Wall Street has been talking about a wave of consolidation in the enterprise software space since the bubble burst. But the wave has yet to crest because valuations are still too high to tempt many buyers.

Today, however, PeopleSoft ( PSFT) caught the market by surprise with its announcement of a $1.7 billion acquisition of J.D. Edwards ( JDEC), a deal that is being viewed positively, if not enthusiastically, on Wall Street. PeopleSoft ended the trading day down $1.42, or 8.7%, to $14.97, while J.D. Edwards closed higher, up 78 cents, or 6.6%, to $12.59.

If nothing else, the deal puts pressure on other large application providers, notably SAP ( SAP), Oracle ( ORCL) and Siebel ( SEBL), and could push them into the acquisition mode.

The first to go, according to numerous reports in the British press, is likely to be the Baan subsidiary of Invensys ( IVNSF). If the rumors are correct, the likely buyer is General Atlantic Partners, a U.S. venture firm that has been investing in enterprise software.

Picking other acquisition targets is much harder, of course, but smaller, relatively specialized application vendors such as Epicor ( EPIC), Retek ( RETK), Aspen Tech ( AZPN) and the recently delisted i2 Technologies ( ITWO) are all subjects of speculation, as is much larger ( and less likely) BEA Systems ( BEAS).

What's driving the acquisition push? Simply put, slow IT spending is forcing application vendors to look for new customers in the largely untapped midmarket space. Additionally, buyers of IT are increasingly interested in purchasing software from fewer and fewer vendors as a way to cut costs and reduce software integration headaches.

From PeopleSoft's point of view, J.D. Edwards does both. JDEC has a strong customer base in the midmarket (the definition of midmarket is flexible but the term often is used for companies with annual sales of $50 million to $500 million), and is strong in manufacturing and distribution, where PeopleSoft is relatively weak, says Mike Dominy, an industry analyst with The Yankee Group.

The downside? There's so little overlap that making the two companies work together might be a bit like having the Golden State Warriors and the Colorado Rockies merge, says analyst Mark Murphy of First Albany. Murphy's tongue was firmly in cheek, of course, but he has a serious point: Integrating the two companies, from both a business standpoint and a technological standpoint, will be challenging.

In an interview, PeopleSoft CFO Kevin Parker said J.D. Edwards software will not immediately be integrated with his company's software, although it will be sold under the PeopleSoft brand. How long the separation will continue "is up to the market," he said.

Making the ultimate integration of the software more difficult are underlying differences. For example, many J.D. Edwards customers run their software on IBM's ( IBM) AS/400 platform. "Going from there to PeopleSoft is a big leap," Dominy said.

Another possible problem: "We expect SAP and Oracleto gain an edge in sales cycles due to customer confusion regardingthe future direction of PeopleSoft and J.D. Edwards," wrote analyst Patrick Walravens of JMP Securites. Although he downgraded PeopleSoft to market perform from outperform, Walravens said long term that "this acquisition should work well." JMP makes a market in both PeopleSoft and J.D. Edwards, but does not have a banking relationship with either.

Merger Urges

Software mergers are conducted to buy customers or buy technology.

Epicor, for example, boasts 15,000 customers, many in the crucial midmarket space, for its CRM solutions in segments that include manufacturing, distribution, services and hospitality. After losing money for six quarters in a row, it turned a nickel GAAP profit in the March quarter. With a market cap of $212 million and no long-term debt, it could be a reasonably priced addition to Oracle or Siebel.

i2 is certainly cheaper than it used to be (it closed at $1.03 on Monday) and it has a big customer base, but analysts and industry insiders are divided about how strong its supply chain management offerings really are. And an investigation by the Securities and Exchange Commission into at least two years of earnings is casting a big shadow over the company.

Retek, with a market cap below $200 million, has solid CRM technology aimed at retailers, an enormous market few CRM vendors have penetrated.

Aspen, which on Monday agreed to sell $100 million in convertible preferred stock to a private equity firm, sells its supply chain management and engineering software to customers in the energy and manufacturing sector.

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