EMC 'Paying Too Much' for Smarts

Acquisitive storage system vendor EMC Corp. (NYSE: EMC) is paying too much for OSS vendor System Management Arts Inc. (Smarts). (See EMC Gets Smarts).

At $260 million, EMC is paying 4.5 times annual revenues for the fault management company, as Smarts says it will hit about $60 million in sales in 2004.

That price is way higher than could have been expected, says Patrick Kelly, a partner at consultancy OSS Observer.

"Assuming Smarts's current revenue growth rate is sustainable for the next three years, it should have been valued at between $140 million and $170 million," reckons Kelly.

"Obviously EMC thinks it can help Smarts lift the pace, but I have my doubts," adds the analyst.The OSS Observer man points to the recent revenues experience of fault management market leader Micromuse Inc. (Nasdaq: MUSE), which managed annual sales growth of 16 percent in fiscal 2004 (see Micromuse Posts Q4 Profit).

Kelly says EMC's offer suggests the storage vendor believes Smarts can build its revenues by between 40 percent and 50 percent over the next four years. That would be a very optimistic target, says Kelly.

Naturally, EMC thinks the price is "in the right ballpark. We're paying for a company, its technology, and its future potential," says an EMC spokesman. "This is an acquisition of technology that will be strategic to EMC in the coming years," he adds.

At least Kelly agrees that the deal makes strategic sense for EMC, as he believes the Smarts' root-cause analysis software is well suited to storage networks.

But the analyst also believes the deal will see Smarts direct more resources into enterprise product developments, and away from the increasingly important carrier market. "I think the EMC acquisition will definitely distract Smarts's focus on the service provider market," says Kelly.And that's certainly an area Smarts has been developing strongly of late. The OSS firm's president, Shaula Alexander Yemini, says a greater focus on carriers' needs is reaping rewards, and means "Smarts isn't viewed so much as just an enterprise shop. We're hoping to announce our biggest carrier customer ever very soon," she says, adding that Smarts is already one of AT&T Corp.'s (NYSE: T) suppliers for its Concept of One project and has growing traction with Verizon Communications Inc. (NYSE: VZ). (See AT&T Needs New 'Underware,' Says CEO).

But Kelly believes the EMC acquisition spells good news for Smarts's main competitors in the carrier market, namely Micromuse, Aprisma Management Technologies Inc., and Hewlett-Packard Co. (NYSE: HPQ).

Conversely, the deal gives Smarts more muscle, increases its potential customer base, and solidifies its growing relationship with Cisco Systems Inc. (Nasdaq: CSCO), already a key partner of EMC (see EMC, Cisco Do the Deed).

Yemini says a wide-ranging OEM agreement was signed with Cisco in August that covers almost all of Smarts's products, though it's still too early for that agreement to be having any noticeable impact on revenues.

Yemini says this is a critical deal for Smarts, as Cisco has, indirectly, been more of a competitor in the past, as it has long been a major reseller of Micromuse's Netcool software.Cisco is less gung-ho about the arrangement, however, saying its ties with Micromuse are as strong as ever. Philippe Roggeband, the equipment firm's OSS solutions manager, says Cisco now offers both products to its enterprise and carrier customers, but "there is no way that one is preferred over the other."

He says both have their strengths. The Smarts software is more "out of the box," and requires less customization, but this makes it less flexible than the Micromuse software, says the Cisco man.

And what of Smarts's senior management? Can EMC hang on to the team that has built up the OSS firm? Yemini says she's staying, and will be "reporting to the CTO, focusing on EMC's management software strategy."

Kelly believes EMC will be pulling out the stops to hang on to the top people. "I'm sure the golden handcuffs have been applied," he says, adding that stock option incentives vesting over a three-to-five year period would be a standard offer.

EMC says it won't comment on whether any such deals have been offered.There's one group of people, though, that will be very happy with their resulting deals should the acquisition close as expected in the first quarter of 2005. Bessemer Venture Partners and Soros Private Equity Partners are Smarts's sole external investors, having pumped in just $25 million, less than 10 percent of the $260 million in cash offered by EMC.

Ray Le Maistre, International News Editor, Light Reading