When Mike Harvey, president of Sterling Software’s application management division, was shifted across to head-up the systems management business at the end of 1998 he was put there for one reason only. Harvey is a deal maker. He is the man that singularly transformed Sterling’s application development tools business into a $366m operation that now brings in 50% of the company’s revenues through instigating a number of acquisitions including TI Software, Synon and Cayenne. Now Harvey is charged with working his particular kind of deal making magic on Sterling’s smaller systems management operation which saw revenues of $204.5m last year.
Acquisitions are necessary for Sterling’s systems management business to continue growing at its current rate. Without acquisitions the business had been showing modest growth and reasonable profitability, having seen revenues increase 18%-20% a year and a consistent 30% profit margins over the last couple of years, according to Harvey. But to maintain that level going forward, Sterling needs to cultivate new revenues streams and to acquisition-hungry Sterling, that means buying new businesses in decline for little more than their market value and turning them around into reasonably profitable operations a la Synon and TI Software.
When I became president of the systems management division there had not been a single acquisition in five years. I’m here to change that, says Harvey. Under Harvey, Sterling has made its first two systems management purchases. At the beginning of March, the company bought storage back-up specialist, SpectraLogic for an undisclosed sum. Within three weeks the transaction was followed by the $64m cash purchase of mainframe to TCP/IP access company Interlink Computer Sciences.
But these acquisitions are clearly part of a Plan B strategy which Harvey is now in charge of executing. Three years ago, Sterling Software had its sights firmly set on buying a large well-established distributed systems management vendor in a bid to broaden its largely mainframe systems management tools into the client/server world. That acquisition strategy failed primarily because the valuations placed on any suitable target in this space were prohibitively high. Furthermore, the depressed nature of Sterling’s stock meant that any purchase had to funded by its $700m cash pile rather than its stock, which placed a further limitation on its purchasing power.
But while SpectraLogic and Interlink fit the Sterling acquisition model in the sense that both were in terminal decline and therefore could be picked up relatively cheaply, the portfolio of products each acquisition brings to the table only fill a small whole in its distribute systems suite. SpectraLogic fills Sterling’s requirement for a enterprise back-up product by supplying a reporting, monitoring and automated back-up tool for Unix and NT file systems. While Interlink’s e-Access product family provide mainframe to TCP/IP connectivity and management.
Interlink, like many mainframe software vendors, had been chanting the internet/intranet mantra by talking up its software as a vital component in ensuring secure and managed access to mainframe servers via TCP/IP networks, thereby effectively positioning the mainframe as an intranet or internet server. Sterling is continuing that message and argues that Interlink’s products are a vital part in providing access, control and management of legacy data over the web or corporate intranet. We needed TCP/IP skills. Performance and access management are key to network management in a client/server world and this acquisition brings both, says Ron Hardy, vp of business development at Sterling’s systems management division.
While this may undoubtedly be the case, the acquisition also brings $19m in cash and some 12,000 customers which are arguably equally as important to Sterling. The cash tops up Sterling’s own cash pile, which is gradually being depleted as it makes more acquisitions. And the installed base provides it with a captive market of enterprise accounts to which it can back sell other mainframe systems management tools, in much the same way it has done in the applications management space.
Interlink’s products mainly play in a different space to Sterling’s, albeit both product lines are mainframe-based. Sterling mainframe systems management products, which it has collected under the Solve brand name, are strictly management products. Interlink brings data movement products in the shape of TurboFTP and TurboTelnet, that facilitate file transfer to and from the mainframe, in addition to TCPaccess, its TCP/IP to MVS connectivity product.
However, there is one area of product overlap in e-Control, the enterprise TCP/IP Interlink picked up in January 1998 from Network Engineering Ltd for $2.9m. e-Control has similar functionality to Sterling’s Netmaster for TCP/IP. Netmaster provides two thirds of the functionality required to access and manage mainframe applications over TCP/IP, e-Control provides the other third. So we’ll merge the products, says Hardy. Exactly how and when this will happen is to be determined this week when Sterling executives sit down to discuss post-acquisition product plans.
Interlink was a company that was waiting to be bought. Its problems date back to January 1997 when it signed a sales, marketing and co-development agreement with networking giant Cisco for its IOS/390 mainframe to TCP/IP connectivity product. Interlink hoped the Cisco agreement would go some way to kick- starting the product’s sliding sales. IOS/390 had been priced out of the market by its primary competitor, IBM, which had been able to achieve volume discounts on its own mainframe to TCP/IP connectivity software by bundling the technology with its OS/390 operating system and mainframe hardware. Interlink assigned all IOS/390 sales to Cisco but the latter’s indirect sales channel could not make the necessary transition to selling into enterprise accounts that was required to be succesful with the Interlink product. Sales of IOS/390 plummeted and Interlink recast the relationship seven months later to enable it to re- establish control of IOS/390 sales.
The company’s other main blunder was to stray beyond its core focus in mainframe to TCP/IP connectivity products into network security with the acquisition of the Netlock business from Hughes Electronics a month later, in September 1997. Interlink had neither the technical nor sales expertise to make the acquisition pay and the company ended up taking a $1.2m restructuring charge in the second quarter of 1999 after it sold the business in December 1998.
Interlink’s strategic mistakes played right into Sterling’s hands as it enable the acquisition-hungry vendor to capitalize on its frail financial health by picking it up at a bargain price. Sterling paid a $9.1m premium on Interlink’s $54.9m market cap which had reported revenues of $29m, down 37% on a year earlier on losses of $7.4m for the year to June 30 1998, compared to a profit of $3.4m in the same period a year ago.
While Sterling’s acquisition history proves that it has the ability to turn this business around, that will not be enough in itself. The company has yet to report a quarter that is not laden with acquisition charges and these two most recent acquisitions will only serve to push that day further away and thus increase investors’ ire.
Furthermore, the task of building a distributed systems management business through smaller, cheaper, piecemeal acquisitions is always going to be harder than digesting one large established vendor that can provide most of the products Sterling requires in one fell swoop. Smaller acquisitions can create more product integration/duplication issues in addition to the sheer volume of work created by closing a number of successive deals.
Sterling is also up against competition that is pulling further and further ahead of it through embarking on similarly aggressive and perhaps more effective acquisition strategies, namely Boole & Babbage which completed its purchase of BMC last week, and Computer Associates which announced it intentions to buy Platinum Technology also last week.
