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EMC Looks to Lasso Legato

By Faith Arner Ever since he became CEO of EMC in January 2001, Joe Tucci has promised to make high-margin software a much bigger piece of his data-storage company. EMC would both build and buy its way to domination of storage software, he repeatedly told Wall Street. But during his tenure, EMC's software sales have stalled at around 22% of revenue. And Tucci seemed too tight-fisted to buy anything but bite-size storage startups -- some so small that EMC (EMC) didn't even report how much it paid.

All that's about to change. BusinessWeek Online has learned that on July 8, EMC plans to goose its software revenue with what could be its biggest acquisition ever: the purchase of Legato Systems (LGTO) in Mountain View, Calif., according to a source familiar with the talks. EMC will pay $1.3 billion in stock for Legato, which primarily makes software tools for data backup and retrieval. The offer represents a 16% premium to Legato's July 7 closing price of $9.10. Though Legato lost $229 million in 2002 on $262 million in revenue, its market value was $1.1 billion on July 7, vs. $25.7 billion for EMC, which declined to comment. Legato didn't return calls seeking comment.

The purchase will do more than bolster EMC's top line. It'll solidify EMC's position as storage-software leader, turn up the heat on top competitors Veritas (VRTS), also in Mountain View, and IBM (IBM), and possibly spur further consolidation within the storage-software market. "This strengthens EMC's value as the go-to spot for storage," says Toni Sacconaghi Jr., a senior research analyst with Sanford C. Bernstein & Co.

"A GREAT THING." This courtship was nearly a heartbreaker: EMC and Legato have long talked on and off about joining forces. An earlier deal was scuttled nearly two years ago because the two couldn't agree on terms as Legato's share price rose and EMC's fell.

While it remains unclear what tipped the balance this time, analysts generally like the synergies they see. "It would be a great thing for EMC," says Nancy Marrone-Hurley, senior analyst at Enterprise Storage Group, based in Milford, Mass. "EMC has pieces. Legato has pieces. If they were all to come together, you'd have a full solution."

Even without Legato's pieces, EMC handily has led the storage software market. In 2002, it boasted a 25.6% share vs. Veritas' 18.6%, followed by IBM with 12.6%, according to Gartner Inc. But EMC trailed Veritas in the key area of backup, where data are often stored on tape. In that sector, Veritas leads with 40.6%, followed by IBM with 21%, Computer Associates (CA) with 8.8%, and Legato with 6.9%. EMC didn't register. "It gives EMC more ammunition to go directly at Veritas," says Tim Leisman, CEO of Storability, a storage-software startup in Southborough, Mass.

FEET ON THE STREET. Other plums that EMC sees in Legato are its sales force and OTG, a company Legato acquired last year. EMC's 5,400-strong direct-sales team used to peddle only hardware and has had trouble getting up to speed on software, analysts say. EMC has been developing a dedicated software sales force, but purchasing Legato would help it get feet on the street faster.

EMC's software-development organization also recently lost its chief, Erez Ofer, who plans to return to Israel. Tucci's immediate appointment of Mark Lewis, a Compaq storage veteran who joined EMC as an executive vice-president a year ago, allayed analysts' concerns about a possible vacuum at the top of the software organization.

OTG gives EMC functions that neither it nor Veritas have. OTG helps manage e-mail by automatically deciding which messages are less important and storing them in the far reaches of the storage network, freeing space for more frequently used data, says Enterprise Storage Group's Marrone-Hurley. It's a key capability to help companies -- especially financial institutions -- meet new regulatory requirements for corporate data. "There's a lot of demand for solutions around e-mail management," says Robert Passmore, a research director at Gartner.

PIECES IN HAND. The expected Legato purchase comes on the heels of another partnership that EMC is banking on to help bolster software sales. On July 2, it announced an agreement with BMC Software in Houston under which EMC will take over BMC's 50-odd storage-software customers and BMC will resell EMC's software instead of its own to its 5,500 other customers.

Now for the hard part: integrating the new pieces into the whole. Marrone-Hurley calls it an "extremely difficult task." But EMC is in good company: Rival Veritas is doing the same thing with two software companies it recently acquired. Each will have to complete smooth mergers or risk losing market share. Whatever happens next, EMC will have key, new pieces for the puzzle. Arner is a correspondent in BusinessWeek's Boston bureau

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