IBM Taking Aim at H-P

Includes: HPQ, IBM, JAVA
by: Ockham Research

“The Wall Street Journal beginning to offer more details of an acquisition of Sun by IBM. Now saying that the deal could be valued at between $10 and $11 per share. That would be the $6.5 billion IBM would be offering in addition to the $1.4 billion in cash that sun has on its balance sheet. More importantly, this deal is expected to be announced this again, according to the Journal, that it would represent a 125% premium over Sun’s trading price earlier on Monday.

This would be a sizable deal. Some are speculating that IBM’s action with Sun is in direct response to Cisco’s entry into the server business announced earlier this week, but everybody I am talking to says that Cisco is not the real target here. This is all about Hewlett-Packard. Cisco going after HP, IBM now going after HP. HP has a lot of new headaches on its hands as far as competition…

I say 125% premium, I can’t help but think back to when Sun was a lot higher than 8 bucks. I’ll tell you what, down here or at least on the trading desks I have talked to, they love this deal, and a lot of deals they think don’t make sense. This makes strategic sense, IBM and Sun are essentially in similar businesses. Sun, of course, is huge in the server business. Huge in the software business in and the street seems to really like it…”ockham historical valuation JAVA

Much of the news today is surrounding a possible deal between IBM (NYSE:IBM) and Sun Microsystems (JAVA). As the caption from CNBC’s reporting suggests, this deal is eliciting a lot of positive feedback from traders. The motive behind the deal is clearly to better compete with Hewlett-Packard (NYSE:HPQ). IBM’s bread and butter is the services business, which brings in more than 50% of revenues and generally has high profit margins. HP went directly after this revenue source when it went acquired EDS last year, and thus far the results have been mostly positive. In this case, it seems that IBM is looking to grab some hardware market share away from HP, especially in the area of servers, which is one of Sun’s strengths at about 30% of their revenue.

Readers will remember that IBM largely got out of the hardware business some time ago as it has much lower profit margins. This move could represent a shift in strategy back into the hardware business. Sun also has substantial revenue streams outside of servers in network computing systems, data management and other services. However, revenue had begun to plateau in that last couple of years and is expected to decline this year. Sun has also struggled to be consistently profitable and estimates call for them to lose 34 cents in 2009 and make just 9 cents in 2010. So, the question we have is, does the company command a 100% mark-up from what the market believes it is worth?

In the short term, Sun may not justify such a premium; IBM might have been able to acquire Sun for less. However, over the long term, this deal could be a winner for IBM, as it gives them a stronger footing in server hardware and some software solutions. Of course, time will tell and there are many things that remain to be seen, such as how corporate cultures will mesh at the straight laced IBM and somewhat more freewheeling Sun. By most accounts though, this deal is worth doing for both companies.

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