microsoft, which are acquiring and developing

more and more pieces of the stack. A classic example would be IBMs latest

acquisition of privately-held database vendor Solid Information Technology, a

deal that is expected to broaden its information on demand portfolio. Going by

this logic, it also makes sense for IBM to go for a CA or a BMC Software, given

their mainframe roots.

And, though Oracle may have the largest middleware portfolio (it includes

almost everything), IBMs middleware plate is definitely more organized and

sumptuous. While Oracles acquisitions have been hogging the headlines, IBM has

been quietly buying up enterprise software companies to enhance its middleware

offerings. Sample these: Isogon (software asset management solutions); Micromuse,

Ascential & Cyanea, (performance management solutions of web-based business

apps); DWL (Customer Data Integration Middleware); Collation (IT service

management software); Bowstreet (portal technologies); Datapower (message-aware

networking); CIMS Labs (virtualization of computing resources); and BuildForge

(compliance software).

However, Maynard speculates that the #1 sea change deal in the software

industry over the next two to four years could be IBM acquiring SAP. IBMs

Global Services and vertical industry expertise would introduce SAP into many

more accounts, Maynard reasons, and SAP would be freed from focusing on its

NetWeaver middleware layer to concentrate on what it does best: core business

apps. Now that could be the mother of all acquisitions (even more sensational

than HP-Compaq). Impossible, some might say, but it would be prudent to remember

that a merger between Microsoft and SAP too seemed unthinkable a few years ago,

until Microsoft admitted it had been considering exactly that. In the end it

dropped the idea only because it seemed too complicated to acquire a European

company.

Enterprise, Or Web 2.0



Microsoft is fighting a multi-front war: on the enterprise front mostly

against IBM and Oracle; on the consumer front against Google, Yahoo, and the Web

2.0 barbarians. Microsoft once talked with SAP about merging to create a

business apps powerhouse, but it now appears that Microsoft is more concerned

about fending off Google. A mega deal to buy Yahoo, however, is still a distinct

possibility. That, however, could bolster the Redmond giant not only on the

consumer front, but also on a certain section of enterprises too.

That for the moment seemed to be Microsofts strategynot to go the

enterprise way head on, but gradually move beyond its consumer face by targeting

specific sections like graphists and Web designers. Microsofts

enterprise-focused acquisitions will continue to be small scale, to augment its

SQL Server, Office, Exchange, Dynamics, and other major lines. And surprisingly,

even open source could be a part of this acquisition initiative. The partnership

with Novell last year for SuSe was the first signal; strategic partnerships with

eBECS and Tyler Technologies could be taking this forward.

Going for these smaller acquisitions also makes sense when considering the

fact that Microsoft had a much harder time than expected integrating the

business applications it picked up with its $1.1 bn acquisition of Great Plains

Software in 2001 and $1.5 bn deal for Navision in 2002. The smaller deals often

do not contribute significantly to the bottom line in the short run. But in some

cases, their effects have been seen relatively quickly in Microsoft products.

Windows Live Writer, a blogging program, was started inside Onfolio, acquired by

Microsoft in 2006; Microsoft introduced a new project, called Photosynth, based

in part on technology from Seadragon Software, acquired also in 2006; in-game

advertising company Massive, another recent Microsoft acquisition, has been

integrating its technology with Microsofts online advertising system.

Speaking at the Web 2.0 Summit in San Francisco, Microsoft CEO Steve Ballmer

reiterated that the company would continue to invest in buying technology,

products and market share. Well buy twenty companies a year consistently for

the next five years for anywhere between 50 mn and 1 bn bucks. With Microsoft

increasingly under fire from old and nascent competitors and also trailing

several steps behind Google in the search business, another possible acquisition

for Microsoft could be Facebook, with whom it already has a partnership on the

advertising side.

Hunters or the Hunted



The software industry, in its consolidation phase, is gradually assuming

Kafka-esque proportions where the hunter does not know when he will be hunted

down. In a big pool where the M&A frenzy is gradually reaching its crescendo,

for companies like SAP and Symantec there are two clear choices available today;

either swim with the sharks and gobble whoever comes on the way, or be ready to

be swallowed in whole by bigger predators moving around you.

Historically, the most conservative of large software vendors, SAP is not

likely to make any acquisitions near-term of the scale of its $6.8 bn deal to

buy Business Objects. And it cannot expect to go on a bidding spree with Oracle

in the near future; the memories of the Retek saga still would be quite fresh.

SAP cannot sit tight though. Like the shark that has to continue swimming to

avoid getting drowned, SAPs likely strategy would be to target companies with

vertical industry and narrow technical expertise.

Eternal optimists and hardcore Oracle baiters would like to see SAP go after

Salesforce.com, which would make it more of a player in CRM while thrusting it

full-bore into software as a service. But that is as likely to happen as India

beating Australia in the Test series Down Under. However, the big question is:

should IBM come knocking, SAP would be interested?

