Sun Microsystems: Slowly Fading Away?

Nov. 6.08 | About: Sun Microsystems (JAVA)

What happens when a high tech loses its way to achieving long-term growth and profitability? It slowly fades away. Sometimes it is because a company does not keep up with the latest generation of whatever they sell and they become a “has been.” However, a new variation on this theme has emerged to latch on to a new generation even if you can’t make money on it.

Is Sun Microsystems (JAVA) slowly fading away?

Its stock certainly has, having closed last Friday at the lowest level in more than a decade (adjusted for a 1-for-4 reverse stock split last year). JAVA is down over 72% year-to-date.  We are in a bear market so many high tech stocks are down substantially.  However, compared to IBM (NYSE:IBM) and EMC (NYSE:EMC) down approximately -13% and -37% [YTD] (see chart), Sun appears to be having a more challenged year (and decade, for that matter).

In the 1990s, Sun Microsystems established itself as a high tech titan by enabling the build-out of corporate networks and the Internet. It had, and still has, great hardware. During the last recession with Internet bubble bursting, many of Sun’s customers went out of business. It, however, enjoyed a significant presence in financial services that it leveraged until that market blew up in this recession. Having a significant block of customers hit hard in each recession, however, is not the only reason its shares and long-term fortunes are challenged.

As a side bar, it is interesting to compare two other high-tech titans both of which have had to re-invent themselves to weather competitive pressures and recessions themselves.

IBM has been counted out several times in its history. When the mainframe was supposed to be dying in the early 1990s and PCs were going to wipe them out, IBM responded by extending the mainframe franchise, getting into PCs and, most significantly, expanding into services. IBM expanded their services business by acquiring PwC Consulting. In recent years they have expanded, both organically and by acquisitions, into software. In the business intelligence space, their significant acquisitions were Ascential and Cognos (COGN). IBM has chosen not to fade away, but to expand out of the hardware business with consulting and services surpassing hardware in profits and growth. When it could not make money in PCs, it sold the business! Sometimes you need to honestly assess a business and jettison it if it does not advance your business rather than devoting resources into a losing cause.

EMC was also hit hard in the last recession, and over the years, it has faced many products that were labeled as EMC-killers. EMC chose to become a commodity vendor through both a hardware and software strategy. In hardware, it acquired a “lower-end” competitor enabling it to offer a broad range of storage products and thus defend its high-end franchise. In software it expanded though organic development but more significantly by acquisitions. Its initial round of software acquisitions extended its core competency of storage capabilities, but then it got into software applications that consumed storage rather than manage it with the notable acquisitions of Documentum and VMware (NYSE:VMW). Both of these acquisitions were “outside of the box” thinking that has proved to be profitable.

IBM and EMC have both been primarily hardware vendors in their history and have broken out of those bounds. They both could have become commodity vendors and faded away but because they both thought outside the box, they did not.

Sun seems to want to be cool regardless of whether it makes business sense.

After posting disappointing quarterly earnings, Sun’s CEO Jonathan Schwartz said that the recession might be an opportunity for Sun since companies may examine using freely distributed "open source" software, which it promotes. It is true that the use of open source software [OSS] may increase, in tough economic times, but does that business really help Sun.

The company makes money if the customer buys a subscription, but how much revenue and profit can they generate from those customers? Sun bought MySQL for a $1 billion dollars (overpaying is another problem), but that company was not earning a profit despite sales of under $200 million and a millions of downloads. If Sun was a start-up with a much smaller organization then maybe it could generate enough profit from this business model to sustain itself, but can a company of Sun’s size really generate enough profit from their portfolio of open-source software [OSS]?

The other argument Sun uses is that OSS will generate profit when a Sun OSS customer decides to buy Sun hardware because it was using that OSS. Often, though, if a customer is looking at OSS because it doesn't want to spend money or it doesn't have money. Those customers are most likely going to buy the cheapest hardware they can get!

Cross-sell and up-sell are staples of retailers and financial services companies but that business model is yet to proven for a high-tech firm of Sun’s size to leverage from OSS.

I like Sun’s hardware and software, and I use Java and MySQL. However, it is not a question of whether the products are cool; but instead, the issue is whether Sun can leverage OSS to make enough revenue and profit to keep its business growing. 

As Neil Young said, "it's better to burn out than to fade away." It would be nice, though, if Sun followed another path and become a growing and profitable high-tech titan again.

Disclosure: None