By Jonathan Rudy, CFA
The soap opera began June 2, with a merger agreement between PeopleSoft (PSFT ) and J.D. Edwards (JDEC ), two midsize enterprise-software providers looking to bulk up to compete against goliaths Oracle (ORCL ), SAP (SAP ), and Microsoft (MSFT ). PeopleSoft announced an all-stock transaction worth approximately $1.7 billion that would pay a 19% premium to J.D. Edwards' closing price that previous Friday. However, the market reacted tepidly, and J.D. Edwards stock closed only about 6.6% above its prior closing price.
On June 6, Oracle surprised the market with a $5.1 billion cash tender offer for PeopleSoft, or $16 per share. Oracle stated that if it succeeded in acquiring PeopleSoft, it would then review a potential acquisition of J.D. Edwards.
Our first thought at S&P was that Oracle was merely trying to derail the PeopleSoft-Edwards merger and put pressure on PeopleSoft's operations, particularly with its second quarter ending in a couple of weeks. Most vendors of enterprise software, the big applications that corporations use to run their businesses, close a significant part of their sales during the end of each quarter. Due to this uncertainty, industry analysts such as Gartner Inc. advised customers that were thinking about buying PeopleSoft or J.D. Edwards products to put these decisions on hold until the situation got a little clearer.
On June 16, PeopleSoft revised its all-stock deal with J.D. Edwards to approximately $850 million in cash and/or a fractional share of PeopleSoft for each share of J.D. Edwards, subject to proration. This new proposal enables PeopleSoft to speed up the merger process with J.D. Edwards and doesn't require approval by PeopleSoft shareholders. With this revision and PeopleSoft's board and management voicing severe criticism of Oracle, we believed at that point that Oracle's initial offer had a remote chance of going through.
All of that changed, however, on June 18, when Oracle increased its cash tender offer for PeopleSoft to $6.3 billion, or $19.50 per share, a 22% premium to the previous offer. We believe this significantly increases the chances of Oracle acquiring PeopleSoft. On June 20, PeopleSoft's board rejected Oracle's latest proposal, saying it was too low and that the deal faces too many regulatory hurdles and "threatens serious damage to its business." PeopleSoft also appears to be proceeding with the J.D. Edwards merger as planned.
In the meantime, multiple lawsuits have been filed on both sides, even including the State of Connecticut against Oracle, and we anticipate a protracted, acrimonious legal battle as the most likely outcome. While it's far from certain that Oracle will be able to acquire PeopleSoft, we believe that its current offer is fair, putting PeopleSoft's enterprise-value-to-sales ratio at 2.2 times, or 3.2 times our 2003 sales estimate and 37 times our 2003 earnings per share estimate.
ON THE UPSWING?
That takeover would result in significant cost-cutting, in our opinion, and would likely result in major layoffs. However, an Oracle-PeopleSoft combination would also remove some excess capacity from the industry.
From an investor's perspective, we now have hold recommendations on Oracle and PeopleSoft, considering the significant uncertainty this situation could have on each company's operations, including management distraction. Still, we believe Oracle is worth holding because of its strong balance sheet, with little long-term debt and over $6 billion in cash, and for profitability that's superior to its peers. Operating results appear to us to be improving as well, with Oracle exceeding our 14-cent EPS estimate for its fiscal 2003 fourth quarter (ended May 30) by 2 cents.
PeopleSoft shares, which closed June 20 at $17.42 -- an approximate 12% discount to Oracle's all-cash offer -- are also worth holding.
The company that may be left out for now is J.D. Edwards. We believe the customer uncertainty surrounding this situation will likely hurt its near-term results, and as a result we would avoid the shares at this time.
We believe this technology soap opera will probably go back and forth for quite some time. The most likely beneficiaries, in our opinion, will likely be the newspapers in which both Oracle and PeopleSoft are spending significant advertising sums to win the hearts and potential votes of PeopleSoft shareholders. Additionally, we anticipate that the uncertainty surrounding the deal will likely benefit main enterprise-software competitors Siebel Systems (SEBL ) and SAP (see BW Online, 6/12/03, "Why SAP Is Sitting Pretty"). Regardless of the outcome, the strategic maneuvering used in this takeover battle should make an interesting case study down the road.
Analyst Rudy follows software stocks for Standard & Poor's
Edited by Karyn McCormack