Companies throughout the tech sector seem to be on a buying spree of late. Oracle, which specializes in database management systems and related corporate software, has completed 67 acquisitions in the last five years. Hewlett-Packard has added Palm and 3Com to its portfolio since last fall. And a bevy of other deals -- or attempted deals -- ranging from Microsoft's pursuit of Yahoo to information infrastructure company EMC's acquisition of Iomega, a producer of networking storage hardware, have been proposed or completed recently.
In many of these recent instances, the target company has lost some of its brand luster or market strength and the acquiring company, attracted by a bargain-basement price, thinks it can do a better job of running things. For example, Palm bet big on one device -- the Pre smartphone -- to turn around the company's fortunes. But the move didn't pay off: In February, Palm cut its revenue forecast; in March, it reported a quarterly loss of $22 million; and in April, the company cut its forecast again. On April 28, HP announced that it had purchased Palm for $1.2 billion, looking beyond the company's problems to see an opportunity to use Palm's well-received WebOS mobile operating system to compete with Apple's iPad.
Other recent examples: Sun Microsystems was losing money -- $2.2 billion in fiscal 2009 -- amid a revenue slide and various restructuring efforts when Oracle came calling in April 2009. Oracle said Sun was unproductive and too decentralized, and outlined a repair plan when it closed the $5.6 billion deal in January to buy the computer company. And Microsoft made a $44.6 billion bid for Yahoo in early 2008, hoping to gain more search engine market share to better compete with Google. But Microsoft ultimately settled for a partnership with Yahoo rather than a merger.
Palm, Sun and Yahoo were all at inflection points, notes David Hsu, a Wharton management professor. Acquirers are trying to airlift the brands, technology and know-how and embed them in a different setting to maximize success.
More than typical M&A activity, these deals -- and others like them -- show that the technology industry has matured, say experts at Wharton. Once companies reach a certain size, acquisitions are one of the few ways to grow and keep the innovation cycle going. As technology companies find it increasingly difficult to move the revenue needle by acquiring startups, larger acquisitions of former superstars have become the focus.
The technology industry is evolving. You can see it mature, says Saikat Chaudhuri, a Wharton management professor. Andrea Matwyshyn, a legal studies and business ethics professor at Wharton, agrees: Tech companies are demonstrating the patterns we see in industries with more longevity.
The goal of these more mature takeover strategies is to gain market share, enter a new market or acquire intellectual property that can head off a competitor. Some technology companies, such as Cisco Systems and Google, tend to buy smaller firms. An increasing number of acquisitions within the industry, however, more closely resemble leveraged buyouts in which the objective is to find value, make the target more efficient and reap the rewards, says Hsu. But these acquisitions come with the usual risks and challenges associated with bringing any new arrival into an acquiring company's fold.
The big difference between what's happening in the tech sector and a traditional leveraged buyout is that there is little to no debt involved in the recent tech deals. Microsoft, Oracle, Apple and others have a ton of cash, notes Hsu. To take the leveraged buyout approach [and turn around a company] you have to be able to finance it. Technology companies have the resources. Indeed, HP had cash and equivalents of $14.1 billion as of April 30; Oracle had $9.3 billion as of February 28, and Microsoft had $8.1 billion ($39.7 billion, if you include short-term investments) as of March 31. For many of these companies, it's like they have money burning holes in their pockets, says Wharton management professor Lawrence Hrebiniak.
Making the Deals Work
The master plan behind many of these purchases is to increase share in a particular market to better compete against a stronger competitor. HP bought 3Com to go up against Cisco in networking. Its acquisition of Palm was about acquiring the intellectual property to sell corporations a variety of mobile technologies. Karl Ulrich, an operations and information management professor at Wharton, notes that each deal has its own story line, as the HP examples show. Any particular acquisition will be motivated by an idiosyncratic mix of factors, he says, which range from intellectual property and brand cachet to operational expertise and price.
Whatever the story line is for the purchase itself, the acquired company has to fit into the buyer's larger corporate narrative, or else problems will develop. Experts at Wharton give both HP and Oracle credit for being able to pull off multiple acquisitions without any big disasters. Wharton experts note that HP has had a history of making acquisitions work. Mark Hurd, its CEO, has been adept at acquiring companies, cleaning them up and stitching them into the company's product portfolio, says Chaudhuri. In a conference call last month, Hurd noted that all of our acquisitions have a pretty extensive filter in terms of [being] strategically sensible [and] financially sensible.
