NEW YORK (CNN/Money) -
You can buy a lot with $56 billion in cash.
Microsoft, which has that amount of dough on its balance sheet, admitted this week that it had last year talked to German software giant SAP about a merger. Those discussions have ended, but the revelation that Microsoft is willing to spend to revitalize its growth prospects is a signal that there could be even more consolidation on the way in the software sector.
"This news is more than anything a warning shot to the rest of software that everybody is going to be involved in a feeding frenzy," said Richard Williams, director of research and software analyst with Garban Institutional Equities. "You are going to see a lot of smaller players go away."
So what could Microsoft (MSFT: Research, Estimates) go after?
Siebel, security or video game deals?
A company spokesowman would not comment about speculation regarding other possible deals. But there's not much else out there that would be a truly monumental deal along the lines of SAP (SAP: Research, Estimates), which has a market value of more than $50 billion and is expected to post sales of $10 billion in 2005.
A Microsoft-SAP marriage would have truly created a software monster, combining Microsoft's dominant Windows platform and Office software with SAP's lead in enterprise software, which helps big businesses automate routine tasks such as customer relationship and supply-chain management.
So if Microsoft wanted to make another move in the enterprise market, it would have to content itself with a much smaller company. Brendan Barnicle, an analyst with Pacific Crest Securities, said Siebel Systems (SEBL: Research, Estimates) could make some strategic sense.
The company, which has a market value of about $5.7 billion and expected sales of $1.6 billion next year, would be a good fit, Barnicle said since Siebel already has a strong relationship with Microsoft. The company writes software for Microsoft's .Net platform.
Other analysts said that security is an area that Microsoft should pursue. Microsoft has been hit by several high profile viruses and worms during the past few years and the continued vulnerability of the Windows operating system to further attacks has been a concern on Wall Street.
|†* data as of June 8, 2004|
Microsoft made a small purchase last year of a Romanian anti-virus software company but Williams thinks that Microsoft will need to do more to beef up security problems. He said that Network Associates, which makes the popular McAfee line of anti-virus software, could be a good fit.
Williams said that Network Associates (NET: Research, Estimates) would be a more likely buy than industry leader Symantec (SYMC: Research, Estimates), because Symantec's market value is nearly five times greater than Network Associates'.
However, Drake Johnstone, an analyst with Davenport & Co., said that if Microsoft were really serious about security, it should look at a company like Check Point Software (CHKP: Research, Estimates), which develops virtual private network (VPN) and firewall security products.
"In one fell swoop Microsoft could address concerns about gaps in Windows and investor concerns that the operating system is not entirely secure," Johnstone said. "Plus, security is a high growth area."
Check Point is expected to post a 10 percent increase in earnings next year and sales gain of 12.5 percent, compared to earnings and sales increases of less than 6 percent for Microsoft.
Finally, Microsoft could also make a further splash in video game software to boost its Xbox gaming console business.
Johnstone said that the company would probably have to look at one of the industry's mid-sized players since a purchase of industry leader Electronic Arts (ERTS: Research, Estimates) would likely raise antitrust concerns. But Johnstone said that a deal for Activision (ATVI: Research, Estimates) or THQ (THQI: Research, Estimates) could be doable.
Nonetheless, investors shouldn't get overly caught up in Microsoft speculation. The odds of it doing a big deal are probably slim since the company has traditionally avoided large acquisitions. Analysts noted that Microsoft's interest in SAP was probably more of a defensive move in response to Oracle's bid for PeopleSoft, an SAP rival.
Microsoft, however, has resolved many of its outstanding legal issues this year, which should free up more of its cash. And the company said that it intends to give Wall Street a clearer outline of how it intends to spend much of it by its next analyst meeting in July.
That fact, in addition to the SAP shocker, has certainly made discussion of other potential takeover scenarios a legitimate exercise. But most analysts still think that Microsoft will wind up using much of its cash to increase its dividend and buy back more stock.
Garban's Williams has a short position in Symantec but no other investments in companies mentioned in this piece. Garban does not have banking relationships with any of the companies. None of the other analysts own positions in companies mentioned and their firms have no banking ties to them.