There has been plenty of hot air expelled this week over whether SAP’s (SAP - Annual Report) acquisition of Business Objects (BOBJ) is a sign that it is adopting Oracle’s (ORCL - Annual Report) big acquisition strategy or whether it is a simply a larger part of SAP’s existing strategy of using small “tuck-in” acquisitions. I’ll leave others to bloviate on those issues.
I am less interested in whether SAP is following Oracle’s strategy than whether they ought to be. And I think the answer to that question is a resounding “yes.”
For one thing, corporate IT buyers’ main concerns tend to be reducing costs and reducing complexity. Much better to have Oracle and SAP tie together the applications from a number of vendors (by directly integrating them) than to devote in-house IT staff to doing it. Research 2.0 criticizes the Business Objects acquisition for this reason, saying “SAP now faces many of the same incompatible architectural challenges faced by Oracle with its many acquisitions.” I think their customers would rather have SAP deal with the incompatibilities than to have to do it themselves. Since when is making life easier for customers a bad thing?
More importantly, however, there are just too darn many application software manufacturers out there. While consolidation in some industries occurs because the weaker businesses fail, software balance sheets are generally too strong to for this to happen. The only way to fix the problem of too many customers chasing a relatively fixed amount of dollars is for an industry leader to soak up the excess capital by leveraging its own balance sheet to acquire other companies - for cash, not shares. Oracle has been pursuing that fix.
Software companies tend to generate significant cash flow, and Oracle has been able to use this cash flow to fund the acquisitions while both maintaining a healthy balance sheet and avoiding dilution to existing shareholders. As an example, consider its first large acquisition – that of PeopleSoft in January 2005 for $11.1 billion in cash. Prior to the acquisition Oracle held more than $9.5 billion in cash and marketable securities on its balance sheet, and had virtually no debt. The company used this cash and a $7 billion bridge loan to complete the acquisition, and by the end of its fiscal year in May, 2005 it had reduced the loan value to $2.6 billion while still maintaining nearly $5 billion in cash and marketable securities and actually reducing its share count.
By May, 2006 the company had made another $4 billion worth of acquisitions (net of the cash held by the acquired companies) and increased its cash and marketable securities to $7.5 billion while restructuring its debt load to $5.7 billion in long-term debt. Even though the debt was $3 billion more than the prior year, most of that was offset by the increase in cash – meaning that the $4 billion in acquisitions was made possible almost entirely through cash flow from operations.
Speaking of cash flow, in the year ended May 2007 Oracle generated $5.5 billion of it from operating activities, and spent only $320 million of it on capital expenditures. That turns out to be a free cash flow yield of 4.5% from the existing businesses. Most of that continues to be invested in new acquisitions for new growth opportunities. The free cash flow has increased 55% since FY2005.
Meanwhile, SAP is generated approximately $2.0 billion in free cash flow last year, giving it a 3.0% free cash flow yield. Its acquisition avoidance has left the free cash flow essentially unchanged over the last three years (though arguably the change in the Euro/dollar exchange rate is providing growth.)
A higher yield and growing free cash flow compared with a lower, flat one is not much of a choice in my book.
If any doubt remains over which strategy is working better, one need only turn to a price chart. Since Oracle closed the PeopleSoft acquisition in January 2005, its shares are up 70% (mostly driven by rising cash flow), compared to just more than 30% for SAP over the same time. To me, it seems like that is exactly the type of “challenge” SAP would want to adopt.
No comments:
Post a Comment