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DECEMBER 6, 2002 NEWS ANALYSIS IBM's Rational Self-Interest Its $2.1 billion deal for this maker of high-end digital "toolkits" shows how intent Big Blue is on grabbing more of the Net software market
In its Dec. 16 issue, which closed on Thursday, Dec. 5, BusinessWeek reported that IBM was in talks to acquire Rational, the leading maker of software tools used by developers to create Internet applications that run corporate operations. The deal marks IBM's largest software acquisition since it bought Lotus for $3.5 billion in 1995. It's easy to see why IBM is eager to get its hands on the Cupertino (Calif.) company. As more corporations use the Net to perform key business tasks, the software that allows them to create applications and Web services is growing in strategic importance. With sales Dataquest expects to hit $5.5 billion in 2004, up from $4.7 billion last year, it's not a sector IBM can afford to ignore. KEY, BUT HIDDEN, CHORES. Others certainly aren't: The likes of Microsoft Corp. (MSFT ) and Borland Software Corp. (BORL ) are also piling in. Buying Rational, says analyst Mike Gilpin of Giga Information Group Inc., "would position [IBM] to compete more effectively against Microsoft." Such a move also bolsters IBM's long-stated goal of increasing the share of sales and profits coming from software. For the last seven years, software chief Steve Mills has focused on building up IBM's position in the key, though hidden, programs that make up a company's computing infrastructure. So where does Rational, which is expected to earn $37 million this fiscal year on revenues of $628 million, fit in? To understand its import to IBM, it's necessary to delve into the geeky world of toolkits. Essentially, these are the programming tools that corporate software developers use to design the programs that allow consumers to buy books online or enable CFOs to run their financial reporting systems over the Net. LOCKED-IN CUSTOMERS. For software providers like IBM, building a strong tools business is critical: It's too expensive to train developers to use multiple toolkits, so buyers usually stick with one and its family of products. That means toolkit providers that lock customers in can drive sales of other software. But while IBM already makes its own basic toolkit, called WebSphere Studio, it doesn't have the high-end software needed to build the most sophisticated applications. It wants Rational to fill that hole. So if it's such a key market, why is Rational selling out? In part, the company is vulnerable because of its past overreliance on the battered tech and telecom sectors. Their troubles caused sales to fall 15% for the fiscal year ended March 31, 2002, and Goldman, Sachs & Co. expects an additional 9% sales drop in the current fiscal year. That helped send its market cap down 40% in the last year, to around $1.75 billion. Investors are also worried about the tough competition that could increasingly cloud Rational's future. Borland recently bought three small companies that specialize in design and configuration tools, and it clearly intends to move from basic to high-end tools. REDMOND'S SHADOW. The real threat, however, is Microsoft, which is also making the same move. While Rational has long been allied with Microsoft, the software giant now shows every sign of developing its own tools. Without IBM's marketing muscle and corporate customer base to sell to, over the course of several years Microsoft could walk away with much of the business Rational now does for it. Rational "needs to be closer to IBM," warns Gilpin. IBM will create a new fifth brand and division for Rational, joining its WebSphere, Lotus, Tivoli, and Database groups. Mike Devlin, Rational's president, will become the division's new general manager and will report to group head Steve Mills. Furthermore, IBM says it will continue to retain Rational's partnership with Microsoft. This is necessary, say analysts, because even though IBM competes against Microsoft in the Net software market, customers often maintain different software platforms that must be supported. IBM said it expects the deal, which is subject to approval by shareholders and government regulators, to close in the first quarter of 2003.  By Spencer Ante in New York Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | DECEMBER |
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