EMC Gobbles Legato

After months of rumored acquisition talks between the two companies, EMC Corp. (NYSE: EMC) today announced that it plans to buy Legato Systems Inc. (Nasdaq: LGTO) for $1.3 billion in stock (see EMC to Acquire Legato for $1.3B and Legato Up for Sale?).

The deal will vault EMC into the backup software market, where it will run headfirst into the leader in the category, Veritas Software Corp. (Nasdaq: VRTS) (see our report on Data Protection).

"I'm 100 percent convinced that the next big thing in storage software is information lifecycle management," said Joe Tucci, EMC's president and CEO, on a conference call with investors today. "There is no company that has more of the pieces than EMC and Legato." [Ed. note: And just two years ago, when it unveiled its Automated Information Storage strategy, EMC was convinced the next big thing was multivendor storage systems management. Maybe data backup is the bigger next big thing?]

Legato is the tenth software company EMC will have acquired since the beginning of 2000. However, EMC bought those other nine software companies largely to speed up its time to market in specific segments. With Legato, according to Tucci, EMC gets more than just technology and products: It will obtain Legato's base of more than 31,000 customers, as well as a support staff of 500 personnel and a "fully baked channel partner program" with 400 partners.

Tucci did add, though, that Legato offers a strong technology heritage with 450 [fully baked?] software engineers: "I'm sure we'll get an additional healthy dose of software DNA," he said.Once the acquisition closes -- which EMC expects to happen in the fourth quarter of 2003 -- EMC said it plans to operate Legato as a software division of EMC. It will keep the Legato brand name, and the group will continue to be headed by David Wright, Legato's current chairman and CEO. EMC will integrate Legato's engineering and development functions into EMC's existing Open Software group, but its sales force will remain separate. Mark Lewis, previously EMC's CTO, was recently named executive VP, replacing Erez Ofer (see EMC Sics Lewis on Software).

Tucci said that in integrating Legato, EMC will borrow the IBM Corp. (NYSE: IBM) business model for its independent Tivoli management software division. "We'll use a little bit of the Tivoli model... We'll certainly spiff [provide incentives to] our own sales force to take advantage of the EMC sales organization already in place," he said. "Over time, the independent selling capability of Legato will be leveraged to take advantage of the broader EMC portfolio."

Wright, asserting that the acquisition by EMC will remove any lingering doubts by customers about the long-term viability of Legato, said there's tremendous opportunity for EMC and Legato to jointly address customers. "My challenge has always been: How can I propagate this technology in the industry?" he said. "We've suffered from a lack of resources in getting to all the opportunities."

In terms of corporate culture, Wright said, the two companies -- and its management teams -- are a good fit: "There are hundreds of zookeepers, and Joe and I are both hunters."

EMC and Legato executives did not say how many employees from Legato might be expected to be laid off, but it's worth noting that Legato recently cut between 5 and 6 percent of its work force -- in hindsight, it would appear that Legato was preparing to be acquired by EMC. EMC ended the first quarter with 17,200 employees; Legato has around 1,500 (see Legato Gets Leaner).Tucci said EMC expects to spell out the integration of the two companies more fully at its Aug. 6 meeting with financial analysts in New York.

EMC expects revenue from Legato to be consolidated early in the fourth quarter, and that the deal will be slightly accretive to 2004 revenues. Tucci acknowledged that Legato may lose revenue from two key partners -- Sun Microsystems Inc. (Nasdaq: SUNW) and Hewlett-Packard Co. (NYSE: HPQ) -- which view EMC as a mortal competitor. However, he said, EMC expects the overall increase in run rate to offset any lost business from Sun or HP.

Meanwhile, Tucci said EMC expects to do one more acquisition "of substantial size" to reach its goal of having software represent 30 percent of revenue. For the first quarter of 2003, software was $299 million, or 22 percent of total revenue, although just one-third of that ($99 million) was from its Open Software products.

"There are segments that we're interested in that we're looking at... I've never said where we're going to hunt... but Legato plus reasonable growth will not get us to 30 percent, and that is still our target," Tucci said.

Rumors of an EMC/Legato tie-up have been swirling for years. So why did EMC wait until now to pull the trigger? For one thing, the deal is entirely tax-free, said Bill Teuber, EMC's CFO: "That's obviously an important point for both parties."Moreover, Tucci said, EMC needed to return to profitability and get the right management team in place before it tried to assimilate a company the size of Legato. "I have a very strong belief based on experience that before any company does an acquisition of any size you want to make sure your own house is in order," he said.

Under terms of the agreement, EMC will issue Legato stockholders nine tenths of a share of EMC common stock for each share of Legato common stock. Based upon EMC's closing stock price of $11.74 on July 7, the deal is worth approximately $1.3 billion. In the fourth quarter, after the acquisition closes, EMC expects to take an expense charge of $30 million to $60 million for in-process R&D. Teuber said EMC plans to account for the rest of the acquisition with $125 million to $175 million of intangible assets and $1 billion to $1.1 billion of goodwill.

EMC's planned deal for Legato follows the considerably smaller transaction it announced last week with BMC Software Inc. (NYSE: BMC). EMC is picking up BMC's installed base of 50 storage software customers, and BMC will now resell EMC ControlCenter software (see EMC Chews & Swallows BMC Unit).

Also today, EMC raised its outlook for its second quarter, which ended June 30, 2003. It now expects revenues to be at the "high end" of the previously stated range of $1.425 billion to $1.475 billion, with earnings per share to meet -- or exceed by $0.01 -- the previously stated net income target of $0.03 per diluted share. EMC expects to announce its second-quarter results on Wednesday, July 16, before the bell.

Todd Spangler, US Editor, Byte and Switch