The Four Hundred

In the application software market, three plus four equals two, now that PeopleSoft has announced it will acquire rival enterprise software maker J.D. Edwards for $1.7 billion in stock. PeopleSoft is the third-largest application provider, with $1.9 billion in sales in the past 12 months; JDE is number-four, with $886 million in sales. The merger vaults PeopleSoft over former number-two, Oracle, but PeopleSoft will still be considerably behind number-one, SAP, which booked 7.4 billion euros in revenues in 2002 (about $8.7 billion).

Under the terms of the deal, PeopleSoft will give JDE shareholders 0.86 PeopleSoft shares for each of their JDE shares. That will give JDE shareholders collectively 25 percent of PeopleSoft's market capitalization, which had a value of about $5.5 billion before the deal was announced. Based on the price of JDE stock at the close of business last Friday, the deal puts a premium of about 19 percent on JDE, which had a market cap of around $1.4 billion. As you can see from the market-capitalization-to-revenue ratios (2.9 for PeopleSoft, 1.6 for JDE), Wall Street and investors like PeopleSoft more than JDE as an investment. But by acquiring JDE, PeopleSoft is making a great investment: It will increase its sales by 50 percent and gain some 6,700 very loyal customers, more than doubling its installed base to 11,800 customers.

There is very little customer overlap between PeopleSoft and JDE, which is one reason why the two companies have been flirting with the idea of a merger for years. The uncertainty on Wall Street and in the IT market in general has kept the two companies from merging, but now that things seem to have stabilized at a crummy economic level, it is probably as safe as it ever will be for such a big deal. Hence, PeopleSoft made the move to acquire JDE. Bob Dutkowsky, president and CEO of JDE, said the two companies had assessed their options to grow organically or through acquisitions in 2002, and both had come to the independent conclusion that PeopleSoft and JDE should merge. In the fall of 2002, the two companies started talking about it, and then Citicorp and Morgan Stanley were brought in by PeopleSoft and JDE respectively, to broker the deal.

PeopleSoft got its start 15 years ago in selling human resources software for mainframes, DEC VAXes running VMS, and various Unix servers. Over the years, it has expanded the number of platforms it supports to include Windows and less-common versions of Unix. Only a few weeks ago, the company committed to porting its full ERP suite to Linux. PeopleSoft's eponymous ERP application suite has sold best at services companies, educational institutions, and governments. The company is best known as a supplier of human resources management software, and that HR software gave PeopleSoft the money it needed to develop and launch a full ERP suite for Unix and Windows servers in the mid-1990s. (The ERP application set is based on C++, Java, SQL, and now various Web technologies.) While, technically, PeopleSoft and JDE were competitors, PeopleSoft spent a lot of time chasing large enterprises, going up against SAP and Oracle. According to Craig Conway, CEO and president of PeopleSoft, only 16 deals in his company's pipeline in the fourth quarter of 2002 had JDE involved as a competitor (he declined to say how many deals were in that pipeline, but it had to be several hundred). The reasons why PeopleSoft and JDE didn't go up against each other often has as much to do with history and platforms as anything else.

JDE started out writing software for the oil and gas industry back in the 1970s, on IBM's System/3X proprietary midrange servers. In the aftermath of the AS/400 launch, in 1988, JDE emerged as the dominant supplier of enterprise applications for these midrange machines, particularly among manufacturers and distributors. Some 4,000 of JDE's 6,700 customers are still using its RPG-based WorldSoftware applications, and they will likely continue to do so for the foreseeable future. The remaining 2,700 customers are using the company's OneWorld cross-platform suite, which is based on a mix of C++ and Java, which runs on Unix, Windows, and OS/400 platforms, and which has recently been renamed JDE 5.

PeopleSoft has always had midrange aspirations and surely wanted a bigger piece of the manufacturing and distribution market, because these two sectors represent a large portion of the world's economy. The company even launched and briefly supported a version of its ERP suite on the AS/400 platform before quietly killing it just after Conway took over the company in the fall of 1999, when ERP software sales started drying up after several boom years. According to Conway, who spoke to the press and Wall Street analysts after announcing the deal Monday morning, supply chain and manufacturing software sales were the fastest growing segment of PeopleSoft's business in 2001 and 2002, but that was said almost defensively, as if to imply that PeopleSoft didn't need to buy JDE to get a bigger chunk of the manufacturing and distribution sectors for large enterprises. But if that were true, PeopleSoft wouldn't be buying JDE. And while PeopleSoft has caught midrange madness, like all other software vendors have, as the sales cycles among large enterprises get stretched out, it is not a core midrange vendor like JDE. About a third of PeopleSoft's new customers have been midrange companies in recent quarters, and this is pretty good. But almost all of JDE's customers are midrange iSeries, Wintel, or Unix shops, and the company has a deep understanding of how to simplify, integrate, and package applications that are digestible for companies that do not have large IT staffs and budgets.

