Analysis: Why Sun should've — and probably could've — bought Sybase

Plenty of interest, plenty of money, plenty of paying customers, but...

Common sense would suggest that in general, buying one company at a price equivalent to 3.5 times its annual revenue is a better deal than buying another company for 21 times its annual revenue.

Yet, Sun Microsystems Inc. took the exact opposite approach when it announced two weeks ago that it would buy open-source database maker MySQL AB for $1 billion, mostly in cash -- while ignoring another firm long rumored to be in play, enterprise software vendor, Sybase Inc.

MySQL recorded $48 million of sales in its most recent 12 months, according to estimates, and is on track to hit about $65 million this year. No one except Sun and MySQL know if the latter is profitable.

What is known is that of MySQL's 11 million claimed users, only one out of a thousand has ever paid the company a dime.

"You pay that much for a company whose customers don't want to pay them any money?" asked Merv Adrian, an analyst at Forrester Research Inc.

By contrast, Sybase last week announced 2007 revenue of $1.03 billion, up 17% from the prior year, with net income of $149 million, up 57% year-over-year. It expects to increase revenue another 6% this year to $1.09 billion.

Fresh eyes on Sybase

Sybase is starting to see success with its 'Unwired Enterprise' strategy, with several fast-growing niche database products along with a booming mobile services business it bought two years ago.

Among investors, however, Sybase has been unable to escape its reputation as merely an also-ran to Oracle and Microsoft in the enterprise database market.

With the enterprise software market apparently still consolidating, Sybase's stagnant stock price -- and its cash hoard, most recently reported to be $738 million -- has made it the subject of takeover rumors.

That's nothing new for Sybase. As far back as 2003, Sybase was among ten companies targeted for acquisition by Oracle. Of those firms, Oracle now owns four of them -- PeopleSoft Inc., Siebel Systems Inc., BEA Systems Inc., and J.D. Edwards (through the PeopleSoft acquisition) -- while three others, Business Objects, Lawson and Documentum, have been acquired by other firms.

Those rumors fired up again when a hedge fund, Sandell Asset Management Inc., announced last October that it had taken a 6% stake in Sybase, making it the Dublin, Calif. firm's second-largest shareholder.

Sales and resistance

Forcing the sale of a company is the fastest, most surefire way an activist investor can get its money back and more. The small but key stakes that such investors can pledge to would-be acquirers offering the right price can open the door to even hostile takeovers.

Think of BEA Systems Inc., which eventually broke down and accepted a $8.5 billion offer from Oracle after ongoing pressure from its largest shareholder, billionaire Carl Icahn.

Indeed, one of the 'suggestions' proffered by Sandell in October was that Sybase put itself up for sale, which Sandell thinks can net as much as $3.7 billion (about 50% higher than Sybase's $2.4 billion market cap at close of trading Monday).

Even at the high end, the buyer would be paying less than 3.5 times Sybase's projected revenue this year. What would it get in return? A solidly profitable company; a strong cash flow, via Sybase's 'legacy' Adaptive Server Enterprise (ASE) database; and huge growth prospects via a trio of Sybase products.

Take Sybase's IQ Analytics Server, a column-based database optimized for business intelligence. Column-based databases store like data together, minimizing read times for large-scale calculations such as deep data mining and analytics.

Sybase added 224 new IQ customers last year, 20% more than it did in 2006. It has about 1,000 customers total, including 200 banks. One of those is a Korean bank, Woolri Investment & Securities, which recently picked IQ to replace an existing Teradata data warehouse.

Anklebiters!

A number of startups pushing vertical databases have recently appeared on the scene. But according to Forrester's Adrian, Sybase IQ remains dominant.

"The others are just anklebiters at this point, playing to a very specific niche," he said. "Sybase still has this market all to themselves."

Sybase's other database, SQL Anywhere, is a midrange relational database optimized for mobile and embedded applications. SQL Anywhere powers every copy of Intuit Inc.'s QuickBooks and will be embedded in a half a million devices used by U.S. Census workers in 2010. Other customers include Kodak, PepsiCo., the U.S. Navy and others.

"SQL Anywhere is the dominant lightweight database out there. Terry Stepien [iAnywhere's president] has done a phenomenal job," said Bob Zurek, chief technology officer at database vendor EnterpriseDB Corp., which competes with both MySQL and Sybase. "I think if you're going to spend that type of cash [to buy a company], spend a little bit more so you can grab something a little further along."