As for Oracle, in many respects it pioneered the approach to acquisitions that is now becoming prevalent in the tech sector. Oracle has acquired a series of former competitors -- PeopleSoft, Siebel Systems and BEA Systems, to name a few -- and some of the targets were struggling at the time they were bought. Oracle's acquisition of Sun puts the company into the hardware business. Traditionally, Oracle has sold database applications that run behind the scenes at big companies. With Sun, Oracle is looking to offer complete systems and compete with the likes of IBM. These companies are fierce competitors trying to move up from the No. 2 or No. 3 spot in a market and challenge the leader, says Chaudhuri. These deals are strategic moves designed to buy specific pieces of a product portfolio.
The challenge for the acquirers is that they have to integrate their targets and then create a new market or product category. HP isn't going to win by adding what everyone else has, says Hsu. These [mergers] are really successful or they go up in flames. Companies need to have a plan as to whether they can integrate relevant knowledge and divest what was holding back the company. This is basically the leveraged buyout industry. An acquirer comes in to reorganize, make managerial decisions and create some value. It's the same idea here.
The Dangers Involved
While shopping for struggling technology companies can be full of potential, dangers lurk at the checkout counter. All companies have to do the due diligence, understand what they are acquiring, know the IP and see if it fits, notes Hrebiniak. Indeed, experts at Wharton say these acquisitions raise a host of issues. For instance, some of these damaged brands were on the decline for a reason. Sun was innovative, but failed to make money from inventions such as Java. Sun had visionary types who didn't know how to implement their technologies, says Chaudhuri. Sun wasn't practical and lacked operations expertise. They were all technology dreamers.
The challenge to the acquiring companies is to right the ship, change the culture and keep the strong parts. If those tasks are not completed, buyers get stuck with a value trap, or a purchase that looks like a bargain but never lives up to its potential. The risks involved with these acquisitions are part of the reason why companies such as Cisco tend to focus on smaller purchases that can easily be folded into operations. If it's a struggling company, there's probably a reason why it's struggling, Hsu says. There were poor choices by management, poor choices on product development and personnel issues. For instance, HP will have to take Palm's assets and strip out the behaviors that led to the company's struggles. It wasn't always the case that Palm struggled. There are definitely assets there in the domain of intellectual property.
Gaining market share in search is what sparked Microsoft's original interest in Yahoo. Microsoft CEO Steve Ballmer said repeatedly that he wanted economies of scale in search to compete with Google. Since that initial effort, Microsoft launched the Bing search engine and is now integrating its search partnership with Yahoo. However, companies can't be blinded by the allure of a head start when it comes to dealing with integration challenges. Culture clashes, departing personnel and the inability to innovate are all risks, says Hsu.
Oracle CEO Larry Ellison has said he is confident that he can innovate with Sun. He told Reuters that Sun management made some very bad decisions that damaged their business and allowed us to buy them for a bargain price. But he noted in a separate interview with Wired magazine that Sun had good engineers and technical managers. Chaudhuri describes the purchase of Sun as a high risk, high reward deal. Oracle's core business has been software, and it has to prove that it can also sell servers and integrated hardware systems that compete with entrenched players like IBM. The challenge is not merely to make Sun more efficient: Oracle has to harness the best parts of Sun and use them to disrupt the existing market landscape.
There are two steps to ensure a successful acquisition, says Chaudhuri. First is the easy part with [implementing] the cost synergies. But companies need to go beyond that and innovate. Tech companies have never been about cost synergies. It's about the innovation that leads to new technologies.
Incomplete Endings and Murky Returns
One thing is certain: The acquisitions will persist as the technology industry continues to mature. IBM CEO Sam Palmisano said last month that the company plans to spend $20 billion on acquisitions between 2011 and 2015. Dell CEO Michael Dell said early this month that his company will continue to look for acquisitions. And other players show no signs of slowing down, either.
It's possible that the real returns on recent and future tech acquisitions will never be completely known, Wharton experts say. In leveraged buyout situations, a company may return to the public markets after becoming more efficient as a private firm. Investors in the revamped company can then measure performance every quarter.
Technology companies, however, often lump acquisitions into established units, so it's almost impossible to track sales after a deal closes. For instance, 3Com became HP's networking unit, which is combined with its enterprise server and storage unit. For its part, Oracle lumps its enterprise applications acquisitions into one division. You can see the rationale for these acquisitions and you can see the prices paid, notes Chaudhuri. But you don't know whether these companies remain also-rans. The verdict is out.