Oracle makes Peoplesoft shareholders an offer they can't refuse - Analysis

Rethink IT, March, 2004

Oracle raised the stakes last month in its bid to take over Peoplesoft, to an irresistible $26 a share level, a substantial premium on Peoplesoft's elevated price of just under $22 at announcement, closer to $23 today.

Peoplesoft thought about the bid for a few days and unsurprisingly rejected it. But given the weakness of Peoplesoft's last quarter, the only reasons for investors to turn down Oracle's massively revised offer is either because it is deemed anti-competitive by the US Department of Justise (DoJ) *, or because shareholders feel it will leave Oracle with insufficient cash to run the combined operation. Software companies do not run well when saddled with debt.

The first hurdle should be cleared on the same day that Oracle has set as the deadline for tendering shares, on or before March 12, so it is likely that at least one of these obstacles will be out of the way by then.

The simple fact of the bid is that Oracle has $8bn in the bank and Peoplesoft has $1.5bn. To exercise the bid will cost $9.4bn leaving a mere $100m in cash in the bank for the combined company.

Debt agency Moody's has already said, at the time of its first offer, that if the deal goes ahead Oracle will have cash issues.

However, last quarter Oracle threw off $600m in cash, while Peoplesoft was at least not bleeding any cash Immediately after the JD Edwards takeover. So Oracle should, technically, be able to afford the deal, and as long as restructuring costs are not too heavy, retain a decent amount of value in its share price, post deal.

It is only existing Oracle shareholders that might be inclined to balk, not those that hold Peoplesoft stock. Peoplesoft shareholders have already seen a remarkable swing in value since Oracle made its first offer flying up front valuing the company at $5.6bn, to the current price which values the company at $8.5bn, with the Oracle bid higher still.

When Oracle first bid for Peoplesoft, one financial pundit said that hostile bids needed to be at 37% on average above the share price in order to succeed. Well, that would have meant that Oracle's bid needed to get close to $8bn. The latest bid is well above that and still offers an 18% margin over the stock's value, h is likely that shareholders will fold like a pack of cards once all regulatory blocks are removed from the deal.

Oracle's share price has stayed pretty flat throughout, valuing the company at between 29 times and 31 times its annual net income.

The Peoplesoft position has been less clear. It was valued at around the same multiple, but with its net income for the year now down to $85m after costs of the JD Edwards merger, its value is more like 100 times its net income. It would need to triple its net income next year ($255m?), which is not out of the question, and achieve the same multiple as Oracle to sustain even its current value.

It is unlikely that shareholders are so confident as to expect that. The truth is that Peoplesoft used to have a net margin of close to 10%, while Oracle's has always been closer to 23%. If Oracle withdrew its bid, the Peoplesoft share price would drop like a stone and the shareholders now know it.

The first date for this deal to have gone through was July 4. Perhaps that day was chosen because Ellison knew that there were going to be fireworks.

Chances are, almost a year after the first bid was made, Oracle's Ellison may well be in sight of the prize.

Ellison said in a statement issued with the offer, "We believe this acquisition is pro-competitive, will benefit the customers of both companies, and will make Oracle an even more profitable company."

Jeff Henley, Oracle's chairman and CFO, said, "Given PeopleSoft's current prospects, including its recent downward revisions to earnings guidance for the first quarter, we believe our offer presents compelling value to Peoplesoft's stockholders. Oracle remains fully committed to completing this deal on terms that will benefit the stockholders of both companies. We expect this transaction to result in substantial cost savings, be accretive in the first year excluding amortization of intangibles, and involve minimal business integration risk."

Oracle put an appeal out to the Peoplesoft directors once more to talk to Oracle and has applied more pressure by putting up for election five independent Peoplesoft directors.

So far Oracle's previous offers have only teased out some 3% of Peoplesoft share holders who have not withdrawn their shares.

* It means nothing concrete, but the lawyers at the Department of Justise who have been examining the proposed hostile takeover of Peoplesoft by Oracle, have recommended that the Attorney General block the sale on grounds of reduced competition in the market.

But given the reputation of this administration to 'put out' for big business, it is still no certainty that the Assistant Attorney General, who is to make the final decision, will agree with his staff.

The Department of Justice will make its final decision by March 2.