Assessment

Sitting through presentations at PeopleSoft's recent users' conference, Connect 2004, our thoughts turned repeatedly to the proposed Oracle acquisition. No matter how interesting the product, we had a hard time rationalizing a recommendation to evaluate it with an intention to buy. Unless there were a pressing business need, it is hard to justify investing another nickel in the software given the uncertainty over the future development and support should Oracle prevail in the acquisition.

In our opinion it is unlikely PeopleSoft users will benefit from Oracle ownership and some (e.g., the JD Edwards user base) are likely to be marginalized in support and ongoing maintenance almost immediately. We think from a PeopleSoft user's perspective the most attractive outcome after an Oracle takeover would be to have the option to vote with their feet: to take their maintenance dollars and go somewhere else.

That "somewhere else" would be an entirely new company ("NewPeopleSoft"), staffed mainly by existing PeopleSoft developers and support personnel. Ordinarily this sort of pipe dream would not be worth discussing because the acquiring company, however unattractive to the user base, is still the more certain and more credible option. In this case, it may not be exactly the opposite, but it is close enough, particularly if the current senior management team (especially the founder and returning chairman, Dave Duffield) were to lead the walkout. In our opinion, it is not unthinkable that in its first year of operation NewPeopleSoft could capture one-third to one-half of the existing maintenance accounts. If that occurred, we would expect a large percentage of the remaining users would move the following year.

At stake are approximately $1.2 billion of annual revenues from the maintenance business. We calculate maintenance contracts are the most profitable element of PeopleSoft's operations. For this reason, it can stand alone as a viable business. Even if NewPeopleSoft were to capture only one-third to one-half of the maintenance contracts, we estimate it could be a break-even or even profitable operation. In contrast, selling new software licenses is not as attractive as it once was. In its prime, the company generated almost $2 in software license fees for each $1 it spent on sales in marketing. Last year and again this year it was less than $1. From this perspective, PeopleSoft is losing money selling new software licenses.

Financing NewPeopleSoft should not be an issue. If Mr. Duffield were to start the company we think he could find other venture investors to join him. In any case, he could easily fund it with the proceeds of the sale of his PeopleSoft stock to Oracle (worth in excess of $500 million in gross proceeds at the current bid).

While the business would be viable and finance should be available, the real issues facing NewPeopleSoft revolve around intellectual property and how existing license contracts are worded. We do not have enough expertise in this field to judge whether Oracle could thwart NewPeopleSoft in the courts. We note, however, there are already companies offering third-party support contracts to PeopleSoft users.

Market Impact

A NewPeopleSoft would be a reasonable option for the existing PeopleSoft customer base. If a sufficient portion (i.e., at least one-third) of user base were to take the option we think the business would be viable and could provide them with satisfactory maintenance and support. However, from our perspective it is unlikely that it would address users' growth and future development requirements anytime soon. (For that matter, on this point it is not clear users' options would be substantially better following an Oracle acquisition.)

In the meantime, we expect the ongoing battle between the two companies will continue to benefit SAP in the otherwise moribund ERP software category and (to a limited degree) Siebel in the equally slow call center software arena.

Recommendation

While the merger is still pending, we advise PeopleSoft customers that can wait six months or a year for an outcome to hold off buying anything. Instead, they should use the money and internal resources to invest in other enterprise software projects that support Performance Management. That noted, different customers face different circumstances. The toughest decisions will have to be made by companies with a heavy investment in PeopleSoft that have pressing business needs addressed by its software. Most will elect not to defer purchases because the benefits outweigh the risks. At the other end of the spectrum, we are far less optimistic about the fate of JD Edwards's customers. In our judgment, an Oracle takeover is likely to leave them on the sidelines for any new features/capabilities development, and they should expect to need to migrate within five years.

A NewPeopleSoft would be an interesting option. If the merger takes place without it happening we advise PeopleSoft customers in general to be prepared to shelve all plans for upgrades that are not critical and sunset their maintenance payments if they are not satisfied with Oracle's roadmap. Our specific advice following a merger will depend on how well Oracle demonstrates its commitment to addressing customers' requirements rather than imposing its concept of the "right" way to do enterprise applications. If the deal closes, we hope (but do not expect) Oracle's management will recognize their new "customers" already rejected its product vision and will act accordingly.