Symantec is still digesting its $13.5 bn acquisition of storage and backup

vendor, Veritasand that came three years ago. Still, the company has made about

a dozen acquisitions since 2005, mostly in security and compliance. However, the

blockbuster of 2008 could see a Microsoft or HP picking up the worlds largest

security vendor. While for HP, the storage management offerings from the

erstwhile Veritas stable would be a logical extension of OpenView suite, for

Microsoft the security bit has always served as lucrative bait. Will 2008 see

someone biting it?

Potential Gatecrashers



Who could be the potential gatecrashers into the software party? HP, for

one, and EMC could be the other. Looking at the BTO (Business Technology

Optimization) division, the biggest of HPs three software units, which would

generate only about $2 bn in revenue this year, one feels HP is still not ready

to tango. For a company with close to $100 bn in total revenue, software still

looks small change for the worlds largest IT vendor. However, with sterling

performances in software and services in recent quarters, HP could finally

buckle the feeling that it lacks the passion to be a first-tier software vendor.

The OpenView system management platform is the centerpiece of HPs Business

Technology Optimization software unit, augmented by the $425 mn acquisition of

Peregrine Systems in 2005, the $4.5 bn acquisition of Mercury Interactive in

2006, and the $1.6 bn acquisition of data center automation specialist, Opsware

in 2007. HP is just starting to move aggressively into what it labels as

Business Information Optimization with its internally developed Neoview data

warehouse platform, based on the Tandem NonStop operating system. A third

software group, called OpenCall, dabbles in software for delivering voice,

video, and data services.

Total value of mergers and aquisitions in 2005, $306 billion; in 2006, $298 bn. Software dominates the scene by a long way

So, while HP has albeit started consolidating its middleware portfolio, it

still lacks adequate credibility in the enterprise business applications space

in the absence of any ERP, CRM, SCM, or BI suites. Clearly, if HP wants to

compete in software on a scale with IBM and Oracle, it will have to spend its

appreciated stock and cash on bigger acquisitions. Data warehouse leader

Teradata, recently spun off from NCR, is one possibility, especially given HP

CEO Mark Hurds and CIO Randy Motts historical ties with the company. Not to

rule out a blockbuster deal like one to buy security vendor Symantec, especially

for its Veritas storage management holdings, or McAfee as a purer security

player.

The HP story might have its ifs and buts but only sky seems to be the limit

for EMC. No major industry player has reinvented itself through acquisitions

quite like EMC has over the past several years. Since 2000, EMC has spent more

than $7 bn on a couple of dozen acquisitions, transforming itself from a

supplier of increasingly commoditized storage hardware to a purveyor of

information infrastructure, including software for storage management

(Legato), data encryption and identify authentication (RSA), security event

management (Network Intelligence), content management (Documentum), digital

rights management (Authentica), and virtualization (VMware).

Where would EMC go from here? Difficult to say, as senior executives like

Chuck Norris are keeping their 2008 cards close to the chest. There might be

some big-ticket acquisition in the personalized spacethat could mean anyone

from Sandisk to an Imation. Broadly, however, EMC would probably stick to

information infrastructure; perhaps even straying into data management by going

after a Teradata or Netezza.

Not all Gloom



Notwithstanding the general perception that software consolidation will

ultimately stifle innovation, the reality might be slightly different. Software

consolidation is not the voracious monster some people perceive it to be. True,

it is driven by big vendors desperate for growth. But technology managers need

not fear that consolidation will eat away at competition or innovation in the

software industry. There are still plenty of new ideas and novel approaches

seeping in. And plenty of old companies that do not operate in middleware,

mainstream business applications, or vertical focused software are likely to

remain untouched in the near future. Companies like Adobe, Autodesk, Amdocs, or

Dassault would be the best examples.

Joseph M Tucci, Chairman of the Board, president & CEO, EMC	Mark Hurd, Chairman of the Board, CEO & president, HP

Acquisition by a larger company can put a struggling software supplier on

more solid financial footing and allow it to scale its architecture. And

consolidation can actually increase a customers influence with a vendor.

Premier customer status can mean better volume licensing deals, better access to

vendor executives, and inclusion on customer advisory boards to influence the

vendors technology road map and strategic direction. Despite rising budgets,

the dictate to run a lean IT department for most enterprises has not changed.

Working with fewer vendors means for many CIOs spending less money managing

relationships.

There is no getting around the fact that the largest software companies like

IBM, Microsoft, Oracle, and SAP are getting bigger. HP, EMC, and Symantec could

remain the perennial bridesmaids without ever actually joining the big gang.

Some insist that a weak IPO market, acquisitive IT vendors, and buyers desire

to work with fewer vendors will make it impossible for a sizable fifth or sixth

rival to emerge. The dark horse could be Google; at a financial analyst meet at

Oracle OpenWorld, Larry Ellison derided Google as the yellow pages on the

Internet. But the new age Net champion does have the potential to fill up that

fifth gap, though whether it would also come up as a traditional enterprise

software company is open to conjecture.

Rajneesh De



rajneeshd@cybermedia.co.in