Competition Drives Software Mergers

THE mergers and acquisitions sweeping the United States software industry could leave it looking more like the media business - with many independent producers and creators but only a few large manufacturers and distributors.

``If you look back at any industry, such as the cereal business or the automotive business in the '30s, they all ultimately consolidated down to five to 10 companies, and I believe in the next decade you will only have 10 software companies,'' says Kevin O'Leary, president of SoftKey International Inc., in Cambridge, Mass.

Mergers and acquisitions in the software and information-services industry jumped 47 percent during 1993, reaching 374 transactions, according to an annual report by investment-banking firm Broadview Associates L.P. in Fort Lee, N.J., and the Information Technology Association of America.

The amount of money that has gone into software mergers and acquisitions this year alone is already larger than the total amount spent for all of last year, says Mark Gorenberg, a partner at Hummer Winblad Venture Partners, an Emeryville, Calif., venture-capital firm that invests in software companies.

The forces driving the merger activity are technical and economic, analysts say. The pressure to compete globally is also driving merger activity.

A decade ago, software companies were selling software for $300 and $400, primarily to corporations, Mr. O'Leary says. Today, software sells for as little as $19.95 because the competition is so great.

For a company to remain profitable, its first step is to merge to create size, he says. Then it can combine manufacturing and distribution, and increase market share.

``In the last two years, we've moved from an industry that sells primarily to businesses to an industry that's going through a violent change to become a commodity,'' O'Leary says. ``Software is becoming no different than a videotape or a record album or a paperback book, and not all of us are ready for that change.''

Formerly based in Mississauga, Ontario, SoftKey International - which develops, publishes, and markets products for the small office and home office, ``edutainment'' (education/entertainment), games, and CD-ROM markets - merged in February with WordStar International Inc., of Novato, Calif., and Spinnaker Software Corporation, of Cambridge, Mass., both manufacturers of personal productivity software for the PC.

SoftKey International saw sales increase 39 percent to $34.5 million in the first quarter of this year. (Leaving aside the impact on revenues of mergers, the growth rate was 20 percent during that period.) Company earnings amounted to $6.6 million, compared with the three firms' combined loss of $35.3 million during the same period a year ago.

``Software is becoming more and more a business of marketing and distribution and not just technology innovation,'' says Mitchell Kertzman, chief executive officer of Powersoft Corporation in Concord, Mass.

``And as it has moved toward the importance of marketing and distribution and global market share, then critical mass and size make more and more of a difference,'' he adds.

In February, Powersoft, a fast-growing programming-tools company with $51 million in sales in 1993, acquired Watcom International Corporation, a small company in Waterloo, Ontario, that specializes in database-management products.

Most analysts agree that there is no benefit to staying small. ``In the overall industry, you're either consolidating, you're being consolidated, or you're evaporating,'' O'Leary says. ``There's no steady state in being small.'' Generically speaking, he says, ``Everybody under $50 million in sales is talking to somebody.''

Mr. Gorenberg explains that merger activity is a positive thing for small vendors ``because it not only allows these small companies to have an exit strategy of going public but allows them, down the line, to consider a merger strategy if, serendipitously, it comes along.''

T/Maker Company in Mountain View, Calif., which manufactures electronic clip-art for newsletters and multimedia software for children, was acquired this month by Deluxe Corporation, of St. Paul, Minn., a leader in providing products and services to the financial payments industry.

Deluxe owns two companies: one that supplies preprinted specialty paper for computer users and the other that sells such products as greeting cards, stationery, and wrapping paper to the consumer.

``The fit is not immediately obvious to the outside world,'' says Heidi Roizen, chief executive officer of T/Maker.

But ``I think that's going to be part of the trick of this business. It's not necessarily going to be inherently obvious to the inquirers or the inquirees what the mutual talents are without exploring things,'' she adds.

Yet, there are a few people who do not see the software industry consolidating. Gorenberg says he sees plenty of room at the top for many large companies.

``The industry is not really collapsing into a small number of companies. It's really just beginning to catch its stride,'' he says, adding that since 1989, the industry has grown from about $27 billion in worldwide sales to $73 billion - a 300 percent increase.

Charlie Federman, the managing director of Broadview Associates, also says that he doesn't see the industry consolidating.

``The change of technology is creating more opportunities than acquisitions are taking companies out,'' he says.

For an industry to consolidate, Mr. Federman explains, one of two factors must be present: Either the total revenue dollars of all the companies participating in the market need to decline or the number of companies participating in the market need to decrease. Neither of these scenarios are occurring, he adds.

``This is an area of unprecedented opportunity,'' Federman says. ``This a great place for an entrepreneur to be because the type of capital you really need is intellectual capital.''