Oracle (Nasdaq:ORCL) has given investors ample reminders that the company intends to be an active acquirer for the foreseeable future. Likewise, management has made no secret of its intention to expand its hardware assets and its desire to add product/industry verticals to its model. Oracle achieved all of the above with Monday's surprising announcement that the company will acquire session border controller specialist Acme Packet (Nasdaq:APKT) in an all-cash deal.
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The Deal to Be
Assuming that both companies take care of every detail, and that no rival bidder pops up, Oracle will acquire Acme Packet in a $1.7 billion deal that pays investors $29.25 per share in cash, a 22% premium to Friday's close. While that may seem like a solid premium for a company that spent the last six months of 2012 below $20 per share, it's still well below the 52-week high ($36), not to mention the all-time high of nearly $84 from April 2011.
At about 5.7 times the 2013 average sell-side revenue estimate, this is not an uncommonly expensive deal for Oracle, nor for growing hardware companies. Given Acme's rather dramatic decline in profitability over the past year, however, the deal will look expensive on short-term profit metrics.
SEE: Analyzing An Acquisition Announcement
Buying into the Lull
As the stock's price performance might suggest, these aren't banner days for Acme Packet. That shows up in the company's fourth quarter earnings report.
Acme Packet reported that revenue fell 15% from the prior year, with product revenue down 20%. That steep decline reflects not only lower carrier spending from companies such as Verizon (NYSE:VZ) and AT&T (NYSE:T), but sluggishness in enterprise customers as well. Even so, this result was slightly better than expected.
Acme's margin performance was also better than expected. The company's gross margin fell about 50 basis points from last year, but it still did about a half-point better than many analysts expected. Likewise, the company kept a fairly tight leash on operating and sales expenses. While the nearly two-thirds decline in non-GAAP operating income was pretty shocking, the resulting operating margin was stronger than expected and drove an operating beat.
Unfortunately, the news of Oracle's bid pretty much dominates this quarter, and management canceled its conference call. Slightly better than expected product revenue was a positive, but I'm not sure that investors in Sonus Networks (Nasdaq:SONS) can take much from that result.
So, What's Oracle Thinking?
I would think that Oracle's acquisition of Acme Packet will puzzle a few investors on a few different levels. For starters, Oracle's acquisition of hardware assets hasn't always gone according to plan, with Sun Microsystems offering arguably as many challenges and problems as opportunities.
SEE: Biggest Merger And Acquisition Disasters
So why does Oracle want more hardware? And why would Oracle want a business that is so heavily weighted (about 80% of revenue) to service providers/carriers?
The carrier exposure is an interesting topic. Given how Acme's session border controllers facilitate the delivery of voice, video and multimedia, it looks like a logical long-term play for ongoing traffic growth. It also gives Oracle a distinct industry vertical into which it can sell a whole stack of software products. Then there's the potential of IP Media Subsystem (IMS) architecture to recapture the over-the-top messaging revenue of companies like Facebook (Nasdaq:FB) and Microsoft's (Nasdaq:MSFT) Skype, but rival Huawei has been making real inroads here.
I would think that Oracle is also intrigued by Acme's potential in the enterprise market. Even though SIP trunking has slowed recently, enterprises really can look to SIP trunking as a superior economic alternative to TDM. More and more enterprises are adopting VoIP and unified communications, and session border controllers are key to that adoption. As just one example, call quality declines significantly for VoIP when SBCs are not in use. It's worth noting that SBCs have a security aspect to them as well, and security could be another attractive market for Oracle for the long term.
Given that most investors and readers who know about Oracle see its substantial market position in enterprise IT, it's not hard to imagine that Oracle sees itself introducing Acme hardware to its large existing enterprise customer base. I also wouldn't ignore the longer-term possibility of additional acquisitions and/or internal developments leading to more comprehensive "plug and play" turnkey solutions for enterprise unified communications.
Plenty Can Go Wrong
Oracle has never been afraid of taking on risks, and while buying Acme Packet in the midst of a carrier spending lull does de-risk the deal to some point, there are still plenty of ways for this deal to go wrong.
For starters, while Acme Packet still has upwards of 50% of the SBC market, it's leveraged toward the carrier market. Rivals like Sonus and Huawei have been chipping away at Acme's share. At the same time, partners/customers like Alcatel-Lucent (NYSE:ALU) could well look to be entering the market themselves.
On the enterprise side, Acme's share is less dominating (about one-third of the market) and the primary competitor, Cisco (Nasdaq:CSCO), is more formidable. What's more, companies like Juniper (NYSE:JNPR) and Cisco are increasingly incorporating the features of SBCs into various routing products.
And it's not just the question of whether the Acme deal goes sour for Oracle or fails to live up to expectations. It's hard to imagine that Oracle won't be following up this deal with additional investments (in the form of further M&A and/or internal complementary hardware/software development), and that could ultimately be throwing good money after bad.
SEE: The Wonderful World Of Mergers
The Bottom Line
I thought that ongoing growth in the SBC market would be enough to support a fair value for Acme Packet in the mid-$20s. On that basis, it would seem that Oracle overpaid and is destroying shareholder value. I'm not so sure, though, since that mid-$20s fair value was predicated on what Acme could do by itself in the enterprise market. The support of Oracle could both accelerate enterprise adoption and increase the likelihood of that penetration.
For Oracle, this deal doesn't change a whole lot - at least not today. Adding the carrier/service provider vertical is an interesting opportunity. These companies spend tremendous amounts of money on hardware and software to support/build/refresh their networks, and delivering a wider suite of hardware and software for this market would add meaningfully to Oracle's total addressable market. At the same time, this gives the company a new market within its broader enterprise focus and the opportunity to benefit from enterprise adoption of VoIP/VoLTE and unified communications.
With a fair value in the mid-$40s, Oracle still looks like an interesting stock today. Combining good strength in middleware with emerging opportunities like Exadata, Oracle looks like an interesting large cap IT stock in a market where valuations and guidance have gotten pretty tricky over the past couple of quarters.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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