Could Oracle’s Next Acquisition Be HP or NetApp?

Oracle has its sights set very high. Although the company is best-known for its namesake database software, a steady string of acquisitions has transformed the company (and its colorful leader, Larry Ellison) into an industry powerhouse. Much speculation revolves around Oracle’s next move, and a surprising meme is developing, suggesting that the company is looking at making another massive purchase. Could HP or NetApp follow Sun into the hands of Oracle?

Basic Facts

Companies typically combine with each other in one of three ways:

1. A straight purchase, using cash to buy up all of the shares in a public or private company. The acquiring company is in command here, offering a price per share fixed well above the current market rate. Purchases can be friendly or hostile, and bidding wars can break out if a rival wants to challenge the buyer (or push the price up). Companies sometimes lack enough cash on hand and will finance a portion of the purchase from an investment bank or by using bonds.
2. A stock swap sees the buyer trade their own shares (or those of a new company to be created) for those of the purchased company. This is advantageous if the buyer lacks enough cash to make the deal happen and can even see odd small-for-large acquisitions. But stock-based acquisitions are risky, since the value for stockholders varies continually right up until the deal closes and a slide in price can tank the deal entirely.
3. A combination cash and stock deal, where shareholders get both cash and shares in the new company in exchange for their shares. This is less risky for shareholders than a stock swap, but less attractive than a straight purchase, since the final price can vary based on the value of the stock included in the deal.

Like any company, Oracle can use any of these mechanisms to acquire other companies. They paid about $7.4 billion to purchase Sun and paid $10.3 billion for PeopleSoft, among their many acquisitions. Since both were all-cash deals, one can presume that Oracle prefers this over a stock swap or merger.

Oracle currently has $23.6 billion in cash and short-term investments and quarterly gross profits of around $5 billion. ORCL stock is currently priced at $27.42 per share for a market capitalization of $137.79 billion. Oracle could easily spend up to $20 billion on an acquisition, and could potentially engineer a much-larger deal by borrowing tens of billions more or using their stock.

The purchase of Sun gave Oracle all the server hardware expertise it needs, but it is lacking in storage and networking, two of the highest-margin areas of datacenter hardware. It would not be at all surprising to see Oracle invest in these areas.

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The Case for HP

Larry Ellison has been clear that his target is to unseat IBM as the preeminent enterprise IT superpower. Although HP is on the rise, Oracle as a traditional software vendor seems more fixated on the full-line services/software/hardware market at IBM. Oracle scooped up ousted HP CEO Mark Hurd last month, and the two companies appear to have buried the hatchet over the resulting spat extremely quickly. They appeared friendly and supportive at Oracle Open World as well.

HP’s annual revenue of $110-120 billion dwarfs Oracle’s $26 billion number, but their annual gross profits ($26 billion and $21 billion for HP and Oracle, respectively) are comparable. This reflects the differing profit margin of hardware and software. For comparison, IBM’s gross annual revenue is just under $100 billion but their $43 billion annual revenue must have Ellison drooling with envy. Assuming no overlap, integration difficulties, or customer defections, a combined Oracle/HP would instantly be dominant in terms of both revenue and profit. But that’s not a likely outcome, at least initially.

An Oracle and HP combination would certainly create an earthquake in the IT market, but the massive overlap between the two raises difficult questions about the role of Sun’s hardware assets. HP competes or leads just about everywhere Oracle/Sun sells hardware. On the other hand, Oracle is making the most of Sun’s software assets (Java, Solaris, virtualization and cloud technology, and even ZFS). Perhaps the deal makes sense even if Sun’s servers and SPARC technology is jettisoned.

But could Oracle pull off a deal like this? HP’s market cap is over $90 billion and Oracle could never raise the $100 billion in cash they would need for a straight acquisition. The two companies would have to merge, and Ellison’s control of the combined company would thus be greatly diluted. He currently holds 1.2 billion ORCL shares, or just over 27% of the company. An HP deal would put Ellison at the helm of the biggest ship at sea, but he would have to share command with many others.

The Case for NetApp

Although Oracle just introduced some impressive Sun ZFS-based storage devices, the company isn’t even a blip on the enterprise storage radar. The entire external disk storage market is only worth $20 billion according to IDC, but is attractive for margins higher than other hardware areas as well as its strategic value as a part of the enterprise IT stack. Therefore, a storage acquisition makes a great deal of sense for Oracle.

Larry Ellison is a major investor in storage startup Pillar Data, and this little company has some impressive technology, but an acquisition there is not the slam dunk many claim. Building Pillar into a force into the enterprise storage market will take effort and time, and that acquisition would be imperceptible on either side of Oracle’s balance sheet.

“Moving the needle” for Oracle would take a much-larger purchase. NetApp is the perennial top-five enterprise storage company, bringing in nearly $4 billion in revenue and $2.5 billion in gross profit annually. They have a wide range of SAN, NAS, and backup technology as well as software, services, and solid sales presence. An Oracle/NetApp combination would have little Sun overlap and would place the company in a duel with IBM for the number-two spot in external storage sales.

NetApp’s current market cap of $17 billion makes the acquisition financially practical for Oracle as well. They could offer a 20% premium right off the bat and could prevail in the resulting bidding war with IBM without resorting to trading shares for the company. They would even have enough left over to consider buying Symantec or Juniper Networks in another year!

Stephen’s Stance

An Oracle acquisition of NetApp makes so much sense, I’m surprised it hasn’t happened already. Combine very little product overlap, a “doable” price, and a poke-in-the-eye for IBM and you have a winner for Larry Ellison. No other available company offers the solid enterprise storage portfolio and sales of NetApp, and few other companies could make the purchase. The recent NetApp/Oracle ZFS settlement makes it look like something could already be in the works. Unless Oracle really is content to stand pat with Sun’s ZFS storage systems, I expect a NetApp deal within a year.

A combination of Oracle and HP is much harder to swallow. Although it would deliver an un-matched smack to the head for IBM, I just can’t see how it comes together. Larry Ellison isn’t about to give up control of his company, and Oracle is nowhere near having the cash to make it happen. I call HP/Oracle a pipe dream.

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