For Novell and Cambridge, 1+1=0
redherring.com
For Novell and Cambridge, 1+1=0
By Dan Briody
Red Herring
March 14
It's hard not to wonder why Novell (Nasdaq: NOVL) thought it would be a good idea to
acquire IT services company Cambridge Technology Partners (Nasdaq: CATP). So far, the
newly announced relationship has been ridiculed by analysts, punished by investors, and
questioned by experts. Both companies have been heading south for the past year, and the
message from Wall Street was clear: two wrongs don't make a right.
Aside from a 12 percent bump in Cambridge's stock on Tuesday, the investment community
has roundly criticized the acquisition, which is valued at about $245 million, or $3.88 per
Cambridge share (a 25 percent premium to Cambridge's closing price on Monday). Making
matters worse, Cambridge was downgraded by three analysts on the news. Novell's shares
fell 4.8 percent, leaving the already decimated stock trading at just $5.53 at the close on
Tuesday, 84 percent off its 52-week high.
Novell is hoping that the move will symbolize the completion of its transition from a
networking software giant into a consulting services company. And judging from the decision
to replace Eric Schmidt as CEO with Cambridge's Jack Messman, we're inclined to think the
transformation is nearly complete. But that's not going to make life any easier for Novell and,
in fact, could make what has been a bumpy road even bumpier.
BAD PRECEDENTS
There are so many reasons to think this acquisition was a bad idea that it's hard to know
where to begin. Most importantly, merging two services companies has never truly been done
successfully. For the most recent example of this, see Marchfirst (Nasdaq: MRCH), the
product of USWeb and Whittman-Hart, which is now trading at just 63 cents a share and is
currently the target of several shareholder lawsuits.
'Mergers in IT services are rarely successful, and there is a reason why software companies
haven't bought services companies in the past,' says Jon Schick, a research analyst at
Lehman Brothers, which downgraded Cambridge's stock to Market Perform on the news.
'There is no precedent and no model out there.'
Novell claims that Cambridge's 3,400 employees, mostly consultants, will combine with its own
300 consultants to constitute one-third of Novell's business going forward. But the IT
services business has been in free fall since early last year, and it's not clear why Novell
would be anxious to acquire a business that has declining revenues and is not expected to be
profitable this year. Cambridge revenues fell 6.6 percent last year, and the company is
expected to lose 27 cents a share in 2001, according to First Call.
In addition, Mr. Messman, though he has served on Novell's board, has been running an
unprofitable services business that is clearly struggling. While it's easy to argue that Mr.
Schmidt had to go, it's much harder to say why Mr. Messman would be any more successful
at the helm. Incidentally, Mr. Schmidt will remain on as chairman.
'Mr. Messman knows the company, but he hasn't run the company,' says Mr. Schick. 'These
are two struggling companies, and Mr. Messman has been in the process of trying to turn
around Cambridge. It's definitely going to be a challenge for him.'
NO-BRAINER
The prevailing wisdom on this deal seems to be that by combining two bad companies, you
get one really bad company. Novell's fall from grace has been difficult for anyone to watch,
but an ill-advised acquisition is hardly the way to go about righting the ship.
Speculation was rampant on Wall Street last year that Novell would spin off some assets,
particularly its content networking unit. To that end, Novell announced last month that it was
forming a new caching and content management company called Volera. Nortel Networks
(NYSE: NT) and Accenture (formerly Andersen Consulting) are investing in Volera, but Novell
will be the majority owner. So the merger of Novell with a consulting firm is just a
continuation of a massive restructuring.
Considering that Novell's year-over-year revenue growth has declined in each of the last
eight quarters, it wouldn't surprise us to see even more changes. In the first quarter of 2001,
the company's revenues were down 22.5 percent over the same quarter last year. Still, the
stock is trading at 32 times fiscal 2001 earnings estimates (ending in October), even though
earnings are expected to decrease 5.6 percent from a year ago. If it hasn't become clear yet,
we don't recommend this stock, even as depleted as it is. Novell's metamorphosis is far from
complete, and we don't see any reason why the Cambridge deal will make things better
anytime soon. |
