Bitten by an ASP

With M&A activity hotting up in the IT sector, customers may want to redo their contracts with tech outsourcers. Plus: HP's new positioning.
CFO Staff and John GoffJuly 3, 2003

The ongoing opera starring Oracle, PeopleSoft, and J.D. Edwards, has many IT-watchers (this one included) predicting a consolidation in the technology sector. Indeed, if Oracle’s hostile takeover bid for rival PeopleSoft is approved by government regulators and PeopleSoft shareholders, it will very likely trigger a feeding-frenzy in the tech world.

Certainly, the M&A tumblers for the IT set are all falling into place. As reported in an earlier Tech Strategies, about 70 percent of technology companies have a market capitalization of under $250 million. That’s a whole lot of small software/hardware vendors out there, and all are vying for the attention of tight-fisted — and increasingly skeptical — corporate customers. Privately, a number of CEOs at technology companies have been saying that consolidation must come to the sector if the industry is truly going to get healthy.

Morever, the price of acquisitions may never be cheaper. Even with the recent run-up on Nasdaq, the share prices of many IT companies remain well below their historical highs. A goodly number of investment bankers — no doubt hurting for business — are likely advising CFOs that these prices won’t last long.

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And while a resurgence in tech stock prices may force corporate acquirers into action, it will also make their all-stock offers damned attractive to potential takeover targets. What’s more, with interest rates at historical lows, debt servicing should not be particularly onerous for all-cash bids like Oracle’s.

All of which means: the deals are coming (see paragraph 1, sentence 3). Actually, the deals have already started. Besides the Oracle bid (and PeopleSoft’s proposed friendly merger with J.D. Edwards), business performance management specialist Geac Computer Corp. announced last week that it was acquiring Comshare. And a few month’s back, budgeting & planning vendor Cognos acquired rival Adaytum.

This dust-up in the tech sector is more than just a localized event, however. If you don’t think so, just ask CFOs who were all set to sign off on the purchase of a PeopleSoft ERP module on June 7 — the day Oracle announced it’s bid for PeopleSoft. That’s also the day Oracle indicated it would not bring out new versions of PeopleSoft products.

The bump up in M&A activity also has serious repercussions for companies that outsource their applications hosting — and that’s getting to be a long list. The concern: what happens if your application service provider is suddenly bought by another ASP, or your ASP is no longer able to offer a particular product because the maker of that product has been acquired and shut down?

To avoid unpleasant surprises, tech consultants advise finance chiefs to revisit their contracts with their ASPs. Says Ted Chamberlin, industry analyst at consultancy Gartner: “Enterprises should consider including a 25 percent acquisition clause into their contract, which allows the enterprise to get out of the contract if the service provider is more than 25 percent acquired by another company.”

Chamberlin also suggests that customers insist on a guaranteed refresh clause in their outsourcing contracts. Such a clause enables corporate customers to incorporate new applications without having to extend the term of a contract and with no major changes in price.

In addition, it’s probably wise to include a preset pricing clause in an ASP contract. The clause, notes Chamberlin, should say that anytime a new application, server or business modeling applications is added, there will be a new cost. Further, these costs should be known upfront so that the upgrade will not be delayed in negotiations.

Gartner says it’s also a good idea to include a service performance guarantee, which allows for credits and termination of the contract if the provider does not meet certain performance metrics. That, too, should help protect a client when the maker of its ERP software, for example, is acquired by a database specialist.

Hey, it could happen.

HP Splits The Difference

Speaking of tech deals: One year after its merger with Compaq, Hewlett-Packard is positioning itself to corporate customers as the sensible third option to IBM and Dell. “IBM is high-tech, high-cost, and Dell is low-tech, low-cost,” claims Jeff Clarke, formerly CFO at Compaq and now executive vice president of global operations. “We’re high-tech, low-cost.”

Clarke points to HP’s $4 billion R&D budget as proof of the high-tech part of the equation. The company is spending heavily on tablet and multimedia PCs and wireless technologies, among other areas. As for low-cost, he cites HP’s commitment to standards, and its impressive postmerger cost-cutting, which racked up $3.1 billion in savings in the first nine months, far outpacing the company’s original pledge of $2.5 billion over two-plus years.

Analysts have grumbled that with cost-cutting taken about as far as it can go, HP has yet to demonstrate any real growth. The company did score a major victory when it landed a massive outsourcing contract with Procter & Gamble earlier this year, a deal that Clarke says a premerger HP never would have been able to handle.

While that was clearly a shot across the bow of IBM’s Global Services division, HP seems more intent on fending off Dell than on trumping Big Blue. Company executives are quick to catalog Dell’s alleged shortcomings as the PC giant readies a broader assault on the corporate IT market. “Dell aspires to be us,” says Clarke, “but 80 percent of their revenue comes from PCs. They don’t innovate. We created the server market. We roll out 50 new printers every six months.”

HP contends that Dell is weak in services and averse to creating its own intellectual property, two points hotly disputed by Dell CEO Michael Dell. Last fall he pointed to the company’s 750 patents as proof that it is “more than just a sales channel.” Will the new HP face a challenge from an even newer Dell? Quite possibly, which will make the year ahead even more interesting than the one just ended.

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