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Oracle: In a Takeover Trap?

By Alex Salkever You can say one thing about Larry Ellison. He knows how to get attention. On June 6, the visible, voluble CEO of business software giant Oracle (ORCL) unveiled a hostile $5.1 billion takeover bid for rival PeopleSoft (PSFT). The all-cash offer came a mere four days after PeopleSoft had announced it would merge with another business-software provider, J.D. Edwards (JDEC), in a $1.8 billion stock transaction. Oracle's takeover effort is hardly friendly. PeopleSoft's board angrily rejected Ellison's original offer of $16.50 for each PeopleSoft share as a low-ball bid. And even after he raised the offer to $19.50 per share, or $6.3 billion total, PeopleSoft's board again rejected it.

Many analysts at first thought Ellison had no intention of buying PeopleSoft. Rather, his was a strategic move to disrupt PeopleSoft's planned acquisition of J.D. Edwards. Oracle's offer came at the end of the quarter -- precisely when PeopleSoft sales reps are pushing hard to close deals. Not only are they struggling to sell pricey software into a stagnant market but now they're also answering questions about what will happen if Oracle buys PeopleSoft. Will Oracle shut down PeopleSoft product lines in financial services and human resources? Imagine being a salesperson in that environment.

LOSE-LOSE SITUATION. Now it seems that Ellison is serious, even alluding to the possibility of upping his offer again. Oracle also dropped its demand that PeopleSoft discontinue the planned J.D. Edwards merger. With Ellison making a such concerted effort, investors are wondering what the proposed deal means for the stock. So far, not much. Oracle shares have moved down only 3% over the past four weeks, according to Thomson Financial First Call. News of the deal dropped share values slightly from the $13.50 range to around $13. On June 25, they floated around $12.50.

With Oracle up by 34% over the past year, however, smart investors will keep a cautious eye on the takeover move's impact -- perhaps from the sidelines for now. "Hostile bids like this get drawn out and become very acrimonious. It doesn't work out for anybody involved," says Jonathan Rudy, software analyst at Standard & Poor's. (Neither Rudy nor S&P holds Oracle shares.)

Oracle's continuing strength has again vaunted it among the ranks of BusinessWeek's Info Tech 100 list, clocking in at 12 this year. But Oracle may have a problem. Its revenues from new customers have been

stagnating as big companies continue to postpone major purchases in software and databases -- Oracle's bread and butter. In the fourth fiscal quarter of 2003, reported on June 12, revenues from new software licenses -- a leading indicator of customer growth - grew by a lukewarm 1% year-over-year. That's an improvement over nine successive quarterly declines in new-license revenues but not enough to make Oracle look like a growth stock again.

IMPATIENT CEO. True, total sales were up 2%, and earnings rose 31% as Oracle reaped more profits from selling services to existing customers and from containing costs particularly well. Still, the ongoing malaise in new-license revenues is clearly hobbling Oracle. In 2002, it posted earnings of 39 cents per share on revenues of $9.7 billion. That's well down from 2001, when it delivered earnings of 44 cents per share on revenues of $10.9 billion.

The database software market has remained stagnant, and in the enterprise-software market Oracle has been losing ground to its biggest rival, SAP (SAP), itself No. 40 on BusinessWeek's new Info Tech 100 list. That's discouraging because Ellison has struggled to build that business in hopes of diversifying from databases and selling customers multiple pieces of software.

Of course, the rest of the software industry is in similar straits. But Ellison can be an impatient CEO, and waiting for an elusive cyclical turn probably doesn't suit him. News reports say Ellison and PeopleSoft CEO Craig Conway have chatted in the past about doing a deal, but a hostile takeover bid is hardly the way to win friends and influence people.

HIGHER BID? Actually, Ellison's play for PeopleSoft could most help the company that Oracle should be most worried about -- rival SAP. By raising doubts about PeopleSoft's future, Ellison may hope to chase customers away from that prey and toward its hunter. But Oracle may wind up pushing those customers into SAP's arms (see BW Online, 6/12/03, "Why SAP Is Sitting Pretty").

Indeed, Oracle probably has more to fear from SAP than from the merged PeopleSoft/J.D. Edwards. Should SAP continue to make big gains in the high-end enterprise-software sector, where it claims controls of 54% of the global market, the German concern will end up with clear dominance. SAP obviously understands this dynamic: It launched a global marketing campaign targeted at PeopleSoft customers on June 10.

To even contemplate Oracle's deal, PeopleSoft's board will certainly require more than the current $19.50-per-share offer. The magic number could be as high as $25. A raised bid to the $20+ range per share wouldn't be as steep as it sounds, however. PeopleSoft has $2 billion in cash on its books, so Oracle's bid would effectively be around $3 billion.

CAUTIOUS NOTES. Should Oracle secure corporate financing for the deal at today's low, low interest rates, it might be able to turn the acquisition into a higher return on capital than its own balance-sheet cash -- especially if PeopleSoft's business picks up and the deal does add up to more than the two discrete parts. And if Oracle could migrate the PeopleSoft users to its own business applications, then Ellison could finally start to see significant revenues.

Sounds good, but this strategy has lots of risks. For starters, hostile takeovers are hardly the best way to build goodwill with the customers Oracle will need to retain after consummating the deal. Should they leave -- for whatever reason -- Oracle shareholders will be left holding the bag.

Further, on a pure valuation basis, some analysts have questions. "I have a hard time seeing how a company 20% the size of Oracle would add $3 billion in incremental profits in any reasonable amount of time. It doesn't pass the sniff test," says Peter Cohan, a business strategist and publisher of the Cohan Letter. (He holds no shares in Oracle and does no work for it.)

Cohan is a tech bear these days. But even bullish analysts who don't see the valuation as excessive, such as S&P's Rudy, have downgraded Oracle stock on the uncertainties created by its swashbuckling approach. In corporate proxy wars, rarely does anyone make a lot of money. So investors might want to be cautious before considering Oracle as a place to seek growth.

Note: This is an updated version of the story that originally appeared as an Online Extra in the BusinessWeek Info Tech 100 issue dated June 23, 2003. Salkever is Technology editor for BusinessWeek Online

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