Sun’s hardware business has grown more profitable since Oracle (NASDAQ:ORCL) completed the Sun acquisition early this year, according to Oracle’s earnings report for the first quarter of its fiscal year 2011.
Oracle’s strategy is to combine its software with Sun’s server and storage hardware products to offer cost-effective, integrated solutions for the enterprise data center market. Management claims that Oracle can double Sun’s hardware revenues and expand hardware profit margins going forward. This strikes us as a highly aggressive scenario. If true, however, it could produce an upside of 5% to the $36 Trefis price estimate for Oracle’s stock. Our analysis follows below.
Sun’s declining hardware market share
In order to double Sun’s revenues, Oracle will need to boost its share of the enterprise server market to around 13% by 2016. This scenario could yield an upside of 3% to the $36 Trefis price estimate for Oracle’s stock.
Here’s why we think Oracle’s strategy may be a tad optimistic. Sun’s share of the enterprise server market slipped to 9.4% in 2009, down from a peak of 10.9% in 2006. Oracle has indicated that it plans to pare Sun’s product line down to only the most profitable products. Although this strategy could certainly boost hardware margins, we would also expect it to cause further market share declines.
We currently expect Sun’s server market share to continue its recent slide, reaching 8% by the end of the Trefis forecast period. You can drag the trend-line in the chart below to create your own server market share forecast for Sun and see how it impacts Oracle’s stock price.
Can Oracle boost Sun’s margins?
As a result of shutting down Sun’s less-profitable business lines, Oracle says that hardware gross margins have already improved, from 46% in the second quarter of calendar 2010 to around 49% in the third quarter. Management predicts that hardware margins will continue to expand, ultimately reaching 60%.
Given fierce competition in the global server market, we don’t expect Oracle’s hardware margins to surpass 49% during our forecast period. But if management’s more optimistic prediction pans out, it could contribute an additional 2% to Oracle’s stock price, for a total upside of 5%.
 As disclosed in Oracle’s FY Q1 2011 earnings transcript