IBM Supersizes It: Purchase of FileNet Announced

Well, IBM is getting aggressive. In it's second large acquisition in a week, IBM (IBM) announced that it is purchasing FileNet (FILE) for $1.6 billion. This comes on the heels of another recent acquisition in the enterprise content management sector, the purchase of Hummingbird by Open Text for roughly $500mm.

Transaction Terms

Purchase Price: $35.00/share

Premium to Pre-Announcement Price: 1%

Enterprise Value: $1.2 billion

Enterprise Value / 2006E Revenues: 2.5x

Price / 2006E EPS: 30x

Target: FileNet

FileNet is an enterprise content management platform vendor. In other words, customers use FileNet's suite of products to build content management applications suited to their own needs. Web pages, word processing documents, spreadsheets, HTML, XML, PDF, email messages and other digital content are all examples of the types of content that FileNet is capable of cataloging, organizing and making available as needed.

FileNet has been in a bit of the doldrums over the last several years, with stock performance being essentially flat since the beginning of 1994 and revenue growth sub-10% annually. While net income has increased nicely over the past several years, operating margins remain rather lackluster at 10% over the past 12 months. Many believe that FileNet, as an independent entity, was not particularly well positioned with tough competition on the high end from EMC/Documentum (EMC) and Microsoft (MSFT) showing early success at the low-end with Sharepoint.

Strategic Rationale

IBM, showing a bit of a "me too" mindset with EMC, is justifying this transaction under its "Information on Demand" initiative. There is no doubt that managing information assets within an enterprise is a challenging and high value effort which equals expensive projects with lots of services. Perfect for IBM's capabilities and strategy.

Architect Partners Assessment

IBM has shown its smarts again with this acquisition. FileNet's products fit well within IBM's overall product set, albeit with some overlap. Most important for IBM's strategy, FileNet products drive considerable service revenue as well. Although as we mentioned above, FileNet's software should be considered a platform, it does continue to move IBM up closer to the application category and as we speculated in our post on IBM's acquisition of MRO Software, we believe this adds further validity to the notion that IBM's strategy around owning applications has shifted. Time will tell if our premise holds true.

One interesting dynamic worth mentioning is the lack of premium offered. Historically, on average, public company control premia have been on the order of 35%-40%. Clearly a 1% premium to pre-announcement stock price doesn't incent shareholders to act. The market's immediate reaction was to bid the price above the offer price by IBM, believing an alternative suitor will emerge. While it's possible, we believe that all logical purchasers had more than adequate time to consider this purchase and have likely chosen to pass on the opportunity. One also needs to consider that FileNet's stock price rose over 27% in the preceding month or so, suggesting takeover rumors were rampant. We bet that shareholders will be disappointed when other bidders fail to emerge. We'll be watching closely.

In addition, NY Times DealBook published a short piece on Friday speculating that another bidder may be lurking in the shadows for FileNet. We place the probability as quite low.

We believe that FileNet has been receptive to a sale for quite some time and it's been very well shopped informally. I'm also certain that alternative logical buyers were approached as part of the recent transaction process. This is wishful thinking on the part of investors who are reacting to the 1% stock price premium offered by IBM. What they are forgetting is that the stock has moved upward 27% in the past month or so on acquisition rumors.

IBM vs. FILE 1-yr chart: