A Long Way To Go And A Short Time To Get There
That is what HP (NYSE: HPQ) has ahead of themselves as they announce their bid of $52 per share or $4.5 billion to acquire Mercury Interactive Corporation (OTC: MERQ).
The prognosticators at Israel’s Globes newspaper called this acquisition on May 1, 2006 but with a price tag of a paltry $3.5 billion. When this “fictitious” article hit the press, Mercury was quick to insist the rumors were false and expertly put a spin around the notion that they wanted to remain an independent software company, put the NASDAQ delisting behind them and continue to serve their constituents with high quality software. What a difference $1 billion can make!
In Mercury’s defense, they were moving along in 2006 appearing as though they were going to remain independent and possibly even somehow re-invent themselves. Some examples of this pursuit were the two acquisitions made in 2006 totaling $123.5 million. For those keeping score the tab was $105 million for Systinet and $18.5 million for Tefensoft.
Now, there are two interesting things about both of these acquisitions: the first is they were forward looking and new technology, not about customer acquisition; the second is neither acquisition had anything to do with their flagship product line of testing. So, while Mercury was going about creating the cloak of independence they were ignoring their bread and butter constituents – the testing customers. One may have interpreted this as Mercury may be willing to sell off the testing business and have a go at being a re-invented independent company.
Fast forward to July 25, 2006 and HP is, in fact, buying Mercury for $4.5 billion – the second largest acquisition in the company’s history. The primary questions are what is HP getting and is it worth $4.5 billion?
The initial reaction to the amount of money being paid is to compare it to the IBM acquisition of Rational back in 2003 for a scant $2.1 billion. At the time of the IBM / Rational acquisition the reaction was IBM over paid. The reaction to the HP / Mercury acquisition – HP is over paying.
The larger question is what is HP getting by buying Mercury? HP gets an instant enterprise software business for the short term. Mercury is, at its core, a testing company. Mercury owns over 50% of the testing market. Mercury has had a great ride in this market since there have been no competitors capable of dethroning the savvy marketer…that is until now. Mercury, long the dominant player in the testing market was able to indulge in premium pricing because the competition could not figure out how to stem the Mercury tide. However, a company from Redmond, WA by the name of Microsoft quietly entered into the testing market via its Visual Studio Team System product line. Mercury’s responses to the entry – hide its head in the sand and ignore the problem and maybe it will go away. Microsoft, known for its aggressive high volume / low margin pricing model, announced in May of 2004 its intent to enter the testing market. Mercury did nothing and continues to do nothing about Microsoft’s growing and wanted presence. Will HP attempt to compete with Microsoft? Or, does HP now want to compete with IBM and its Rational suite of products. HP has a long way to go to compete against either Microsoft or IBM and a short time to get there.
With this short term “insta-software” business HP is also buying a culture clash. Mercury is a software company and behaves as a typical software company. HP is a hardware / toner company. The two cultures are not conducive to one another. Mercury has long been focused on the application. HP on the other hand is focused on the network. These two approaches are fundamentally different and require a different mindset of how to market and sell products. The total number of Mercury people who make the transition to HP and stay more than one year will be minimal, at best.
HP should enjoy its “insta-software” business while it lasts because Microsoft and IBM are not docile competitors.
HP may very well think they will be purchasing a world class sales organization with the Mercury deal. The Mercury sales organization is as aggressive and tough as any in the business, but…sales is a context sensitive and highly transient profession. And, selling for a vibrant energetic company like Mercury once was is a far cry from selling for a toner company.
The argument could be made that HP is acquiring top executives. Yes, Mercury’s executive team is strong, but how many top executives in a growing company are willing to take senior manager positions in a behemoth like HP? Executives will stay for 366 days and then "pursue other interests."
HP may think they are getting top worker talent through its acquisition. Realize, Mercury’s foundation has been weakened by its recent NASDAQ delisting and investigation. Much of the top talent has been recruited to other hot companies in the Valley. And, Mercury’s people at the worker level were superb in their execution, making them attractive targets for some of the hottest companies such as E-Bay, Google, VMWare (EMC), etc.
And, without a doubt, HP is buying a large risk. The risk of the unknown and what will happen with Mercury’s 2005 fiscal and quarterly filings, their first and second quarter 2006 filings, and the pending lawsuits filed by shareholders.
So, at the end of the day what is HP getting for $4.5 billion? Answer: a short term software business that is likely to be consumed by Microsoft and IBM.
Customers of Mercury’s products should be wary of the new steward of the technology and begin to investigate other options. An investigation of other options is warranted even if they make no move. If customers decide to move away from Mercury products, the move should be a phased process and customers need to understand both the soft costs and hard costs of such a move.
Given the purchase price is astronomically high one has to wonder what other companies were in the bidding war for Mercury and is Compuware the next independent software company to fall?
What's next?...are you flexible?