While PeopleSoft seems to be aiming at Oracle and SAP in terms of size and breadth, it is probably most worried about Microsoft. Having acquired Great Plains and Navision, Microsoft is hell-bent on creating a $10 billion application software business by 2010. And while Great Plains and Navision together account for only about $500 million in sales right now, Microsoft has more cash in the bank than any other company on the face of the earth. Time is on its side, and it has decided to invest $2 billion to attack the midrange application market. This is the most serious that established ERP vendors have ever faced. Buying JDE is PeopleSoft's girding its loins to do battle with Microsoft on its own Windows turf. PeopleSoft's recent enthusiasm for Linux shows you the weapons that the company intends to use against Microsoft, and indeed against any other ERP player.

Both Conway and Dutkowsky were adamant that they were not going to try to merge the PeopleSoft 8 and JDE 5 product lines, or try to force customers to move from one server platform to another to simplify the now significantly expanded PeopleSoft product line. While the PeopleSoft and JDE sales forces and management teams will be merged across industry vertical groups and company size strata, PeopleSoft intends to keep the two product lines distinct, even after the development teams are merged. "All enterprise software companies have to protect their installed bases," said Conway on the call. "We're not going to do anything that alienates or causes suffering for either of our installed bases. We are not going to push anybody to where they do not want to be." Kevin Parker, PeopleSoft's CFO, said something that will probably make iSeries and AS/400 companies a little less jumpy about the deal, given that PeopleSoft has already once killed support for the platform. "The success of this deal is not predicated on changing the support level for the iSeries or any other product."

Based on what Conway and Dutkowsky said, it looks like PeopleSoft will cherry-pick pieces of the JDE 5 suite and pull it into PeopleSoft 8, where it has gaps, and grab the HR and other modules that JDE 5 is missing and pull them down into that suite. Eventually, over the course of years, PeopleSoft may change its mind about merging the two product lines. But given the distinct requirements of large enterprises and midrange businesses, this seems unlikely.

In the end, PeopleSoft is buying a big installed base with a nice maintenance revenue stream and the expertise of a programming team that knows about manufacturing and distribution to a depth that PeopleSoft does not. The JDE acquisition also gives PeopleSoft critical mass in Europe, the Middle East, and Asia to go head-to-head with any of the big players among enterprise customers, and gives it better footing to shove smaller players out of the midrange.

The combined company will have about 13,000 employees, and Parker said that massive layoffs were not in the cards, although he did say that there would be some adjustments. Exactly how the head count will work out as the management, sales, and programming teams from both companies are merged is unclear. Parker said that PeopleSoft had already identified about $80 million in potential savings from the merger, which puts the new PeopleSoft on the track to be a $3 billion company with about $300 million in net earnings, and Parker said that he believed that the company could get gross margins in the high teens even though JDE has had more trouble hitting that gross profit level than PeopleSoft.

As long as the profits hold out, PeopleSoft is not going to stir up the hornet's nest of platforms and ERP suites. But if the economy sours further, PeopleSoft may have no choice but to consider emphasizing one suite over another, or a merged suite with enterprise and midrange editions. Just because the company is making such promises today does not mean that it can keep them tomorrow. What is clear is that PeopleSoft bought JDE for its customer base as much as anything else, and it will do everything in its power not to upset them and its reseller channel.

PeopleSoft is really making a long-term bet that PeopleSoft 8 and JDE 5 customers will, after being treated fairly by the merged company, come back to them when they need to add new software modules that one or the other company did not offer before the merger. This is a sound idea. Many midrange shops are already supporting mixed Unix-Windows or OS/400-Windows environments, so supporting mixed PeopleSoft 8-JDE 5 applications on these mixed environments is not that much of a jump. If PeopleSoft can move modules around and tightly integrate them to bolster the PeopleSoft 8 and JDE 5 suites, this deal has a good shot of succeeding while not antagonizing customers.

That is unless Oracle doesn't scuttle the whole deal. At press time, Friday morning, Oracle launched a $5.1 billion, all-cash, hostile takeover of PeopleSoft. This is barely a 5 percent premium over PeopleSoft's current market value and would deplete just about all of Oracle's money in the bank. Oracle CEO and chairman Larry Ellison, who would like to be the number-one application vendor in the world, would likely go higher to get PeopleSoft, but exactly how high is unclear. Oracle says that it would not continue to sell PeopleSoft's line of products, but put them in maintenance mode while merging some modules into the Oracle Applications 11i suite and then asking customers to "upgrade" to that Oracle suite at their convenience. This, says Ellison, is a better option for PeopleSoft customers and shareholders than the merger with JDE. This could be a real deal, and then again it could be a publicity stunt like Ellison's on-again, off-again flirtations with network computers.