Eat ... Or Be Eaten

By Chris Taylor/San Francisco

In a tech industry in which news seems to trudge to the same dreary drumbeat--a relentless sales downturn, profits stagnant at best, venture capitalists with their wallets shut tight--at least Larry Ellison can still come up with a surprise. The founder of Oracle--one of the world's richest men, with company stock worth more than $17 billion--spent last week pushing a hostile bid to take over rival business-software firm PeopleSoft for a lowball price of $16 a share--about 50-c- less than the market value of the stock. Neither analysts nor competitors seemed sure whether to take him seriously. "Larry's just having some fun with these people," says Jim Goodnight, CEO of software firm SAS, based in Cary, N.C. "He's trying to mess up sales they're trying to close before the end of this quarter."

The 8,200 employees of PeopleSoft, based in Pleasanton, Calif., were not amused. CEO Craig Conway, 48, himself a former Ellison protege, had just successfully negotiated a $1.7 billion merger deal with another rival, Denver-based J.D. Edwards. That was supposed to be the big story in the software business. Then Conway's customers started talking about the Oracle offer and whether they should postpone purchases until things settled down. Even after the PeopleSoft board concluded there would be antitrust problems with an Oracle takeover, Ellison was still pressing the deal on PeopleSoft shareholders. By the end of the week, PeopleSoft and J.D. Edwards had launched lawsuits against Oracle. "I've observed his business practices before and not agreed with them," says Conway. "But this is a whole new level of Larry behavior."

And Ellison? The Oracle chief, 58, can't deny he's having fun. "I love flying planes and racing boats," he says. "This is more challenging." But at the same time, he insists, he is deadly earnest about PeopleSoft--and adds that other similar offers may be on the way. "The industry went a little mad over information technology; now we have to adjust," Ellison says. "Companies are going to get gobbled up, absolutely."

Even assuming PeopleSoft fends off his offer, Ellison may yet have the last laugh. This is the era of consolidation in computerland. Companies like IBM, Microsoft, Yahoo and USA Interactive have spent billions of dollars snapping up smaller competitors. Others, like Palm and Handspring, have tried to stave off the hungry advances of these giants by merging. Now it's the turn of Ellison's realm, the complex world of business software, to go through some serious cyclical slimming. The outcome will be crucial to owners of widely held tech stocks and people who use their products, which includes just about everyone.

"When the economy isn't allowing you to get any bigger, the risk of staying a small fish in the pond is pretty big," says Tom Topolinski, vice president of the Gartner research firm. Already, 25% of the software manufacturers in existence in 2000 have disappeared, mostly by burning through their venture-capital cash. Gartner predicts another 25% will vanish by the end of 2004 through waves of mergers and acquisitions. The recovering stock market is boosting the shares of stronger tech firms more than those of weaker rivals, so there are plenty of bargains around for those whose pockets are still deep.

Ellison may have some of the deepest pockets in his industry. Oracle boasts $5 billion cash on hand and $9 billion in annual revenues, and its net income increased 31% in the most recent quarter. But Ellison also faces a whole range of challenges. His biggest asset is Oracle's Database software: 70% of all packaged business applications worldwide run on it, making it as hard to ignore as Microsoft Windows. Even Oracle's biggest rival, German giant SAP, chooses to use Oracle Database over its IBM and Microsoft-made counterparts. Oracle Database is a huge part of that virtual plumbing system known as back-office software, which helps keep track of payroll, makes sure products leave warehouses on time--and remains mostly invisible to all but the client company's IT department.

Trouble is, the market for back-office systems is rapidly maturing. Most companies that need them already have them; upgrading is costly and generally happens once a decade. The big growth prospects these days are found in the front office: customer-relationship-management (CRM) software, the stuff that helps a retailer tell, for example, whether you're a customer worth pampering. As anyone who has spent hours in customer-service hell knows, these products are not as widely used as they could be: 30% of the FORTUNE 500 has no CRM software. Because it is difficult to operate, front-office software is also a gold mine for consultants. Siebel Systems, one of the larger CRM-software manufacturers, makes 66% of its revenue from consulting.

Oracle dipped its toes in the CRM market, but the results failed to impress. "They built it, and no one came," says Erin Kinikin, vice president of Forrester Research. Oracle's e-business suite, known as 11i, was plagued by early reports of bugs that turned installations into nightmares. Meanwhile, Microsoft was making inroads into the database business with its fast-growing SQL Server software. And SAP just kept getting larger. Its share of the market for enterprise applications has grown from 51% to 54% in the past year alone. By contrast, Oracle has a 15% share and PeopleSoft has 11%.

