Sun Microsystems: Burnout or Takeover Target?

Sun Microsystems (JAVA) is a company that serves as a great example of what happened during the tech bubble. In the late 1990s, Sun’s stock could do no wrong as it rapidly climbed from the $50 level on Jan 1, 1999 all the way to $250 level in late summer of 2000. The return in that short period was more than 500%. The stock was flying extremely high and surely overvalued, as were most tech companies at the time. When the bubble burst, Sun lost more than half of its newly acquired value by the end of the year 2000.

The stock’s performance since then has been abysmal, and though the losses have been less severe than when the bubble burst, they have been just as painful. After the close Thursday, Sun reported earnings that were well below the estimates (see conference call transcript) and the stock lost over 20% during the day. It now sits at $12.64.

Sun Microsystems struggled in their third quarter which ended March 31, as the company swung to a $34 million loss. Analysts’ estimates had Sun earning 18 cents per share, but instead the results were a loss of 4 cents per share. Sun took a $52 million dollar tax hit, compared to a $3 million dollar tax benefit in the quarter a year prior. Also, adding to the disappointing results were charges related to the February acquisition of free-software maker MySQL AB.

Furthermore, the company blamed sluggish sales to U.S. businesses that are holding off on IT expenditures until the economic outlook improves. They also foresee revenues to be relatively flat for the next quarter to round out the fiscal year. The financial difficulty necessitates that Sun will cut some 1500 to 2500 jobs, which would be a substantial portion of their work force.

With the performance of Sun Microsystems in the last few years, it appears that the company stands at a crossroads. The old way of doing business at Sun in not working, and management may need a shake-up. Sun has products— such as technology platform JAVA— that are widely used, but the business continues to struggle. The company is in need of a new direction; as the purchase of MySQL AB would suggest, perhaps that new direction is to a free-software or open source platform.

As far as Sun’s valuation, we have it rated very highly as it is trading well below its historical norms. The stock has fallen steadily from to be worth nearly 5% of its previous highs. An example of how undervalued Sun appears is in the price-to-cash flow metric which is historically between 22.82 and 45.90, but at the current price it is at 6.98. The valuation metrics we use suggest that for Sun to be trading within the range that the market has been willing to pay would mean a price of between $42-$60. Anytime a stock is that undervalued versus historical norms it means that either the stock is headed for 0 or it will return to generally more normal valuations.

Thus, since we do not think that Sun is going out of business after 5 straight profitable quarters before this quarter’s hiccup, we do think that the substantial underlying value for Sun makes it a potential take-over target.

Disclosure: none

Comments

[Jase]

It's almost impossible to decouple Java and other Sun initiatives from the technology framework that most relevant existing or emerging technical plays rely upon. They have a powerful, albeit subtle, influence on the entire technology ecosystem. The mobile arena (whether it be Apple's iPhone offering, RIM's Blackberry, or Nokia's product suite) all use Sun's technology. While this represents a very small fraction of Sun's revenue, it does result in a lock-in of ever- growing user base. And it's the best type of lock-in--the users aren't forced to be there--they simply prefer to be.

I've never been a big fan of hardware. Historically, the real money is in software. Still, their blade product offerings are growing fast, especially in emerging markets (60% of Sun's revenue is outside the US); they also received awards from DARPA for their research focused on microchip interconnectivity via on-chip optical networks enabled by Silicon photonics and proximity communication. This is a big deal for datacenter productivity, another huge growth area.

I should mention another point that few seem to be talking about: Sun bought back 300 million USD worth of their shares (at over $17/share) this quarter. Add that expense to the two big acquisitions (one of which was MySQL) and that might help explain why their earnings fell short this quarter. Sprinkle in a little "slowing US economy" drivel for good measure. There are a ton of initiatives and progress reports that will be shared at JavaOne (the conference starts in just a couple of days (Tuesday May 6th to 9th in San Fran). Personally, I feel that Sun's restructuring/turnaround is taking shape fairly well, they've had some measurable improvements over the past four five quarters. The sell off on Friday was just a crankypants tired-ass market punishing Sun for making them wait, people have been holding their stock anticipating a turnaround for a long while. Sun wasn't particularly attractive at $23/share, at $12/$13 per share however, it's a bargain.

[Iownyou]

The comment above kind of make sense, hopefully SUN will pull through in the next quarters :)

[robert_wolf_toronto]

sun's hardware is coming out of favour with intel boxes taking the lead.

Sun lost its edge by being too expensive.

Intel running either Microsoft or Linux is the future platform. Bye bye sun.

[petyaczar]

We disagree Mr. Robert wolf = that's what makes a market!

SUN is the #1 choice platform of developers/ NOT Microsoft or Linux.
As someone who has managed several SW companies, I can tell you this provides SUN with a huge ongoing competitive advanatage.

