H-P Buys Mercury Interactive

Updated from 4:54 p.m. EDT

Hewlett-Packard(HPQ) has agreed to buy troubled software maker Mercury Interactive(MERQ)(symbol) for $52 a share, or about $4.5 billion, net of existing cash and debt.

The acquisition price reflects a 33% premium to Mercury's Tuesday closing price of $39. Shares of H-P were recently off fell $1.23, or 3.9%, to $30.10 on Instinet.

Mercury, which was delisted by the Nasdaq in 2005 when it became one of the first companies to admit that some of its executives profited from backdated options, is a bit difficult to value because of the restatement associated with its role in the scandal. In 2004, revenue was $685 million, 35% higher than the previous year. For the first two quarters of 2005, the latest available, revenue totaled $405.8 million.

If, as some analysts believe, the company could have reached the $800 million sales mark last year, the acquisition would then be a less-eye-popping 5.6 times sales. In any case, Mercury's top-line growth rate is much faster than the 8% or so typically earned by competitive management software vendors, such as CA(CA), says George Hamilton, research director of the Yankee Group.

Mercury will increase the size of H-P's software business to more than $2 billion in annual revenue. It will, said H-P CEO Mark Hurd, "make us a force to be reckoned with" in software. Immediately following the close of the transaction, Mercury will become part of the H-P software business and both companies' sales forces will begin reference-selling each others' products, H-P said in a press release.

Mercury makes software used to test and optimize systems and software applications. H-P, of course, is a major vendor of enterprise hardware, software and services, which makes the acquisition "complementary," said IDC analyst Stephen Elliot, who has been predicting the sale of Mercury for some time. Moreover, "the two product lines have little overlap," said Elliot.

Despite being delisted, Mercury's share price has been surprisingly strong. The company's sale has been rumored for some time. H-P said there were other vendors in the running to buy the company, but did not disclose their names.

Earlier this year, Mercury wiped out $525 million in previously reported profit to correct the accounting problems caused by the options manipulation and disclosed that the practice ran deep within the company.

Asked if the overhang from Mercury's role in the options could damage his company, H-P CEO Mark Hurd said the issue was studied during the due diligence part of the deal and said "We are comfortable with where we are in that process; We think the issues are limited to those disclosed."

H-P forecasts that on a non-GAAP basis, the combined H-P software business will deliver revenue growth of about 10% to 15% and operating margin of about 20% in fiscal year 2008. On a pro forma basis, the transaction is expected to hurt earnings before items by 4 cents a share in fiscal year 2007 and will add about 2 cents a share to non-GAAP earnings in fiscal 2008.

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