Scotia research on SAP / BOBJ / Cognos

Here is a summary of this morning’s research note from Paul Steep of Scotia Capital. The business intelligence market continues to consolidate, with SAP’s takeover of Business Objects. Wellington Financial Fund II portfolio co. Longview Solutions recently announced that it was being acquired by Exact Software of The Netherlands for US$51.5 million.

Hard to believe that Goldman Sachs dropped their rating on Cognos to “hold” from “buy” this morning on the back of the BOBJ news, according to CNBC. It would appear that Goldman figures Cognos is losing dance partners; they might be right (see post “Takeovers to come“, April 15-07).

“Event

? On October 7, SAP announced an all cash tender offer for Business Objects worth $5.3B (net of cash on-hand). The offer has been unanimously approved by both boards and the transaction is expected to close in Q1/08.

What It Means

? We believe that the SAP BOBJ combination is positive for SAP and represents a major competitive threat over the long-term to the remaining independent BI vendors. Our expectation is that the independent BI vendors will have a one- to two-year opportunity as both Oracle and SAP seek to aggressively pursue the BI market.

? Our view is that Cognos is likely to seek out a transaction with one of the remaining potential buyers (e.g., IBM, HP). We anticipate that given the limited field of potential purchasers that the valuation premium paid for Cognos is likely to be contained relative to the multiples paid for Hyperion and more similar to those paid for Business Objects.

? Rebalancing BI stocks. We are increasing our target price on Cognos [from $46.00 to $54.00] reflecting a value reflective of an acquisition scenario and changing our recommendation on Business Objects to 4-Tender.

SAP Offer Reflects Substantial Purchase Premium

? In our minds, SAP’s proposed purchase price for Business Objects represents a significant valuation reflective of the strategic nature of this transaction (see Exhibit 1). SAP’s purchase of Business Objects represents the second major strategic acquisition of a leading BI vendor following Oracle’s purchase of Hyperion in March 2007 (see Exhibit 2).

Exhibit 1 – SAP offer reflects premium acquisition multiples

F2007E F2008E F2009E
P/Revenue 4.1x 3.6x 3.3x
EV/EBITDA 16.4x 13.3x 12.6x
P/E 27.0x 22.5x 21.6x

Source: Company reports; Scotia Capital estimates.

Exhibit 2 – Oracle’s purchase of Hyperion offers another view of strategic value

F2007E F2008E
P/Revenue 3.4x 3.1x
EV/EBITDA 12.5x 11.6x
P/E 26.8x 24.5x

Potential for a take-out of Cognos

? Our view is that further potential share price appreciation exists for Cognos based on the current market values. We believe that a limited number of large potential buyers remain in the market including IBM, and Hewlett Packard that are likely to pursue Cognos. In evaluating a range of potential take-out values for Cognos the range could vary between $53.00 per share and $58.00 per share based on precedent transactions.

? We are increasing our one year target price on Cognos given the potential for further M&A activity within the sector. Our Cognos target of $54 per share is based on a 22x multiple (undiscounted) on our F2008 EPS estimate (previously 21x discounted at 9%) that includes a 3x multiple point premium for potential as a takeover candidate. We believe that Cognos’ valuation is supported by an underlying fair value (i.e., not including any takeover premium) using a discounted cash flow that provides a range of values from $40.00 to $45.00.

? We believe that operational and valuation risks remain for Cognos over the longer term in the absence of acquisition by a larger vendor. Over the next year, our expectation is that both Oracle and SAP will remain largely distracted with integrating the independent BI vendors. Our view is that concerns over increased competition from major vendors (e.g., Oracle, Microsoft, and SAP) will remain a limiting factor to multiple expansion as investors worry about increased pricing pressure on new license transactions.”

MRM