As a successful CHAIRMAN, CEO, PRESIDENT of several= more than 3
computer companies= sw aapplications, IMO this last quarter was an example of a new CEO "Clearing the decks" most likely driven by the requirement to recognize one time acquisition costs and a desire to downsize one more time, BOTH of these are one time costs, the new CEO logic could be, "Well if we have to recognize those costs, then also hit the books with the TAX COSTS ALL AT ONCE and get it over with. We'll take the hit once, setting up a going forward situation in which we can compete as a low cost producer in our space.

IMO SUN WILL RISE AGAIN and those who stay away or sell out at this low valuation will come to regret it.

ALSO Sun is the obvious remaining takeover target in the space with its predominant share of market.

IMO

[User 188207]

When Jon Schwartz took over as CEO he promised to remove the "poison pill" share dilution defense to take-overs. So Sun is a prime target to companies like Apple or maybe a private equity company. Remember the PIPE they got from KKR a while back (see www.sun.com/aboutsun/pr/2007-01/sunflash... ). I believe that Sun can turn around by driving hard at:
1) xVM virtualization to compete with VMWare
2) MySQL subscriptions, storage h/w and online service
3) Software-as-a-Service (Saas) e.g. Project Caroline to compete with Amazon
4) Virtual tape (fronting a tape back-end with disks, e.g. StorageTek 5800)
5) Delivering Rock in early 2009

If they continue to piss around with money wasters like Project DarkStar (gaming server) and Project Looking Glass (3D interface) they'll miss a huge opportunity to get some focus, deliver some value and make some profit.

Finally, the key issue with almost all Sun technologies is usability. Solaris is harder to use than Linux. Java is harder to use than C#, PHP, Ruby, etc. And this problem stems from "expert-mindedness" (experts like 100 bells and whistles, whereas regular folk want to "cut to the chase"). So it's time for a philosophical shift at Sun to drive simpicity and PLEASURE into the whole experience of engaging with the company, it's services and products.

[srw]

Sun is a bad doer in the software arena.
Java is currently successful not because Sun, it's because the Apache foundation, BEA software, IBM and a lot of contribution from the open source community and companies. There is not vendor lock-in here, there are many Java implementations and now Sun will open source their own. So Java is currently more a specification than a vendor owned product, IMHO Sun is currently irrelevant to the Java business. It's important to remember that Sun promoted Java in the client side, that there were thin-clients to run Java applications, but finally Java won the space in the server side.

Let's look at other hot software areas where Sun has failed:

- JavaFX: While Microsoft came finally with Silverlight to fight Adobe/Macromedia Flash/Flex business, Sun lost a precious opportunity with JavaFX, anybody plan to use JavaFX right now? I don't think so. If somebody wants some objetive data, While JavaFX has not delivered anything yet to really compete with Adobe or Microsoft, the open source innitiative Mono has implemented an early verion of Moonlight/Siliverlight as open source in 21 days: tirania.org/blog/archive/2007/Jun-21.html

- OpenSolaris: How many companies are using OpenSolaris? Why you'll choose OpenSolaris instead of Linux/FreeBSD/others?

- OpenOffice: While the product is very good, it's not clear how this free product benefits Sun. IBM has been promoting free platforms like eclipse but they have seen it as part of an ecosystem with commecial solutions like WebSphere, Notes and others.

So, I don't think you can trust Sun in the software business arena.

[softwareGuy]

Hardware companies trying to do software is recipe for failure. SUN make zero dollars on JAVA but sinks large amounts of human capitial dollars in it. The same will be true with MySQL. A losing game...

SUN h/w is losing ground, not because their hardware isnt any good, but because of the Operations and Maintence dollars associated with SUN gear. Why in the world would I buy a SUN box and pay huge amounts of money for maintenece, when I can buy a LINUX/INTEL box for 1/10 the cost and pay zero maintence? If it breaks, rip it out and insert a new box. Gut the old box and give it to an Admin or developer.

[petyaczar]

Hypotheoses and speculation, dreams, threats and assertions.

Check the cash flow, look at support revenues, back out acquisitions and taxes and look at the value of operations.

Sunw - oops Java is a $35 stock... compared against its stable mates.

[mr mo jo risin]

Sun is on its way to become a $2 stock again...sorry but I still look at their price and divide by four. Their little game with JAVA and a 4-1 stock split reversal did nothing by crater the stock...look at the price since the little game began. SPARC is end of life, T2 is a one or two chip system in a virtualized world. JAVA is a non money maker and if I hear how great Sun is because of free downloaded of Solaris again I will puke. MYSQL is the $1B mistake to try to fix the Oracle problem and it only made it worse. The stick with Oracle is wrong when you are a hardware company with no carrots. The blades are a joke 10 blades in a 10u....sounds like expensive 1U's horizontal. The refresh of pre-dot-boom is over for Sun and they are doomed to a Fujitsu OEM, Slowaris OEM, Intel future.

