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Analysts: Oracle isn't PeopleSoft's only problem

Yes, fending off a hostile buyout is a pain, but that external challenge is just the obvious problem.

The Oracle antitrust trial isn't the only thing that's throwing PeopleSoft off track these days, according to financial analysts.

PeopleSoft issued a warning on Wednesday that earnings for the second quarter, which ended last week, would fall short of its goal by about a third. It primarily blamed issues surrounding rival Oracle's hostile bid to acquire the company.

"They seem to be pointing only to Oracle, but I think it's also related to some internal execution problems," said Patrick Mason, an analyst at Pacific Growth Equities.

PeopleSoft said it now expects earnings per share of 13 cents to 15 cents, excluding certain items. Previously it had forecast earnings of 20 cents to 22 cents per share. Analysts on average had expected earnings of 21 cents per share, according to Reuters estimates.

Including items such as 2 cents per share in Oracle-related costs, amortization and restructuring charges, PeopleSoft predicts net income of 5 cents per share, lower than its April forecast of 10 cents to 12 cents per share. Analysts on average had expected 12 cents per share on that basis, but promptly lowered their earnings and revenue guidance. In a July 7 note, J.P. Morgan Chase analyst Adam Holt slashed his second-quarter revenue forecast from $674 million to $660 million. Fiscal year 2004 drops from $2.8 billion to $2.7 billion.

"PeopleSoft does not have the critical mass to survive in this business."
--Charles Phillips
Oracle president

The company blamed the ongoing Oracle antitrust trial, which began in June, for the miss. If victorious, Oracle will almost certainly continue its $7.7 billion hostile bid for PeopleSoft. Testimony concluded last week, but a court verdict remains weeks away.

However, securities analysts say the company's problems aren't so simple. Though the trial was certainly a detriment, PeopleSoft is also troubled by the logistics of last year's merger with rival J.D. Edwards, they said. And the company is grappling with a wobbly recovery in the corporate software market that is affecting many suppliers.

"We did expect something like this to happen," said Charles Di Bona, a Bernstein & Co. analyst. "(Wall Street's) expectations were running too high, and we were concerned (PeopleSoft) wouldn't be able to generate the type of efficiencies they wanted from the J.D. Edwards merger."

Problems at home
Specifically, analysts said, PeopleSoft overestimated the sales synergies of its J.D. Edwards buyout. The J.D. Edward customer base didn't produce as many sales opportunities as PeopleSoft had expected, Mason said. The reorganization of its sales team to incorporate J.D. Edwards' staff has been bumpy, and that may have affected the company's financial performance as well, he added.

PeopleSoft also faces a high rate of defection among certain former J.D. Edwards customers, according to Pacific Crest Securities analyst Brendan Barnicle. Customers using an aging version of the J.D. Edwards software tied to IBM's AS/400 operating system are shopping around for new systems and aren't necessarily staying in the PeopleSoft fold, he said. About 28 percent of PeopleSoft's 12,200 customers use the AS/400 programs, according to the company.

A PeopleSoft spokesman declined to discuss the company's financial performance, saying the company would provide more detail on July 27 when it officially announces earnings.

In addition, the business-software sector continues to face tepid demand for its products, analysts said. Along with PeopleSoft, software suppliers JDA Software Group and Veritas Software have issued warnings about second-quarter earnings this week. Oracle, Informatica, Ascential Software and FileNet have also missed certain financial targets recently, Mason said. The bad news is surprising because market indicators predicted a stronger recovery this year.

"Companies intend to spend a lot on software but, they just didn't feel like doing it right now," Mason said.

Oracle to the rescue?
Oracle executives seized on the news. Reiterating the company's argument for being allowed to buy PeopleSoft, Oracle co-president Charles Phillips said PeopleSoft does not have the strength to go it alone.

"PeopleSoft does not have the critical mass to survive in this business, so it's a matter of whether we buy them out or Computer Associates buys them two years from now," Phillips told delegates to Oracle's OpenWorld user conference in Melbourne, Australia, on Wednesday.

"They're much better off with us," he added. "Believe me."

Analysts bolstered that viewpoint. The report from Holt said SAP, Oracle and Microsoft were in the strongest position among the top applications suppliers. He wrote that the deep discounting practices made public during the court case give customers "significant negotiating leverage today, which...could handicap a rebound in PeopleSoft's business."

PeopleSoft's two chief competitors in the market, Oracle and Germany's SAP, also spoke of uncertainties. SAP CEO Henning Kagermann said he was cautious about IT spending. "Customers are buying more incrementally. It's not the big replacement of information technology infrastructure we used to see," he recently told CNET News.com. "So I think deal size goes down on average. We have less large deals, but we have more deals."

Overall, "IT budgets will not grow," he added. Customers will try to squeeze down total cost of ownership by targeting commodity offerings such as hardware, but he said he's hopeful the enterprise applications market still has room for growth. "If you look at where really the value is created, it's with the enterprise applications, which is sometimes less than 10 percent (of the IT budget). There is enough demand for applications, so therefore the amount of application spending will grow. Therefore the application market will grow."

Both Kagermann and Oracle CEO Larry Ellison say consolidation is inevitable in the business software market. "There will be a few large players with a comprehensive offering," Kagermann said in the recent interview. "This middle size, I think, will go out."

In testimony last week at the antitrust trial, Ellison said increasing competitive pressure from SAP and the entry of Microsoft into the market spurred Oracle to launch its hostile bid for PeopleSoft last year. "We wanted to be a survivor and a consolidator, and we felt the only way to survive and prosper was through acquisition," he said. Andrew Colley of ZDNet Australia contributed to this report.