If IBM (NYSE: IBM) is in the due diligence phase of acquisition talks with Sun Microsystems (NASDAQ: JAVA), as news reports suggest, then it has an awful lot to be diligent about.
In a merger of this scale, IBM would need to take a hard look not only at Sun’s finances but also at any antitrust issues that may arise, as well as potential conflicts related to intellectual property. Those could include compatibility of software licenses and patent agreements with third parties.
“In a deal of this size, there are typically lots of moving parts,” said Randall Bowen, an attorney at Grad, Logan and Klewans in Falls Church, Virginia. “Think of a kaleidoscope, where you turn it and everything comes together to form a nice symmetrical shape. Either that happens and everything falls into place, or else it shatters.”
The Wall Street Journal reported last Friday that IBM was scouring Sun’s business contracts for potential conflicts in a prelude to a possible merger, a process it said was expected to take “a number of days.” With another week over and no word about a deal from the companies, some observers are starting to wonder if there’s a holdup.
“It’s impossible to know what it is they’re looking at, but the fact that it’s taking this long gives one pause to wonder whether there’s just such a volume of contracts to look at that it’s occupying all this time, or whether they’ve found some issues that they’re busily chasing down,” said Steven Frank, a partner with the law firm Goodwin Procter.
To be sure, the due diligence process for a merger this size could take months to complete. But companies often do a cursory review of the business they hope to acquire in order to announce a preliminary merger agreement. They then take several months before the deal is finalized to pore over the details.
If they do plan to merge, Sun and IBM may simply be haggling over price. But if the due diligence is holding them up, the thorny area of intellectual property could create some sticking points, said Frank, who spoke about IT industry mergers in general and not specifically this one.
Both companies have vast product portfolios governed by a mix of open-source and commercial licenses. They also have numerous patent and cross-licensing deals with third parties, including a byzantine agreement that Sun forged with Microsoft in 2004 that ended a lawsuit between them over the Java software technology.
Sun may be licensing a technology from a third party that is vital to one of its products, for example, and such agreements sometimes have clauses stipulating that the license can’t be transferred if the licensee is acquired. IBM would need to approach the third party to extend the license, or decide whether to go ahead with the merger even if it has to find another way to build the product.
That’s the issue Intel raised about Advanced Micro Devices’ sale of its manufacturing operations to an Abu Dhabi investment group. Intel accused AMD of violating a cross-patent agreement on x86 processors that could not be transferred to a third party, and the companies are in talks with a mediator to resolve the dispute.
Conflicting software licenses can also be a problem. Dozens of Sun’s products, including OpenSolaris, NetBeans and its GlassFish Web software, use its Common Development and Distribution License, which is based on the open-source Mozilla Public License. Its MySQL database is offered under the GPL or a Sun commercial license, while still other products use different licenses.
Depending on what IBM has planned for Sun’s technologies, the mix of licenses could be a challenge, said Randall Colson, a partner at Haynes and Boone. For example, some industry analysts speculate that IBM wants to merge the best of Solaris into IBM’s AIX Unix, which is offered under an IBM commercial license. If Sun has merged a third party’s open-source code into Solaris, IBM may find barriers to merging Solaris with its proprietary AIX software.
Perhaps most complex for IBM would be the intricate deal that Sun entered into with Microsoft (NASDAQ: MSFT), which ended a long-standing lawsuit between them over Microsoft’s alleged attempts to undermine Java.
The deal netted Sun almost US$2 billion from Microsoft, including payments of $700 million for Sun to drop its Java lawsuit, and a further $900 million for a patent-sharing agreement that could be extended for as long as 10 years. IBM, whose software business depends heavily on Java, would need to pull those agreements apart to ensure nothing could interfere with its business or expose it to legal risk from Microsoft.
With reports of the due diligence work only a week old, it would be premature to assume that any talks under way have run into trouble, Bowen said. But the longer they take, the more uncertainty it creates for the customers and investors.
“It’s fair to say that with every day that passes, it makes it seem a little less likely that this deal is going to happen,” he said.
