Mercury Interactive

(Nasdaq:MERQ) is paying a fairly steep price for Freshwater Software, CIBC Oppenheimer declared yesterday, the bank believes it was a great deal.

"Freshwater offers tremendous growth potential, synergies, and accretion to earnings," write analysts Melissa Eisenstat and Jeff Burnett in a research update on the Israeli company. "This combination will be an example of the strong just getting stronger", they sum up.

Mercury announced the deal to acquire Boulder, Colorado-based Freshwater for $147 million cash on May 21. Mercury also assumed Freshwater's stock option plan, it announced.

The huge potential in the deal justifies the relatively steep price Mercury paid for the company, the analysts write. The price is 7.35 times Freshwater's expected sales in 2002. The deal won't affect Mercury's operating profits, just its financing income. Moreover, Freshwater can be expected to generate $5 million for Mercury in 2001, hence the deal won't affect earnings per share. In 2002 Freshwater is expected to generate $20 million, which should begin lifting Mercury's profits.

In fact, CIBC Oppenheimer likes the deal so much that it is reiterating its Strong Buy rating for Mercury. Eisenstat and Burnett promise to update the company's price target soon. The last 12-month target they set was $70, but Mercury stock shot up 75% in April, voiding all the calculations on which the target was set. Yesterday Mercury hit a price of $69.

Refreshing lack of overlap

The unique quality about the acquisition, the analysts write, is the lack of overlap between Mercury and Freshwater.

Freshwater's products complete Mercury's operating spectrum. Freshwater products, networks and systems monitoring and management solutions, target the systems level. Mercury's products target the application level.

The acquisition enables Mercury to offer a more comprehensive solution in detecting bugs in systems and testing load capacity. Functionally, customers buying Freshwater products still need a product at the application level, Mercury told Oppenheimer. In other words, the companies have tremendous synergy.

To date Freshwater has sold its products solely through its website. Deals are typically worth less than $10,000 each. Boosted by Mercury's powerful sales force, performance could substantially improve.

The analysts have not yet updated their forecasts, but promise to do so soon. Their current predictions are therefore earnings of 95 cents a share for 2001, and $1.16 per share for 2002.