Perhaps Sybase's most promising business is Sybase 365. Acquired a year and a half ago, Sybase 365 is one of the two most popular services -- VeriSign Inc. operates the other -- used by carriers to manage the delivery of text or video messages to mobile phones.

Sybase 365 recorded $136.5 million in revenue in 2007. Besides processing 8 billion SMS text messages a month, Sybase claims to lead in the nascent market for Multimedia Messaging Service (MMS) messages, which can include pictures, audio, video as well as text. Sybase 365 also recently introduced a messaging service aimed at banks wanting to communicate with customers.

"People scratched their head a little bit when Sybase bought 365," Adrian said. "But I've watched Sybase's 'unwired' strategy slowly unfold and flower. I think the world is finally catching up to Sybase.

A private conversation?

Publicly, Sybase maintains a cool attitude towards selling Sybase, or following Sandell's other suggested strategies (buying back $1.5 billion in shares or spinning out its mobile and niche database units for IPO, ala EMC Corp.'s successful move with VMware Inc.)

"Yea or nay, I can't comment," said Raj Nathan, Sybase's chief marketing officer, when asked last week if the company was talking to any potential acquirers. But, he added, the fourth-quarter earnings report "is a reflection that we are doing well enough running our business, that things we've been doing are bearing fruit."

Besides Sandell breathing down Sybase CEO John Chen's neck, there is other circumstantial evidence that Sun would have done more than simply sniff around and then dismiss Sybase:

- Sun and Sybase are very familiar with each other. Both are Silicon Valley firms of about the same venerable age; moreover, they are longtime partners in the banking industry, where Sun's high-performance servers and Sybase's ASE database remain popular. Sybase certifies and supports its three databases on Sun's Solaris for x64 servers.

- One of Sandell's planned nominees for Sybase's board is a former long-time Sun executive, John McFarlane, who, at one point, ran Sun's software division. In a voicemail, McFarlane declined to comment.

- Sybase reportedly hired Merrill Lynch & Co. late last year to evaluate the options promoted by Sandell, including a possible sale.

- Other firms that have been mentioned as potential buyers of Sybase turn out, upon closer inspection, to have issues. "Oracle is very acquisitive, but it has an equivalent product to Sybase's in almost every market," said Forrester's Adrian. "Same with IBM. And Microsoft is not that kind of acquirer."

Of course, starting buyout talks with Sun -- with or without any true interest in selling -- could have bought Chen enough time to get to last week's strong year-end earnings announcement, which could bolster Chen's case for Sybase to stay independent, or raise its value if other buyers come knocking.

Sun's name never came up, mostly because of its hardware-centric heritage and, until the MySQL buy, its seeming lack of interest in the M&A game. But with hindsight, Adrian says that "Sun is not a bad candidate."

Of course, paying up to $3.7 billion is a much bigger investment than the $1 billion Sun spent on MySQL. But Sun could afford it, with $4.7 billion in cash and equivalents today.

Zurek says Sun could have also bought Sybase and then spun out one of its promising units such as SQL Anywhere for an IPO in order to recoup much of its outlay.

Well gee, in that case...

So why didn't it happen? Observers offer three reasons.

First, independence has an undeniable charm. "Ultimately, I just don't think Sybase wants to be bought," Adrian said.

Secondly, while expensive on paper, "with MySQL, you have to see where it is going," said Miriam Tuerk, CEO of Infobright Inc., maker of a vertical database engine that runs with MySQL and competes with Sybase IQ. "MySQL has a serious opportunity to dethrone Oracle. I wouldn't say that about Sybase."

Third, Sun is building an open-source software stack to pair with its hardware at a low price to startups who Sun hopes will eventually come back to buy pricier tools and support contracts, Adrian said.

With Sun "committed to an open stack, MySQL made a lot of sense in that context," Adrian said. Spending $1 billion is Sun's buy-in to become a full player in the enterprise software poker game, he said, to enable Sun "to be able to say to customers, we can be your one-stop shop."

Asked today about Sun's potential interest in Sybase, a spokeswoman for Sun said that the company doesn't comment on rumors. But in a Jan. 19 blog posting, Jonathan Schwartz, Sun's president and CEO, defended the notion of spending $1 billion on a company like MySQL that doesn't get any money from most of its customers.

"Facebook gives its products away for free, too," Schwartz wrote. "They make money on ads; we make money on service, support and infrastructure. MySQL has a big business, growing very rapidly. Investing in the future has more value than buying the past — which is why the latter so often comes at a discount."

Copyright © 2008 IDG Communications, Inc.

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