IBM's ( IBM) $5 billion acquisition of Cognos ( COGN) is the company's largest takeover in its history, and underscores the importance that software plays in reaching its long-term financial goals. The deal adds to a series of acquisitions and upgrades aimed at moving IBM's mature software business onto a growth track. The company hopes that sales of business applications will grow to account for 50% of total pretax earnings by 2010, which can help it boost annual earnings per share to $11 from $6.06 in 2006. "The transaction wasn't entirely unexpected, and fits with the company's plans to move into higher margin software and services business," said Tony Trzcinka, a portfolio manager with Pax World. Pax holds about 30,000 IBM shares in its growth fund, accounting for about 2.5% of assets. During a conference call with the press, IBM said it expects to receive shareholder and regulatory approval during the first quarter. The company would not say how the deal will affect its 2008 earnings. Acquisitions have played an important role in helping IBM transition away from commodity hardware businesses into higher margin business. Since Sam Palmisano became chief executive and chairman, IBM has spent $17.2 billion to acquire 61 companies, with software companies accounting for 38 of those transactions. Also, IBM has tried to make its business software more attractive by features like instant messaging, blogging and user profiles that mimic social networking sites like Facebook and News Corp.'s ( NWS) MySpace.
The acquisition of Cognos builds on IBM's software growth plans by filling a void in its array of software products, says Gartner analyst Colleen Graham. Cognos software provides so-called business intelligence features that help companies use data from their operations to find ways to increase sales and profits. One of the most widely touted achievements of business intelligence was helping grocery retailers identify that shoppers who buy diapers are likely to buy beer. Information like this can help companies determine how to manage their stores, how much inventory to keep on hand and how often to change prices. The market for business intelligence software is worth about $5 billion and will grow 12% in 2007, outpacing the expected 10% growth for the overall software market, says Graham. Investors recently bid up shares of Cognos after a flurry of takeovers left if as a prime target for larger companies like IBM looking to get into business intelligence. Its shares soared over 13% after SAP's proposed $6.8 billion acquisition of Business Objects ( BOBJ), announced in October. That deal followed Oracle's ( ORCL) $3.3 billion acquisition of Hyperion earlier in the year and vaulted the German software giant SAP into the leading position among vendors of business intelligence software. The SAP and Oracle deals raised the stakes for IBM, says Gartner analyst Dan Sommer. As a result, IBM may have paid a premium for Cognos. The deal puts IBM roughly on par with Oracle in the business intelligence market.
"The general consensus from people I've spoken with is that IBM didn't overpay too much, and the price was worth keeping Cognos out of a competitor's hands," said Tony Trzcinka of Pax World. A key concern among investors was making sure that a rival like Hewlett-Packard ( HPQ) or Microsoft ( MSFT) didn't snap up Cognos and leave IBM completely shut out of the business intelligence market. IBM shares, which were recently up $3.06, over 3%, to $103.31, remain well off their 52-week highs. Worries over exposure to the ailing financial services sector have battered shares, which reached a high of $119.60 in October. Pax's Trzcinka says IBM remains attractive because of its focus on increasing profit margins as well as its exposure to sales in fast growing parts of the world.