Robert Kugel's Analyst Perspectives

I recently received an update from ERP software vendor Epicor, my first since it was acquired in May 2011 by Apax Partners, a private equity company, and simultaneously merged with Activant, an ERP and point-of-sale software company serving midsize retailers and distributors. In my view, taking the company private is a good idea since it will have to make ongoing investments that would not have been treated kindly by the stock market. Bringing Epicor and Activant together (and perhaps adding other companies to the portfolio) could allow the entity to spread some development costs over a broader base of revenues, but software combinations are difficult to execute well.

Epicor, with total 2011 revenues of about US$834 million, has a global presence and sells mainly to midsize companies, in contrast to, for example, Oracle and SAP, which focus on larger ones. Because of their greater economic resources, large organizations can afford to spend more money and time customizing and configuring their software. They also can have larger and more specialized IT departments than midsize ones to implement and support them. Yet the functional requirements of these two sets of buyers are quite similar. For that reason, midsize companies benefit when a software vendor has offerings tailored to a specific industry (or a specific line of business – from an ERP system perspective, grocery is a very different business than retail) and that are easily configurable to the practices and requirements of a given company. Epicor’s focus is in manufacturing, distribution, retail, hospitality as well as financial and professional services. It mainly uses its own direct sales force worldwide and has a professional services arm to assist in implementations, unlike Microsoft Dynamics and Sage, which utilize partners for these functions. The direct sales approach has advantages if a customer prefers to deal with the software company rather than a representative. Epicor’s midmarket focus and direct sales approach most closely resemble Infor, which also is owned by a private equity group.

I listen to such briefings partly in the context of the basic business issues facing the vendors. The core business strategy for software companies in mature markets is to retain maintenance-paying customers and, if possible, increase the cash flow from each of them. The latter may be achieved by increasing maintenance fees. However, major ongoing gains are possible only by adding more fee-based services – either expanding the software footprint (more users and/or additional functionality) or adding complementary offerings (such as monthly third-party data feeds or reference table updates such as for taxes). Meanwhile, even though the pace of technology change has decelerated in the ERP category in recent years, it is not standing still, so vendors must at least maintain technical parity to offer competitive capabilities and minimize the total cost of ownership.

In the briefing company executives focused mainly on the Epicor ERP (not Activant) side of the business. This part of the company is largely the result of a combination of Platinum Software (one of the first client/server ERP systems on the market, aimed mainly at larger midsize companies), Dataworks (ERP aimed at midsize manufacturing companies) and Scala (ERP, supply chain, manufacturing execution systems, field service and project management. To retain its customer base, Epicor has been taking an approach it describes as “protect-extend-converge” that is similar in concept to other software companies that consolidate a string of acquisitions.

The protect part involves ensuring that users are comfortable with the company’s intention to support their software, adding functionality (and potentially revenue) while moving the development of the legacy applications to a common, integrated platform. Epicor runs all of its products on Microsoft’s .NET architecture. It continues to invest in its legacy applications, making it easier, for example, to support a geographically distributed organization by enabling configurations (not modifications, which are harder to implement and maintain) that control local currencies, accounting standards, calendars, charts of account, rounding routines and other small but crucial differences. Its business process management capabilities simplify the implementation and modification of workflows, even complex conditional ones, without having to alter the underlying application, and that facilitates software maintenance and upgrades.

The Epicor product extensions include a human capital management (HCM) application and embedded CRM capabilities. The HCM product category goes beyond the traditional human resources management system (HRMS). Its broader set of capabilities is an increasingly important as corporations look to manage their workforces more intelligently. Companies now have more varied relationships with employees (for instance, the growing use of contractors in the United States) and more complex regulatory environments, especially if they operate in multiple countries. Embedding CRM into Epicor ERP is another enhancement that enables customer-facing employees to access all customer-related information and processes (easier search and, for instance, a case or trouble ticket) and at the same time work with invoices, projects, returned material authorizations and other items typically managed by an ERP system.

To remain competitive in the enterprise applications market, Epicor has been investing in mobility, easy access to business information (through dashboards, alerts and search) and the use of social media techniques to enhance visibility into customers or collaborate with colleagues. Epicor also offers options in deploying the software: on the customer’s premises or through the Internet via a hosted license or an on-demand subscription. Although most finance organizations continue to want on-premises deployment, a hosted option can be attractive in situations where a company wants to use the same software in a smaller facility and/or a geographically remote location but would find it difficult to support an on-premises deployment at that site.

I see a couple of reasons why Apax acquired Epicor along with Activant. One is that to enhance their competitiveness, both needed to invest in R&D, sales and marketing and professional services. Doing this as a public company is challenging, less so for a private equity firm. Another is that Apax also may be planning to bulk up its enterprise applications software portfolio through additional acquisitions. In this respect, it would be following the same path as Golden Gate Capital with its investments in Infor, which I recently reviewed. However, amalgamations of enterprise applications software companies rarely go smoothly, and most of the attractive targets have been acquired.

I think Epicor’s key challenge over the next several years will be to stay competitive despite being smaller than most of its key rivals, notably Infor, Microsoft Dynamics and Sage Group, as well as to a much lesser extent, Oracle and SAP. Thus, it needs a knowledgeable and patient private equity parent willing to make the investments that will enable it to keep up.

Regards,

Robert Kugel – SVP Research