Mercury eyes a place at the top table with brave merger plans

Rethink IT, June, 2004 by Peter White

Almost every time that anyone has about Mercury Interactive for the past three years they have told two stories about its current CEO, Amnon Landan: that he once hunted terrorists for the Israeli army and that his first trip to Silicon Valley was in a beat up old Chevy Vega, as he traveled across the US, sleeping rough.

OK, so we haven't been the exception by not mentioning them, but every young Israeli has to serve in its army, and like as not they see action, and if you haven't traveled rough across the US, what have you done?

It isn't those feats that make Landan exceptional, it's his guidance and clear thinking in the middle of the last IT spending freeze and shares meltdown that make him stand out, and what eventually might make Mercury interactive stand out as an organization.

He won't be the first man who correctly analyzed the spending freeze and did something relevant to reposition his company. IBM has conjured up its 'on demand' strategy; Hewlett-Packard its 'adaptive enterprise': Cognos, Hyperion and Business Objects have all gone for the Business Performance Measurement mantra while Documentum, OpenText and Ixos have applied compliance pressure and BMC has reinvented systems management as Business Service Management.

Every shift was designed to either save money, realign IT to business, or to give buying flexibility to IT departments and most of them resulted in a new TLA (three letter acronym). Mercury Interactive's creation of the Business Technology Optimization is no exception. BTO joins BPO, BPM and BSM as one of the hot new TLAs after the era of ERP, CRM and SCM.

Say Business Technology Optimization or BTO and most CEOs and CIOs feel their eyes begin to cross--they switch off. But ask them if they'd like a set of tools that can guarantee that their IT departments will run cheaply and more efficiently, and they're all ears.

And that, in a nutshell, is what Landan and his management team saw way back in the first half of 2002, just three years into his tenure as CEO and about 18 months into the biggest and most unforgiving IT spending freeze the world has ever seen.

But Landan didn't just shift his company into a nearby safe byway, and duke it out with familiar competitors. Instead he borrowed half a billion dollars from a nervous market, spent much of it on three overnight acquisitions, and went about attacking a completely new segment of business. The fact that he seems to have pulled it off is what makes Mercury Interactive appear special.

He also switched his entire sales operation from talking to the handful of guys who were running quality assurance in the software group, in trying to get an audience with the CIO or CEO of major corporations.

This puts us in mind of the trick Hyperion tried to pull when it bought Arbor Software back in 1998. One slick east coast financial software house that had the ears of CFOs went and bought a Californian techie start-up that sold to database fiends in the darkest recesses of the IT department.

It was a mismatch made in hell and many business school papers will be written on how difficult such a cultural change is.

Hyperion rook two companies that separately had growth rates of 70% and 32% and managed to rake them ex-growth. Even the current team hates talking about those times, which are way behind it now.

Mercury could easily have the excuse of a cultural mismatch and could easily have been staring down the wrong end of a shares spiral and trying to explain away to an angry market just what went wrong. In fact, that's very nearly what did happen.

Instead, it took a single quarter's losses on the chin and ramped revenues by $25m the next quarter, some 20% sequential growth. It followed up this quarter with an even better one, bringing in revenues of $156m, the biggest net income in its history, and is back on track in terms of operating results. All the while its cash position remained incredibly high.

When it took onboard the $500m, it committed four transactions straightaway, mostly in cash. It paid out $22.5m for J2EE diagnostics firm Performant, followed weeks later with $225m for Kintana, its entry into BTO, and swiftly followed this up with reporting technology from Allerez and more application management tools from Motive for another $16.25m between them.

You'd expect that Mercury's cash pile would have shrunk somewhat with a total of $263m, more than half its convertible debt note, being paid out, but if you look at our diagram on Mercury's cashflow, it has hardly been dented. Just $100m of the Kintana deal was a trade in shares instead of cash.

Today, as it announces yet another $49m cash acquisition for auto-discovery and application mapping specialist Appilog, it has over $1.33bn in the bank, and its cash generation has more than replaced all of its acquisition costs to date.

THE ACQUISITION TRAIL

But the journey began perhaps as early as May 2001 when Landan decided on his first acquisition in the form of Freshwater, In effect, this represented the first subtle change in emphasis for Mercury and Landan's first taste of aggressively driving change through his organization.