M&A activity has yet to live up to optimists' expectations this year, but the content management software world is abuzz with speculation about further consolidation.

Several vendors -- whose products help companies manage such content as video, email, Web pages and documents -- are attracting investors betting that an expected windfall from Sarbanes-Oxley legislation business only will feed the merger and acquisition urge.

FileNet

( FILE) is the sector's biggest publicly traded firm -- and an oft-cited takeover candidate. Others include former Internet darling

Vignette

( VIGN),

Interwoven

( IWOV) and

Open Text

(OTEX) - Get Report

.

"While 2003 was a good year to own the content management vendors, we believe 2004 will be a breakout year ... just in time to be swallowed up by the large enterprise infrastructure players," ThinkEquity analyst Nate Swanson wrote in a "ThinkPiece" overview of the infrastructure software market earlier this year.

Speculation about enterprise software players such as

Oracle

(ORCL) - Get Report

and

SAP

(SAP) - Get Report

dipping into the content management field has been swirling at least since last October, when storage vendor

EMC

(EMC)

announced its acquisition of

Documentum

, the largest content management company. At the time, rumors of other bidders circulated on Wall Street.

Growth is obviously one attraction of the $2.7 billion content management market, which is still evolving to include collaboration tools and portals. Gartner estimates the market will balloon to more than $4.1 billion in 2008 -- a 52% expansion over five years.

Charlie Brett, a Meta Group analyst who follows content management, estimated that the field ultimately will get a 15% boost in sales driven by Sarbanes-Oxley and related compliance efforts.

Companies from behemoths

IBM

(IBM) - Get Report

and

Microsoft

(MSFT) - Get Report

to storage vendor

Veritas Software

( VRTSE) have started encroaching on the field by

peddling products to help companies comply with Sarbanes-Oxley.

Sarbanes-Oxley, the landmark corporate reform legislation, was supposed to be a boon to content management players this year. Specifically, increased business was expected because of Section 404 of the act. The section requires public companies with market caps over $75 million to include (in their annual filings) reports from management on internal control over financial reporting and an accompanying auditor's report.

But that expected windfall has been pushed back to 2005; in February, the

Securities & Exchange Commission

delayed the compliance deadline for Section 404 to fiscal years ending on or after Nov. 15 vs. July 15 previously. For now, industry observers say that only auditors and niche players are benefiting from the regulation.

After companies comply with Section 404 at the end of this year, they'll have the luxury of taking several months next year to buy and install more complicated technology to automate those manual processes, analysts say. The delay has postponed some expected revenue for content management providers but hasn't stopped speculation about consolidation in the group.

Start Your Engines

As the largest standalone content management company, after EMC aquired Documentum, FileNet is a logical acquisition target and hence investment choice, said Rick Ruvkun, portfolio manager of the

( SLFRX)Seligman Frontier fund, which holds FileNet shares.

"We think it's a large growth space, and they've been executing extremely well," Ruvkun said of FileNet.

"All these

content management companies are potential targets," he added. "The question gets to be, do you want to buy a Cadillac or do you want to buy a Chevy?"

ThinkEquity's Swanson suggested Oracle or

Network Appliance

(NTAP) - Get Report

may want to go the Cadillac route. Oracle could be attracted to FileNet's market share and applications focus, while Network Appliance may make a move as a "reflex reaction" to EMC's Documentum acquisition, Swanson wrote. (Swanson has an overweight rating on FileNet; his firm hasn't done any banking with any of the content management software vendors he covers.)

The one cloud hanging over FileNet's head, however, is its operating margin, which sat at a minuscule 4% last quarter. That's far short of the 15%-plus margins software investors have come to expect, said Brandon Osten, a software analyst with Sprott Securities in Toronto. (Sprott hasn't done banking with FileNet.)

Ruvkun acknowledged that an acquirer looking to buy on the cheap may pass over FileNet. Just that possibility prompted two other buy-side fund managers to own shares of smaller rival Interwoven, which was cash-flow positive from operations in the first quarter for the first time since early 2001.

One manager, who asked to remain anonymous, noted that Interwoven's price-to-sales ratio of 3 is half that of Canadian rival Open Text, for instance.

The other fund manager, who also requested anonymity, said that Interwoven offers the best risk-reward based on price. Its stock has slid 28% since the beginning of the year, significantly underperforming a 2.4% decline in the Goldman Sachs Stock Index.

Both IBM and Oracle make sense as possible Interwoven buyers, given the company's strong brand, large installed base and key partner relationships, Swanson suggested.

Open Text, the second-largest company in the content management market, is the only stock in the group to register stock gains both since the beginning of the year, up 50%, and over a one-year period, with an 81% gain. But the company has grown through acquiring what Osten called "not so great vendors."

"You have to wonder whether they're diluting the quality of their core product by buying legacy-type products," he said. (Sprott Securities hasn't done banking with Open Text.)

The company reported third-quarter results that were lower than expected, with net income of 7 cents a share on $80.2 million in revenue vs. 16 cents a share on $44 million in revenue a year earlier, in part due to distractions from closing its IXOS acquisition.

One key issue will be the effect of that deal on IXOS' close relationship with German applications behemoth SAP, Osten said. SAP is the only logical acquirer of Open Text, given its IXOS relationship and that roughly half of Open Text's revenue comes from Europe, Swanson said.

Former Internet highflier Vignette is another player that has gone on a shopping spree to expand into portals, collaboration and content management after its main Web publishing business evaporated after the dot-com implosion. Its stock is the only one in the group to suffer declines since the beginning of the year, down 28%, and in the past year, off 32.1%.

Swanson suggested that Vignette could be picked up by

Sun Microsystems

(SUNW) - Get Report

, already a Vignette customer and partner. Such a combination would bolster Sun's attack against Microsoft's desktop, suggested Swanson.

One problem for Vignette and other smaller companies is that customers are favoring fewer, large software vendors these days, said Steve Roth, a software and data storage analyst with the

( NTTFX)John Hancock Technology fund, which was a big holder of Vignette shares last year but it liquidated its position.

"They succeeded in turning their product around, but it's just a tough environment out there for small application companies," said Roth, who now favors SAP.

That tough environment is yet another reason why content management software makers may be ripe for the picking.