[SaltOfTheEarth]

"An example of how undervalued Sun appears is in the price-to-cash flow metric which is historically between 22.82 and 45.90, but at the current price it is at 6.98."

Simply put, the investor community do not value it as much as actual customers (and, as noted, potential acquiring interests) do. That means there are hidden areas of the business, that don't get the PR that Java, free software, etc get. Ergo, Sun either learns how to PR all the "boring" cash cow revenue streams or, gets subsumed by someone with lots of cash (or access to debt). No other outcomes are likely.

[SaltOfTheEarth]

I would add that the fact that all the things customers don't really care about (and investors make fun of) get the PR, instead of the things that actually result in cash flow, would imply that those are the things in need of spin off or outright kill. Well, if it's taken private, you know the sharp knives will be out and about.

[SaltOfTheEarth]

RE: "If they continue to piss around with money wasters like Project DarkStar (gaming server) and Project Looking Glass (3D interface) they'll miss a huge opportunity to get some focus, deliver some value and make some profit."

Not to mention, having many execs, and an increasing number of rank and file, being encouraged to play around in Second Life on company time. Time to execute, focus on the real cash cow lines of business, and eating the lunches of Dell, HP, IBM, et al. Market timing, price, effective PR, support. Simple things. Stop screwing around in Second Life, forget about curing world hunger and selling one time deals (later pirated) to Communist dictatorships and get cracking. Read "Good To Great." It's all about excelling at boring stuff, the way Fed Ex did.

[Flash Gordon]

Here are my comments on Sun. I used to work there.

- I don't know how they ever made any money off Java. They tried to compete with Websphere by cobbling together some internal IT projects and didn't win. Without creating a robust middleware you can sell to corporate customers, I don't know what money java makes for Sun.

- As of early 2000 everyone at Sun was overpaid on average. I remember as a manager competing with all the startups with huge salaries. Then the tech bubble music stopped and all these highly paid people were still there staring at each other. If they've had huge turnover since early 2000 this isn't a problem anymore but if not they should just cut everyones' salary 10 or 20%.

- Unix sold to heavy techies is their sweet spot but I bet they spend 10% of their time trying to make Unix Systems Administrators/Developers happy and give them neat new things. In the past their box's were always very good. With all these cutbacks you have to wonder if they cut into the magic development group that built the highly capable servers.

- The thing that really killed Sun was McNealy's insistence on Unix as a client platform for too long. We spent a lot of time inside Sun working with vendors to support a Unix client platform. Windows won as a client, get over it, something different will happen in the next lifetime. You didn't see IBM tell customers they weren't cutting edge if they were using Windows client. I work for a big financial institution now and they have a very cost effective infrastructure with windows desktops and Unix servers (a lot of them Sun).

- I think Raduchel (CFO/CIO, went to AOL as CTO) was the brains of Sun. An economists' sense of business tradeoffs overlaid on a good understanding and love of technology. He did see the tech bubble bursting (he told me to short netscape) and would have prepared the company much better for the tech bubble burst when it came.

... Flash

[SaltOfTheEarth]

Interesting some of the comments about Intel and Linux. This is itself evidence of Sun's PR failures. Sun is on a steep growth curve regarding Intel systems. Anyone can order any Sun X64 product with Linux. Problem is, most people are stuck thinking of Sun as Solaris / SPARC. I had mentioned some notions of spin offs. Here's one - spin off everything having to do with SPARC. Consider spinning off Solaris.

[Cyberqat]

Games are a niche market....

Like telco and banking are niches. Its a more then 10 billion dollar industry today and still growing rapidly. Of that growth a large peice of it is online. A server infrastructure company would be foolish beyond all measure to ignore it.

Im curious what the poster thinks ISNT a "money waster?"

Banking? Accounting? ERP? These are all blue-shift industries-- industries whose need for computer is growing slower then moores law. Any computer company who focuses on these will die a slow death as every year the need these companies have for computers *decreases.*

Online games, social sites, these are red-shift industries which is to say they are industries whose need for computing is growing at a rate that far outstrips moore's law. If your a computer company, and you want growth for your investors, these are the kinds of places you *must* look.

[HanginOn]

I'll jhang with you for a litle here. When do you believe what you are saying will show up in higher stock values? I keep things simple - results. How the company gets there is the board room talk I don't need to waste time on.


On May 05 05:56 PM petyaczar wrote:

> Hypotheoses and speculation, dreams, threats and assertions.
>
> Check the cash flow, look at support revenues, back out acquisitions
> and taxes and look at the value of operations.
>
> Sunw - oops Java is a $35 stock... compared against its stable mates.

[sniper6]

I would be glad to sell for $25 each every share I own. Sun Micro is a loser. Takeover? In my widest dreams.