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One acquisition leads to another

PeopleSoft's decision to swallow J.D. Edwards earlier this week led Oracle to launch its hostile takeover of the software maker, many analysts say. But why?

PeopleSoft's decision to swallow J.D. Edwards earlier this week led Oracle to launch its hostile takeover of the business software maker on Friday, according to many analysts.

Pleasanton, Calif.-based PeopleSoft, best known for its human resources software, on Monday announced a $1.7 billion acquisition of J.D. Edwards, which specializes in software for manufacturing. Analysts said the deal rounds out PeopleSoft's product portfolio and could help the software maker in the promising midsize business market.

Four days later, Oracle faxed a letter to PeopleSoft asking to buy the company for $5.1 billion. "We think the timing of the offer was prompted by PeopleSoft's offer to acquire J.D. Edwards," analyst Brent Thill of Prudential Securities wrote in a report.

So what would a combination of J.D. Edwards and PeopleSoft look like?

The acquisition, which is expected to close in the third or fourth quarter of this year, is the largest in PeopleSoft's 16-year history. The stock-swap transaction is expected to double the company's customer base to more than 11,000, increase annual revenue from $1.9 billion to $2.8 billion, and expand its work force from about 8,000 to 13,000.

By acquiring Denver-based J.D. Edwards, PeopleSoft would complete its evolution from a software company focused on personnel tasks to a comprehensive business applications provider.

Potential European clients, for example, tended to view PeopleSoft as more of a human resources software company, said Nathan Schneiderman, an analyst with Wedbush Morgan Securities. The deal "certainly gives the company a lot more credibility in the manufacturing area and the supply-chain area," he said.

J.D. Edwards has focused on providing business software for industries such as manufacturing, mining and construction, as opposed to PeopleSoft's concentration on service sectors such as education, health care and government. And while PeopleSoft has had success with large corporations, J.D. Edwards is seen as a leader in the midmarket--defined as companies with annual revenue between $50 million and $500 million. PeopleSoft described those complementary strengths as the rationale behind the merger. "Both midsized and large enterprise customers will have access to the broadest suite of integrated enterprise software applications in the world," PeopleSoft CEO Craig Conway said in announcing the deal.

To analysts Jim Shepherd and Randy Weston of research firm AMR Research, such talk is not hype. "While merging companies always say they have market synergy, this one is for real," Shepherd and Weston wrote in a research note this week. "The two companies have very little market overlap because of the concentration on different industries and markets."

The acquisition comes amid tough times for companies hawking so-called enterprise resource planning (ERP) software, which handles business tasks such as finance, human resources, supply-chain management, and manufacturing. Software licensing revenue in the ERP market has basically been flat the last two years, with a significant decline so far this year, said Paul Hamerman, an analyst with Forrester Research. "That's certainly a factor in this consolidation," he said. "They're going to be able to drive some efficiencies because of the merger."

In particular, PeopleSoft expects to reduce operating expenses for the combined company by $80 million annually within the first full year of combined operations. The company also said the deal should add to its 2004 earnings, excluding amortization and other items.

That would be welcome news to PeopleSoft, given its sluggish financial performance of late. In the first quarter of this year, PeopleSoft's software license revenue fell 39 percent year over year to $80.8 million, while net income dropped 14 percent to $38.5 million. In 2002, PeopleSoft sales dropped 8 percent and earnings fell 5 percent.

Going after the midmarket is one strategy for pumping up sales, Hamerman said. "The large enterprises have already invested in the ERP" products, he said. "The midmarket is a better growth opportunity for software companies."

Competition heats up
That market is getting more competitive, however. Microsoft recently reassigned its top sales executive to spur expansion of its small and midsize business applications unit and hopes to transform its business solutions division into a $10 billion unit.

PeopleSoft Chief Financial Officer Kevin Parker said the J.D. Edwards acquisition should help fend off the threat from the Redmond, Wash., giant. "This puts us in a better position to compete with Microsoft and their Great Plains product," he said.

But the promises may not all come true.

For one thing, PeopleSoft may have paid too much for J.D. Edwards. The deal calls for each share of J.D. Edwards stock to be exchanged for 0.86 of a PeopleSoft share, valuing J.D. Edwards' stock at around $14.10--a 19 percent premium over the May 30 closing price of $11.81. C.S. First Boston analyst Gibboney Huske suggested PeopleSoft may not get its money's worth. "For the acquisition to (add) to PeopleSoft shareholder value, revenue synergies must be realized," Huske wrote in a note Tuesday. "However we believe revenue synergies will be difficult to achieve given the limited integration of products and organizations initially envisioned by the company."

Then there's the question of whether J.D. Edwards will help PeopleSoft beat out its main remaining rivals, SAP and Oracle. SAP, for its part, claimed it's not frightened by the acquisition news. "Given current economic conditions, SAP has been expecting a consolidation of the industry for some time," the company said in a statement. "SAP continues to gain market share and expects that momentum to continue as other players consolidate to try and remain competitive."

As for Oracle, it let its money do the talking, all $5.1 billion worth.