Sun Micro: Put Spreads to Play Merger Arb?

IBM has been rumored to make a bid for Sun Microsystems (JAVA) ever since the tech boom in 2000. Big Blue made the right move by not overpaying for Sun, which then had a market cap of $50b. Since 2000, IBM has made a big bet on JAVA in their own products and service offerings and seen little cooperation from Sun in developing standards and plugging holes in JAVA. In ten years, JAVA platform is core to IBM’s $12b + revenues from middleware and WebSphere suite and another few billions in services revenues.

The street is focused on synergies in server business and dubbing the acquisition as a data-center consolidation move. IBM, Dell (DELL), and HP (HPQ) have entered multi-year partnership with Sun to distribute Sun Solaris operating systems, and Cisco (CSCO) is already a Sun OEM. Sun’s 10% market share in the server business will allow IBM to increase its share to 40% from current 30%, well ahead of HP, which has about 30% market share. However, an IBM acquisition would prompt Dell and HP to take a hard look at their partnership with Sun.

IBM’s control on the JAVA platform seems a more attractive reason for a potential acquisition. IBM tends to acquire mid to large software (iLog, Cognos, Informix, Rational etc.) companies, integrate their products to WebSphere, middleware and database suite and distribute through its Global Services arm. IBM’s acquisition of Java would be more in lines with that of Rational, which also had significant backing from IBM as a software design platform.

IBM’s possible offer for $6.5b or $4.5b, adjusted for Sun’s $2b net debt, makes sense now. Sun stock has slipped 22% since the WSJ first reported the news. JAVA $6 April puts are priced at 60c (180% implied vol) and $5 puts at 25c. Selling the March put spreads would credit 35c and limit the downside to 65c should the deal falls through and Sun falls below $5 level before the announcement. In the event of a deal, $6 is a reasonable floor price based on the premium that IBM has paid in past deals.

Disclosure: Author holds a long position in JAVA

Comments

[moose60061:]

I believe you mean April puts!

Apr 01 08:12 AM

[Amit Kumar:]

Yes. April puts. Thanks

Apr 01 08:35 AM

[longtime IBMer:]

Yeah and the number of people who care satisfied with IBM global services, whose unofficial motto is "billable hours", can be counted on the fingers of one hand.
<p>
That's about how many people are glad to see heir middleware be acquired by IBM and further "developed" or "maintained". IBM's acquisitions set the following dynamic into motion: current customers of their products realize that the quality is going through the floor and begin to look for an exit strategy to another product. Many customers bp's are so intimately entwined with the product that they have no choice but to stay. The actual product starts to fall behind the curve, and as time goes on, those customers competitive positions are punished more and more, until the CTO finally bites the bullet and tries (and often fails) to break free.
<p>
This is like the old Computer Associates, who used to buy popular products then milk that cash cow until it was dead, doing nothing but taking the cashing the checks and some marketing. Computer Associates was where software went to die, and IBM is where software goes to hell.
<p>
All that's going to become of MySQL is it will be "neglected" and serve as a feeder to DB2. Netbeans is toast and if you want to know what the fate of Java is, you need only look at SWT, a GUI library that was supposedly an "improvement" over Java's Swing GUI library. That's what the NIH geniuses at IBM do when they get the chance.
<p>
A lot of companies are in deep with Sun. If the deal doesn't go through, those companies may see the light and they and Sun may want to work out some revenue generating licensing agreement in order to keep Sun writing the brilliant software that Sun gives away for free now.
<p>
IBM doesn't innovate much of anything, their cash-for-trash "software and business method" patent portfolio notwithstanding. What they do is what all failing companies do- they lobby and manipulate the IP laws in order to tip the scales in their favor, that is, they lawyer (but see the distinguished career of IP strategist and lawyer Marshall Phelps for details) and they buy companies that do innovate. Oh, and they perform labor arbitrage in the form of H1B and outsourcing, which wouldn't be so bad if it was a strategic move - acquiring certain hard to find talent- and not a tactical "keep this pig flying a few more years" move, wherein programmers of lesser ability are brought in to replace programmers of greater ability.
<p>
This is what IBM has become. No wonder Dell is cackling with glee; they're right on the money. IBM and Sun's culture are so diametrically opposed integrating the two is going to consume all the attention and resources of both these companies for the next three years. Then it will fail, IBM will sell off what it bought, Palmisano will get shown the door and the world will be left with net value destruction.
<p>
Three cheers for the omniscient market.

Apr 01 08:53 AM

[JOETRADER:]

What April puts are you talking about?


On Apr 01 08:35 AM Amit Kumar wrote:

> Yes. April puts. Thanks

Apr 01 08:54 AM

[HIGHWATER 888:]

A .60 - .25 'Bull Put Spread' yields a .35 credit NOT .45. Jeezzz....

Apr 01 09:12 AM

[Amit Kumar:]

right. 35c. the spread is almost gone (down to 13c) with the rally in Sun stocks today.

Apr 01 12:08 PM

[is the end ...:]

as a Sun employee I, and many of us, don't relish the thought of working for 'big blue'. NOt so long gone are the days Sun VP's were advocating the insinuation that IBM was a 80 year old dinosaur. Who would want to trade a fresh young thing for one of those I ask myself!

Apr 01 06:22 PM

[Amit Kumar:]

IBM lowered its intended takeover price for Sun Microsystems to between $9 and $10 a share, according to people familiar with the matter. Sun agreed to accept the lower price in return for stronger commitments from IBM that it will complete the deal despite facing intense regulatory scrutiny. The companies previously discussed a price in the range of $10 to $11 a share. The two sides continue to negotiate, and it remains unclear when they will reach a deal. - WSJ Report

Apr 02 01:51 PM

[BeachRider:]

JAVA and IBM are a culture clash, as seen here.

From a market perspective, it is better. JAVA, MySQL, Solaris and the UNIX development community bring value/cache to Sun, from IBM's perspective.

There never was a question that both Sun and IBM should aim their guns at Microsoft, not each other. Will they do that?

Apr 02 01:57 PM

[Amit Kumar:]

Talks between International Business Machines Corp. and Sun Microsystems Inc. were on the verge of unraveling Sunday, threatening to undermine a potential $7 billion acquisition that would place one of Silicon Valley's iconic companies under the Big Blue umbrella - WSJ Report.

Apr 05 09:50 PM