Oracle's Bid for BEA Systems Comes at the Perfect Time

Oracle (ORCL) management picked a near perfect time to publicly announce its $6.68B bid for BEA Systems (BEAS).

1. BEA is under pressure from Carl Icahn to sell the company

2. Few possibilities of a competing bid

a. SAP (SAP) - a likely competitor for BEA, - is distracted by its recent Business Objects (BOBJ) acquisition

b. Others such as IBM (IBM), Sun (JAVA) and HP (HPQ) are unlikely compete for BEA

c. Private equity firms are unlikely to pay the high EBITDA premium

3. BEA’s operating results continue to be uneven

The proposed transaction is hardly surprising for it has been long speculated. BEA has repeatedly declined interest in becoming a part of larger company in general and of ORCL in particular. BEA CEO and co-Founder Alfred Chuang has joked once that he “did not want to be cleaning barnacles off Larry Ellison's boat”.

While one would expect the BEA board to ask Oracle for more, Oracle’s proposed $6.68B price for BEA – at $17/share –  is a 25% premium to BEA’s previous closing price and values the business relatively fully. We expect Oracle to be rather firm on the valuation and only move the price up slightly, if at all. BEA has been struggling in many aspects of its business - operational, competitive and regulatory matters – so we strongly suspect that many shareholders will welcome Oracle’s bid.

Icahn’s increased ownership and advocacy for a deal creates pressure on the BEA board to respond to Oracle’s bid. However should the board and key shareholders push for a much higher price, this deal could become a long winter war akin to the Peoplesoft saga. If that happens, BEA’s board and shareholders may find themselves feeling very lonely as their sales pipeline shrivels. The only long-term winners would be Oracle and in part IBM which competes head-on with BEA.

Oracle President Charles Phillips declared ORCL’s desire for a friendly transaction. Interestingly enough, Larry Ellison is so far keeping a low profile in this deal. Phillips also underscored that ORCL’s previous acquisitions prove that ORCL lives up to its commitments regarding support of the acquired company’s products. Here we have to note that Oracle’s MGI Index (a metric of corporate efficiency or corporate body mass index) has been steadily improving over the last 3 years, despite having done a number of large and smaller acquisitions.

The charts below plot Oracle and BEA monthly closing stock price, adjusted for any splits and dividends vis-à-vis the corresponding values of the MGI-A – MGI Index Annual data point and its trend line. Stock prices are on the left vertical axis and the MGI-A values are on the right vertical axis.

click to enlarge

As the charts illustrate, Oracle’s MGI scores are twice as high as BEA and rising at around 2000, whereas in contrast, BEA’s MGI Index values are between 900 and 1000 and have been declining. In our view this clearly illustrates that Oracle has a great deal of opportunity to create value through the transaction.

Oracle typically acquires companies that have lots of headroom for improving operating efficiency and has so far managed to maintain and actually improve its MGI Index score and rank. As we noted in our SAP/Business Objects note, Oracle has been able to make acquisitions pay for themselves within a year.

We do not see viable competing offers emerging for BEA. HP would have been the logical choice to acquire BEA, but pure logic is often wrong. In practical terms HP would not want to jeopardize its Oracle relationships and lose valuable sales channel cooperation for an uncertain gain on BEA. HP simply will not risk its huge server business over a middleware company. Private equity firms will not approach BEA at this price and at this time of credit tightening. SAP management has admitted having a full plate and has its own middleware technology..

Another interesting timing aspect of Oracle’s public bid for BEA is Oracle’s own internal product issues related to its Fusion integration technology. If Oracle is successful with its bid to acquire BEA, we would expect Fusion to fizzle out and key team members to leave or be re-assigned. Key delivery milestones for Fusion are due in 2008, so the timing of the BEA transaction could be auspicious. We believe that most Oracle application customers were already discounting Fusion as a viable long-term solution.

Oracle’s position in application servers and middleware begs the question of any potential regulatory risks in this acquisition. We believe that the regulatory risks of this deal are either minimal or easily mitigated. Oracle has never made a successful push into integration and transaction processing middleware outside its own customer base. The combined Oracle-BEA entity would be a powerhouse in application servers, but would still be up against IBM, JBoss and numerous other open source alternatives.

In terms of timing and process, there are four possible short-term scenarios:

• Scenario A: BEA agrees to the proposed transaction – probability 0.1. We expect BEA to put up some sort of a fight to ask for more
• Scenario B: BEA rejects Oracle’s offer and attempts to stay independent – probability 0.1. That would be suicide for BEA and open it up to lots of shareholder suits, not to mention a fight with Carl Icahn
• Scenario C: BEA asks Oracle for more money – probability 0.7. It is what shareholders would expect them to do
• Scenario D: BEA looks for a white knight – probability 0.1. Good luck!!

Bottom Line

We believe that in the bid for BEA Systems, the odds of prevailing are in Oracle’s favor. Oracle has the resources and track record to successfully execute and absorb this transaction. We do not see successful competing bids emerging. The price for BEA Systems may be revised up, but we do not expect it to go materially above the proposed $17.00 per share.

Disclosure: none