Ironically enough, it was PeopleSoft's Conway who first suggested to Ellison last year that the applications side of their businesses should merge. The discussions were cordial--hard to imagine after a week in which Conway compared Ellison to Genghis Khan--and the two companies exchanged fact-finding teams. The sticking point: who would run the joint business. "He said, 'I'm your man,'" says Ellison. "Conway didn't see a single antitrust problem then." (Conway does not dispute this account of the meeting but points out that discussions were over in a matter of hours.) After negotiations broke down, Ellison kept the idea of some kind of PeopleSoft deal in the back of his mind.

In Silicon Valley rumors abounded that Oracle was looking to buy someone out. The name mentioned most often was that of Tom Siebel, another of Ellison's estranged proteges and CEO of Siebel Systems. Siebel executive vice president David Schmaier, however, says the company is an "acquirer" as opposed to an "acquiree." (Ellison describes Siebel as "in play" but says the company is too vulnerable for him to consider purchasing it.)

After his fruitless talks with Ellison, Conway kept looking for a partner, and found it in J.D. Edwards. Their businesses were widely regarded as complementary. PeopleSoft tended to sell to high-end firms, J.D. Edwards to the middle market. Four days later, Ellison announced his competing bid for PeopleSoft. Coincidence? Conway thinks not. "If we were ever looking for confirmation that the J.D. Edwards merger was right for the industry," he says, "Larry provided it."

Some analysts concurred. Buying PeopleSoft, they said, would be a onetime adrenaline boost for Oracle, nothing more. The companies are not a natural fit since both are heavily invested in the back office. The only way it makes sense is if Ellison is taking a leaf from the Microsoft playbook: getting bigger, with less competition, is better. Although a combined Oracle-PeopleSoft would not rival SAP's user base, it would be in a more competitive position--and create an ever wider market for Oracle Database. "[Ellison] doesn't need PeopleSoft's products," says Reg King, an analyst for WR Hambrecht & Co. "But what's wrong with buying its customers?"

Some of those customers are not happy with the idea of being traded like poker chips. Conway says he has received calls of support from 26 of his customers' chief information officers. The majority, he claims, were indignant enough to consider switching from Oracle Database to its Microsoft and IBM rivals. The idea of Oracle splashing out $5.1 billion on PeopleSoft also unnerved investment analysts at Moody's, who downgraded the firm's outlook for Oracle from stable to negative; however, few investors followed suit. Oracle's stock rose to $13.48 at the end of the week, up 3% over the previous week's close.

Ellison has shown no signs of moving from his $16-a-share offer, even though PeopleSoft's stock ended the week at $16.92. In any case, as Kevin Parker, PeopleSoft's chief financial officer, contends, the board's decision to reject the bid is final. And because board members' terms are staggered, it would take a significant shareholder rebellion to overturn it.

The spat between Ellison and Conway would be little more than an amusing sideshow if not for two things. First, it shows the reach of Ellison's influence. He has been CEO of Oracle since 1977--several lifetimes in the tech industry--and a coterie of former Oracle executives, dubbed the Little Larrys, has fanned out to rule much of the business-software world. Conway, Siebel and Marc Benioff, CEO of Salesforce. com, a company that lets clients hire out its enterprise applications, are members of the Oracle alumni e-mail list. There is no love lost for Ellison among them: "He's not great at relationships," says Benioff. "He struggles ... in his personal and professional life." But the feeling is not mutual. "Even when I'm fighting them, I feel proud of these guys," says Ellison. "I would compare our alumni with that of the best business school."

More important, Ellison's bid is indicative of an industry that is frantic to partner up. HP was scoffed at last year for spending $16 billion on Compaq--an effort, opponents said, to get big fast without thinking about the structure of the business. Now the HP deal looks prescient. No matter which organization PeopleSoft merges with, there will be one less company around. "This is like The Bachelor, reality TV brought to the software industry," says Benioff. "Each day you turn on the TV and see who's getting the next rose." --With reporting by Laura A. Locke/San Francisco and Dody Tsiantar/New York

With reporting by Laura A. Locke/San Francisco and Dody Tsiantar/New York