Competitive Intelligence

Oracle vs. PeopleSoft: Department of Justice Signals Against Merger as PeopleSoft Rejects its Determined Rival’s Latest Bid in Hostile Takeover

One of the chief reasons I’ve been hesitant to opine any thoughts on the Oracle vs. PeopleSoft hostile takeover for the past eight months was because of the competitive dynamics of the industry and the likelihood that regulators might oppose the matter entirely, essentially mooting the point of any significant competitive analysis beyond FUD-factoring Larry Ellison against Craig Conway. This despite what appeared to be a warming of relations between the two firms in the past week, as Oracle upped its bid and PeopleSoft playing hard-to-get by teasing that the offer was still just not dear enough.

Lo and behold, in an announcement posted to PeopleSoft’s Web site last night, PeopleSoft revealed it had been informed by the U.S. Department of Justice that the staff of the Antitrust Division has recommended that the Department file suit to block Oracle's proposed acquisition of PeopleSoft and that the staff recommendation has been submitted to the office of the Assistant Attorney General pending a final decision no later than March 2nd, 2004.

The recommendation represents a significant victory for PeopleSoft and CEO Craig Conway, a former Oracle executive, who has predicted antitrust regulators would block Oracle from consuming his company. Conway had argued the takeover would hurt competition in the $20 billion market for business applications software used to automate a wide range of administrative tasks for companies large and small while Oracle had argued the deal would create a stronger competitor to German market leader SAP and a surging Microsoft as it enters that market.



On Monday, PeopleSoft had rejected Oracle's latest tender offer, coming late last week as Oracle raised its bid from $19.50 to $26 a share indicating Oracle was determined to complete the deal. This set the stage for a showdown at PeopleSoft's shareholder meeting on March 25, having called Oracle's $9.4 billion cash offer "inadequate" and issuing a more detailed analysis of its rejection of the bid, in the strongest indication yet that it might negotiate if the price was right. PeopleSoft said the bid valued it at a lower earnings multiple than other enterprise software companies and was below the price target set by analysts, implying a multiple of only 27-28 times earnings based on PeopleSoft’s expected earnings. By comparison, SAP trades at 32 times expected 2004 earnings, while Siebel, which is recovering from a deep earnings slump, stands at 46 times prospective earnings.

The analysis of the Oracle bid and PeopleSoft's decision to reverse its earlier position and make price rather than regulatory considerations the main argument for its rejection suggested that last week's renewed strategy from Oracle may have shifted the dynamics of the takeover battle. Before yesterday’s DOJ recommendation, PeopleSoft's shareholders would have been able to decide at next month's meeting whether they wanted the company to give more serious consideration to Oracle's offer, despite Oracle's complaints that PeopleSoft's poison pill takeover defense prevents it from taking control in the short term and essentially means shareholders have no power to influence the outcome of the bid.

However, that point is moot if regulators don’t approve and Oracle can’t win on appeal – so, here’s a quick run-down of the antitrust dynamics at work.

Throughout the DOJ’s probe, Oracle has essentially argued that competition is robust, with hundreds of mid-size and small software companies all competing to offer applications to handle different business administration needs. The company has argued that if it bought PeopleSoft, the combined company still wouldn't possess a number one market share position in any major business software category.

PeopleSoft, on the other hand, argued that the software market was far more narrowly defined, saying that a market for software "suites" exists in the form of prepackaged software applications designed to work together and that PeopleSoft, SAP and Oracle were the three principle competitors in that market, which would be reduced by one key player after an Oracle acquisition.



PeopleSoft has argued that Oracle launched its bid in June last year simply to disrupt its pending acquisition of JD Edwards and the market for business application software. Oracle, who dominates the database software market, ranks third in the biz-apps market behind PeopleSoft following its JD Edwards buy-out and the leader SAP. Investors had always anticipated that the merger could run into anti-trust problems with U.S. or European regulators, which was why PeopleSoft's shares had traded below Oracle's most-recent offer.

For those without knowledge of the full background here, it gets pretty interesting. In a statement, Oracle spokesman Jim Finn said the initial proposal to merge the business applications units of the two companies had come from PeopleSoft's Conway, who thought he should run the combined business. But when Oracle countered by offering to buy PeopleSoft, "Conway said he wouldn't sell at any price," Finn said. "He then began a long and intensive lobbying effort...(that) resulted in complicating and prolonging the Justice Department review of this merger." Finn added, "While no decision has yet been made, Oracle believes this merger will eventually be approved," indicating a fight ahead on appeal should a ruling come down officially against the merger.

In addition to the regulatory review, the merger is also being challenged in court by PeopleSoft and by the Attorney General's office of Connecticut. Oracle, in response, has a lawsuit pending against PeopleSoft over the actions it has taken to try to block the takeover, including "golden parachute" severance payments estimated at more than $60 million for Conway alone. Oracle also complained that a customer assurance program PeopleSoft put in place puts the company at risk of having to pay out up to $1.55 billion in the event of an Oracle takeover.

There’s little chance Assistant Attorney General Pate will ignore eight months of work by the Antitrust Division or the 200-plus depositions from PeopleSoft’s software customers saying how Oracle’s takeover would make their business software more expensive. The most important key conclusions however are that the department has defined the software market narrowly and has determined where there could be higher software prices as a result of a combination, after an earlier definition of the market in question as one for core financial and human-resources systems sold to large and complex organizations - a market served by only SAP, Oracle and PeopleSoft.

That means the department's conclusions on any anticompetitive effects would NOT be focused specifically on Conway's software "suites" argument, which PeopleSoft had said there was a market for shortly after Oracle launched its bid, which is what led many to believe suites were also the focus of the DOH probe.

Putting limits on the market definition to just financial and HR for large, complex businesses means that all those other pesky facts applying to any broader markets get tossed out as the DOJ skips over any markets for selling software to mid-size or small businesses, the market for customer relationship management and supply chain management, or anything on the database front. This all appears a decided advantage for Oracle, as well as the lack of any argument that Oracle has pricing power in the database market that it will be able to leverage into business applications software, similar to the way Microsoft's Windows monopoly has been tied to competing in other software markets, such as Web browsers and office-suite applications.

However, software license sales alone don’t account for all those billions in revenue generated by SAP, Oracle and PeopleSoft, as sales of software services, support and maintenance to existing customers generate annuity income every month once the customer makes a software purchase.

The DOJ is also concerned with whether new competitors could enter the market in the event that Oracle increased prices, and supposedly, the staff report will conclude that the price of new software licenses could be driven higher in the narrowly defined market if there are only two competitors, instead of three, and that few new suppliers will fill the gap in a market defined as "core HR and financial software for large customers".

On top of that, should the DOJ look at maintenance and support for existing PeopleSoft customers, Oracle could be seen to have a near-monopoly there, post-merger. Many believe a merged Oracle-PeopleSoft could generate a tremendous influx of new customers which the combined company could enforce its monopoly on. And, if the DOJ accepts that analysis, it will be virtually impossible to argue that any new company could enter and compete in delivering support and maintenance services on Oracle and PeopleSoft software.

Still, understanding Larry Ellison, he’s probably not finished yet – he’s likely to recommend the company fight any official ruling from the DOJ that might materialize in March, although the likelihood that Oracle would prevail in that is also poor. Should Oracle appeal however, Conway and PeopleSoft will have a few months more fight ahead – but, in my view, this DOJ Antitrust Division recommendation essentially kills the deal.

- Arik

Posted by Arik Johnson at February 11, 2004 01:10 PM | TrackBack