More Idle Talk About IBM or Microsoft Buying SAP

Published: May 18, 2009

by Timothy Prickett Morgan

Last week there was chatter, once again, about either IBM or Microsoft acquiring software giant SAP. And both companies picked a different media outlet to shoot the rumors down.

Steve Mills, the general manager of IBM's Software Group, spoke to Fortune and tried to quash the recurring rumors, saying that Big Blue has "consistently shied away from going deep into the applications space" and that the company did not intend to change that strategy. Which could turn out to be one of the stupidest strategies that IBM has, now that Oracle is shelling out $5.6 billion to buy Sun Microsystems and has patched together the second largest revenue stream and the largest ERP customer base in the world thanks to acquisitions.

If Mills wanted to be completely honest, what he would have told Fortune is that no matter what IBM might desire, it can't afford to buy SAP and that the only possible combination between the two companies with be something akin to a merger of equals, despite the lopsided sales levels between Big Blue and SAP. IBM has spent $86 billion on share buybacks from 2000 through 2008, which boosted its earnings per share every quarter like crazy. But that also means that IBM doesn't have anything close to enough cash to buy SAP, which has a market capitalization of $46.6 billion as we go to press. IBM exited the first quarter with $12.3 billion in cash and securities, but it has $7.6 billion in debt (and that doesn't count the $23.4 billion in debt that its Global Financing unit has racked up leasing machines to customers and fronting wares to resellers). IBM can't afford to buy squat as long as it continues eating its own shares with the cash it throws off, which it needs to do so the top brass and the Wall Streeters who make a living off of rising IBM shares can continue to do so. This is the dark side of financial engineering: it is addictive, and it limits your options.

Mills is talking nonsense, by the way. IBM used to have a huge application software business, and it decided to back out of it in the early 1990s when it wanted to focus on selling systems. That left the market open for the SAPs and Oracles of the world, and you can debate for yourself who was the winner on that strategy. (I'll give you a hint: hardware gross margins, maybe 35 percent, software gross margins, maybe 85 percent.) IBM could reverse itself on this no-apps strategy just as easily and as quickly as Oracle has done as it explains to everyone it wants to keep Sun's hardware business and be an application platform maker. Oracle never wanted the Sun hardware business, but it had to take the hardware to get its mitts on Java and Solaris.

Anyway, if IBM wanted to merge with SAP, the merged company would have three IBM shares for every one SAP share, and the final board would have about the same split. (That's based on $133.95 billion market capitalization for IBM as of last Friday.) If IBM did merge with SAP, based on calendar 2008 financials, the resulting company would add $11.6 billion in annual sales and $1.87 billion in profits to IBM's $103.6 billion in revenues and $12.3 billion in profits. SAP would only boost IBM's Software Group by around 50 percent. And giving up a quarter of the control of the resulting Bigger Blue might not be worth it. What is clear is that IBM surely does not have the $50 billion to $100 billion to acquire SAP outright, and such an acquisition would not pay for itself for decades based on net earnings. A merger only makes sense; an acquisition is financially impossible.

Last week, Microsoft floated out some perfectly boring senior unsecured notes to the tune of $3.75 billion, which the company said was going to be used for general purposes and perhaps for stock repurchases or acquisitions of other companies. And so off the tongues went a-wagging about an SAP-Microsoft deal.

Microsoft's chief executive officer, Steve Ballmer, told Reuters that this was silly talk. Or rather, a "random rumor" that he had no intention of talking about. Microsoft has more cash than IBM--I guess we all know who has the stronger monopoly, eh?--with $7.3 billion in cash and $18.1 billion in short-term investments. Microsoft has no debts, but $25.4 billion in cash is nowhere near enough money to buy SAP, and adding a piddling $3.75 billion takes it not one step closer to doing a deal. Microsoft is undergoing its first layoffs in its history--5,000 people were cut from the company--and is not going to merge with SAP to solve its problems. Nor will it buy Yahoo until that company crashes down a lot further.

Sometimes, a company is too big to acquire. Even by other powerhouses.

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