Size Matters in Software Merger Derby

A small acquisition by IBM speaks volumes about the advantage for larger companies.
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With the software acquisition frenzy showing no signs of slowing,

IBM

(IBM) - Get Report

has bought a small, but technologically significant company and strengthened its hold on the $7 billion middleware market.

Its purchase on Tuesday of Gluecode Software for an estimated $100 million is a ringing endorsement of the open-source software movement. And when coupled with IBM's recently completed purchase of Ascential Software, it suggests yet another sign that the largest players with the broadest offerings are calling the shots in the software industry.

Hardly a household name, the El-Segundo, Calif.-based Gluecode sells support and service for an application server called Geronimo, which is used to make disparate applications work together on a computer network. Geronimo itself, like other open-source products including Linux, is free, and is not a direct competitor with high-end application servers like IBM's WebSphere or

BEA Systems'

(BEAS)

WebLogic.

But the lower end of the market where Geronimo plays is far from saturated, creating an attractive "green field (brand new customer) opportunity." Moreover, IBM figures that customers will start small, and as they grow will scale up to larger and more expensive versions of WebSphere, said Robert LeBlanc, IBM's general manager of application and integration software.

The acquisition also gives a boost to IBM's play to move ever more strongly into services, commented AMR Research analyst Eric Austvold. Open-source products, he says, have largely been used to run less-than-critical functions like Web servers, mail and print servers and the like, processes a company could outsource with less risk than critical functions. "Now IBM can go to a customer and say, 'Why not run Linux on those servers, and by the way, we'll manage them for you,' " he says.

More broadly, IBM, BEA and others plan to provide a software layer to deliver new services -- and drive new sources of revenue. Earlier this year, BEA launched Project DaVinci, a suite of products and tools to help telecommunications companies build VoIP (voice-over-Internet protocol), multimedia and wireless services. The market for those is not yet huge -- about $250 million or so -- but within three years, said Yankee Group analyst Rob Rich, it will be several billion dollars.

IBM's open-source application server will compete directly with a similar product developed by JBoss, an Atlanta-based open-source software maker. While acknowledging the competition, JBoss' vice president of strategy, Bob Bickel, notes that Big Blue gives open-source that much more credibility with customers. "IBM will define and explain the market in ways that we can't," he said.

Bickel's take may sound a bit like someone whistling in the wind, but analyst Dennis Byron of market researcher IDC says he has a point. "IBM legitimizes his business," he says.

But traditional vendors, including BEA and

Oracle

(ORCL) - Get Report

, will be forced to respond. "All of the other app server vendors will have to make a decision on open-source sooner than they might have wished," he said. Those companies will likely jump on the open-source bandwagon, and will have to pick an open-source developer (of which there are a number) to partner with.

Not playing at the low end, which refers more to the size of the deployment than to the size of the business, is probably not an option.

Coping with IBM's move in middleware is especially critical for BEA. Last year, IBM's share of the market increased to 37.2% from 36.3% the year before, while BEA's slipped a full point to 7.2%, according to IT researcher and consultancy Gartner. The shift in share is far more significant for BEA since applications servers are the heart of its business, while much-larger IBM is highly diversified.

"Competition in the application server market continues to intensify," Goldman Sachs analyst Sarah Friar wrote in a note to clients published Tuesday. "Our feedback continues to be that BEA's best-of-breed value propositionis often not enough to win against IBM WebSphere's significantly lower total cost of ownership in many competitive situations." Goldman has a banking relationship with BEA and IBM.

Similarly, IBM's $1.1 billion acquisition of Ascential pressures vendors who sell software that integrates and cleanses data.

There's some disagreement about how

Informatica

(INFA)

, the largest remaining publicly traded competitor, will fair. Independent tech analyst Rob Tholemeier, who has followed the space for years, believes the stand-alone company is not in trouble. "Customers will have trouble trusting IBM. Data integration needs to be done by someone independent," he said.

Other analysts disagree, saying customers want to reduce cost and eliminate complexity by dealing with as few vendors as possible.

"A broad information integration system will become more appealing over time, which suggests that pure-play integration vendors will have difficulty convincing customers to buy their technology," said AMR's Austvold. Customers, he said, want a single set of technologies that address the problem of data integration (making disparate data sources accessible to other applications).

Large as it was, the Ascential deal was hardly a blockbuster, at least not when compared with recent software acquisitions like the $10.3 billion takeover of PeopleSoft by Oracle, the $13.5 billion merger of

Symantec

(SYMC) - Get Report

and

Veritas

(VRTS) - Get Report

, or the $3.4 billion purchase of

Macromedia

(MACR)

by

Adobe

(ADBE) - Get Report

.

And those were just the most-publicized deals.

Between Jan. 1, 2004, and March 31, 2005, the enterprise applications market saw at least 191 reported buyout deals worth more than $30 billion among 2,500 enterprise applications vendors, according to a study by IDC.

IDC research director Albert Pang calls it an arms race that software companies cannot afford to lose. "The new generation of industry leaders are gaining powerful tools, such as substantial recurring revenue, global reach and combined customer lists, forcing rivals to compete on new, more demanding terms.

"Many vendors who remain stagnant during this period of rapid consolidation may find themselves cornered in the middle of an industry niche, segment or product category without any upward mobility," he says.