IBM's Acquisition Philosophy: Opportunity and Long Term Value

by: Rob Black

IBM’s (NYSE:IBM) software Mergers & Acquisitions team has apparently been very busy in recent weeks. Having spent over $3.6 billion this past month, the company leads the way in medium to large scale acquisitions and delivers on our expectations for continued consolidation in enterprise software.

IBM is seen as a “disciplined acquirer” of other software companies and insists that market valuation does not drive the selection of its targets. Rather, the company measures acquisition candidates according to which one offers the best return on use of cash as it works to complete its architectural model.

IBM may sometimes pay a higher multiple for smaller companies if there is meaningful strategic value that can be realized as part of IBM, though this is less likely for larger acquisitions. Interestingly, IBM’s software team does not involve itself in the price negotiation process – that is done by corporate staff.

IBM does not engage in hostile acquisitions - the target company must see value in joining IBM, and the opportunities afforded by its platform. The opportunity for “lift” is measured in terms of the global reach of over 15,000 field sales and support representatives. According to Steven Mills, Senior Vice President and Group Executive, IBM Software Group, if the opportunity is not there, IBM will not do the deal. IBM stresses the importance of spending more time on the outcome of acquisitions rather than simply focusing on the acquisitions themselves.

In total, IBM acquired over $1 billion in annual revenues in the month of August, representing roughly 6% of its resulting $18 billion software business – the second largest in the industry next to Microsoft (NASDAQ:MSFT). IBM is not about doing the deal, but about making it work after the fact. As such, we expect that the company will be very busy in the months to come, integrating their most recent spate of acquisitions:

* Webify, a private SOA software company on August 2nd for an undisclosed amount, to be integrated into the WebSphere brand.

* Asset and service management software company, MRO (MROI) Software, for $740 million on August 3rd, to become part of the Tivoli software unit.

* $1.6 billion for FileNet (FILE), a business process and content management company, on August 10th, to be become a part of IBM’s Information Management unit.

* August 23rd acquisition of Internet Security Systems (ISSX) for $1.3 billion, to be part of the Infrastructure Management Services business unit, which is part of the Tivoli brand.

The combined package represents approximately $450 million in recurring maintenance revenue over the last twelve months in exchange for roughly $2.8 billion in enterprise value. This represents 6.2x EV/LTM Maintenance, greater than the 3.5-5.1x range for the financial value of a software acquisition, implying modest incremental strategic expectations for these deals.

The recent pace of activity prompts analysts to question IBM’s overall software acquisition strategy. Are these acquisitions truly strategic in building out their architecture? In certain cases, are they attempting to consolidate a particular segment of the market?

Or, are perhaps some of these acquisitions defensive? At this time all of these motives apply in whole or in part to each deal. For example, both Filenet and Internet Security Systems acquisitions were partially defensive. Analysts will continue to monitor IBM’s activity with these criteria in mind.