Making sense of Oracle's $10.3 Billion Purchase of Peoplesoft

by Kevin Shockey

Of all of the companies that are playing the open source card, the one I least understand is Oracle. HP, IBM, and even to some degree Sun Microsystems are easy to understand. Promoting open source helps them sell more hardware, like I said easy. Fundamentally, Oracle's interest in Linux is the same, by promoting open source it helps them sell more software licenses. However, that's the kicker. Until Bill Gates' prediction comes true and hardware is essentially free, there is a big difference between these two positions.

Hardware manufacturers are not on a collision course with open source. Computer hardware and open source are complimentary markets. On the contrary, database management servers, middleware, web servers, finance and accounting software, and customer relationship management software are dead center the target of some of the most aggressive and successful open source companies. A simple example is MySQL AB, that competes, or will compete, directly with Oracle in the database market.

I've been confused by this for a while, but this week I was stunned. After a relentless pursuit, Peoplesoft Corporation surrendered to Larry Ellison and Oracle Corporation. This week the Peoplesoft Board of Directors took the advice of the "Transaction Committee" and accepted a cash bid from Oracle of $26.50 per Peoplesoft share, for an estimated total transaction value of $10.3 Billion.

As I'll break this transaction down later, it is my opinion that this purchase may be a serious mistake by Oracle Corporation. I'll show through a very brief review of their finances, that with the growing credibility of open source software in the server room, both Oracle and Peoplesoft will be directly threatened by a strong contender in some of their most successful product areas. This threat will drain new software licenses faster than they expect and they will be slow to respond to this threat.

In the end, I commend the Peoplesoft share owners in successfully raising Oracle's offer price per share from $19 per share to $26.50. If completed, this will be a huge financial windfall for all Peoplesoft share owners. Although their 2003 annual report does not even mention a threat from open source it is curious to note that one of their key ex-executives believes differently. As we have already seen in the attempt from Novell to hire ex- PeopleSoft exec Ram Gupta to replace departed vice-chairman Chris Stone, it seems the executives at Peoplesoft know where the future lies. I predict that some of the biggest Peoplesoft shareholders, those who will reap the most from a successful sale, will head into open source.

More and more to get a sense of how little this makes sense, we only need to examine the numbers. The best place to go for any public company are the federally mandated Security and Exchange Commission reports. Let's first check out the basic numbers from Oracle Corporation (ORCL). First, according to the Oracle Corporation 2004 10Q, Year End Report they claim that "We are the world's largest enterprise software company." They are most definitely somewhere in the top five of all proprietary software companies in the world. In 2004 they generated a total of $10B revenue, with $8B in software licensing (79%) and $2B from services (21%). 44% of those software revenues were from new software sales, while the remainder comes from license renewals and upgrades. Due to the well deserved reputation of their marque product, the Oracle database, they seem rock solid.

It is worth mentioning though, they do have open source on their radar. I guess they believe, as many of us do, that open source is important to watch but it is anyone's guess when it might actually have any material impact on their revenue. Oracle admits: "We may also face competition in the open source software initiatives, in which companies such as JBoss and MySQL provide software and intellectual property free over the internet." and "We may also face increasing competition from open source software initiatives, in which competitors may provide software and intellectual property free over the internet. If existing or new competitors gain market share in any of these markets, at our expense, our business and operating results could be adversely affected." I say that when a risk finally makes it into the management discussion, it is probably too late to do anything to stop that threat from becoming an issue.

So the risk is there, fine. So let's take a look at Peoplesoft. Reading from Peoplesoft Corporation's 10Q Quarterly statement for the third quarter, they have booked $1.9B in revenue in the first 3 quarters of 2004. They are on track to surpass the annual numbers from 2003. Digging a little deeper, they have $1.3B in software license related revenue and $0.6B in service revenue. We see less of an emphasis on software licensing, but it is still heavily dependent on software licensing. It is also very important to look at what it would take to see a return on investment for Oracle's $10.3B.

With $61 Million in net income in the first nine months of 2004, it would take approximately 384 years to earn back the investment based only on profit. Maybe it makes more sense to look at the almost 4 years it will take to have the Peoplesoft annual revenue to cover the sale price. Now I realize this freshman business school student's analysis of this transaction is way off, but I stand by my analysis that this is a fantastic deal for Peoplesoft's shareholders and an anchor around the neck of Oracle. Companies are bought and sold for many reasons, and I'm sure we may learn why Larry Elison pushed so hard to get Peoplesoft. In the meantime, let me elaborate on some of the open source projects that I hope, err I mean "may", represent some of the biggest risks to Oracle and Peoplesoft.

In no particular order, here are some companies and projects that should be giving the Oracle sales staff nightmares before too long:

Anyone, or maybe several, of these companies or projects may rise to be a serious threat to Oracle's future software revenue. Only time will tell, however, I know that if I had $10 Billion dollars burning a hole in my pocket, I imagine there are better ways to invest it.

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What do you think Oracle's purchase of Peoplesoft means for the software industry?