Why Sun should have bought Sybase

Eric Lai asks whether a viable takeover candidate was overlooked.

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 took the exact opposite approach when it announced last month that it would buy MySQL AB for US$1 billion (NZ$1.27 billion) — while ignoring another firm long rumoured to be in play, Sybase.

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

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

By contrast, Sybase last week announced 2007 revenue of US$1.03 billion, up 17% from the prior year, with net income of US$149 million, up 57% year-over-year.

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 US$738 million — has made it the subject of takeover rumors.

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

Those rumours fired up again when a hedge fund, Sandell Asset Management, announced inOctober that it had taken a 6% stake in Sybase, making it the company's second-largest shareholder.

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, which eventually broke down and accepted a US$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 could net as much as US$3.7 billion.

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 optimised for business intelligence. Column-based databases store like data together, minimising read times for large-scale calculations such as deep data mining and analytics.

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

A number of start-ups pushing vertical databases have recently appeared on the scene. But according to Forrester analyst Merv Adrian, Sybase IQ remains dominant.

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

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

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 operates the other — used by carriers to manage the delivery of text or video messages to mobile phones.

Sybase 365 recorded US$136.5 million in revenue in 2007. Besides processing eight 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 and video as well as text. Sybase 365 also recently introduced a messaging service aimed at banks wanting to communicate with customers.

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

"Yea or nay, I can't comment," said Raj Nathan, Sybase's chief marketing officer, when asked recently 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 CEO John Chen's neck, there is other circumstantial evidence that Sun would have done well to do 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 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," says 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've bought Chen enough time to get to last month's strong year-end earnings announcement, which could bolster his 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 US$3.7 billion is a much bigger investment than the US$1 billion Sun spent on MySQL. But Sun can afforded it, with US$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.

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 says.

Secondly, while expensive on paper, "with MySQL, you have to see where it is going," says Miriam Tuerk, CEO of Infobright, whose flagship product is 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 start-ups who Sun hopes will eventually come back to buy pricier tools and support contracts, Forrester's Adrian says.

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

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