When Platinum Technology’s CEO, Andrew Flip Filipowski, flew into Winston, Salem, North Carolina to have dinner with Sanjay Kumar, president and CEO of Computer Associates, he knew he would walk away having sold the $1bn business he worked twelve years to create to a long-term rival, and one that was, ironically, as acquisitive as itself.
Despite publicly decrying the notion of selling his mainframe systems management baby to anyone, least of all a staunch competitor such as CA, Flip has been known to be secretly shopping for a buyer for at least six months. His company had hit a glass ceiling and selling the business seemed like the only viable exit strategy left open to him.
The acquisition tear Platinum had embarked on, buying two to three companies every six months for the last three years, had elevated it to one of only two software companies with $1bn in revenues (the other being PeopleSoft). Profitability, however, had been sacrificed for revenue growth and no amount of restructuring could squeeze out higher margins. Our margin objectives were between 10% and 15%. We made 10% last year and our plans were to increase to 15% for 1999 but that just wasn’t enough. We were still being penalized for the lack of margins in our business, Flip told journalists on a conference call.
There were two offers already on the table when Flip finally met Sanjay who, according to the Platinum CEO, had been trying to get hold of me for quite a few months. The $3.5bn offer Sanjay placed on the table represented an astonishing three and half times Platinum’s 1998 fiscal revenues. And CA, in characteristic style, was offering to close the deal in cash. Sanjay was offering to pull Flip and his company into the largest software deal ever to create a $6bn power house. It was an offer only sheer stupidity could refuse.
CA’s offer also meant that Flip could fill his duty as CEO by exacting the maximum shareholder value from the sale of the business and also leave himself with a comfortable nest egg. Having traded a war of words in systems management with its one time rival, Flip had no choice but to put CA’s astronomic cash offer to the Platinum board. The offer was naturally accepted.
Just a week after Sanjay and Flip met for dinner, if both parties are to be believed, both executives were publicly espousing the merits of the deal. Any suggestion that the companies had been bitter rivals in systems management was dismissed as mere good theater or rhetoric. Any mention that CA had bought a vast number of tools that mirrored its own, particularly in the DB/2 management tools space was cast aside as nonsense. Nobody was particularly convinced. There are a number of product issues that have been thrown up by this deal (see separate story) and, furthermore, a number of short term issues it will need to address once the acquisition closes in 60 days time.
Principally, CA will need to improve Platinum’s 10% operating margins to somewhere closer to its own 40% in order to make this deal accretive and persuade Wall Street of the sagacity of this transaction. Morgan Stanley has upgraded CA stock from neutral to strong buy, but the majority of investment houses are still waiting to see how CA will digest its largest acquisition ever before giving it their blessing by upgrading its stock.
The obvious and most expedient method of regenerating Platinum’s margins will be to cut any dead wood in personnel and eradicate any products that already duplicate its own – in typical CA asset management style. Although Platinum has already undergone one restructuring this year for which it took a $100m charge in the March quarter to reduce headcount by 1,000, there is believed to be further fat to trim. CA is tap dancing around the issue of lay-offs but they will be significant, says Lance Travis at AMR Research.
That said, CA might find that it already has an employee exodus on its hands and lay-offs may not be quite so necessary. For a start, Flip, Platinum’s ebullient and
headstrong leader, is unlikely to stick around, and neither is a significant proportion of senior management, say analysts. Many of Platinum’s senior management are likely to leave and that may extend across the board. There’s likely to be a big culture clash and Platinum folks won’t stick around because the employment market is buoyant and there are too many better opportunities out there, says Travis.
One knock-on effect could be that CA ends up with Platinum products that it deems to be strategic in datawarehousing or business intelligence, for example, few Platinum people to support them and no expertise to drawn upon within its own ranks, say analysts.
An employee exodus would also not bode well for CA’s plans to bolster its service business through the acquisition of some 1,000 Platinum consultants. The consulting business is arguably one of the key draws for CA which has spent the last year building an army of consultants through a series of smaller niche acquisitions.
The other potential risk is that any potential accretive aspects of further headcount cuts to Platinum’s newly trimmed 5,000 employees may be countered by the increased debt and in-process R&D and goodwill amortization charges the transaction brings. Merill Lynch estimates that goodwill amortization will amount to $2.3bn over 20 years and in-process R&D amortization will amount to $500m over the next five years. These charges will have a fairly significant drag on earnings and could result in as much as $0.9 to $0.10 per share per quarter for the next five years, if Merill Lynch’s estimates prove correct.
Furthermore, having extended its credit line from $2.6bn to $4.5bn to finance the all cash purchase, the investment community is concerned that CA is now too heavily geared. Moody’s Investors Service has placed CA’s debt ratings on review for a possible downgrade, on the basis that the $2.8bn in debt securities it already has will be affected by this $3.5bn cash transaction. While CA has been an active acquirer of enterprise software companies and has a solid track record integrating such acquisitions, the bulk of its acquisition activity has been of more moderate sized companies, Moody’s said. Ratings placed on review include CA’s Baa1-rated senior notes and unsecured bank credit facility, and Platinum’s B1-rated senior unsecured bank revolver and B3-rated subordinate convertible debt.
CA is nevertheless characteristically bullish. It asserts that Platinum will be able to add $450m in operating cash flow in the next 12 months and that the acquisition will generate sufficient revenues to enable it to pay back the $4.5bn it has now borrowed within four years.
Whether this proves to be the case remains to be seen. CA, rather like many enterprise software vendors, has been facing intense pressure of late. The acquisition of Platinum Technology will shore up its market share but will not ease the pressure that market consolidation in this sector as a whole has created. Boole & Babbage has strengthened its position through the acquisition of BMC’s high profitable DB/2 tools business and IBM’s Tivoli division still remains a strong contender. á
