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Sun Microsystems has benefited from some misplaced optimism and will likely see its share price fall in the coming weeks, according to one of the most respected financial analysts.

Sanford C. Bernstein & Co. analyst Toni Sacconaghi has called Sun out as an overachiever in a new research report. Sun, which has enjoyed a more than a 50 per cent surge in its share price since August, was downgraded to underperform from market-perform by the research firm. Investors have prematurely rewarded Sun for efforts such as its new line of Opteron-based servers, Solaris 10 operating system and JES (Java Enterprise System) software subscriptions, according to Sacconaghi.

"Our channel checks do suggest that overall IT spending is fairly strong in (the calendar fourth quarter of 2004), but that (Sun's) quarter did not experience a material acceleration, and we do not see upside to its FY Q2 05 revenue expectations," the analyst wrote. "Moreover, while we applaud (Sun's) effort to reinvent itself and its numerous new initiatives (JES, x86, partnerships with Fujitsu and MSFT), we simply do not see enough evidence among leading financial indicators . . . to warrant holding SUNW at current levels."

On a down day for tech stocks in general, shares of Sun dropped more than five per cent to $5.10.

Sacconaghi noted that Sun's shares have tended, in recent quarters, to rise ahead of earnings reports and then drop significantly after Sun issues disappointing financial results. The analyst expects this trend to continue when Sun reports its second quarter earnings on Jan. 13. Sacconaghi has a $4.40 per share target set for Sun.

Sun has proven innovative both with its products and sales methods, but these bets on new gear have yet to pay off, according to Sacconaghi.

Sources have informed Sacconaghi that Sun may create a more flexible model for JES, which is currently sold at $100 per employee per year.

"Our field contacts suggests that JES's all or nothing flat rate pricing approach has not been well received in the field (some contacts view it as "confusing", others as "not giving customers what they really want"), and that that Sun is currently rethinking pricing and the go-to-market approach for the offerings," the analyst said.

JES sold well when it was first introduced, but after just 5 quarters on the market, sales have already slowed. Sun moved 42,000 JES subscriptions in its first fiscal quarter of 2005 - down from 47,000 in the same quarter last year.

Bernstein also charged that Linux (65 percent) is being picked up more often than Solaris x86 (35 percent) on Sun's Xeon and Opteron systems. If this trend continues over the long haul, it would be bad news for Sun, as Solopteron sales are more valuable to the company that Linopteron sales.

Overall, the analyst firm noted that Sun just doesn't seem to be capturing CIOs' hearts as it once did.

"We believe that SUNW's recent stock appreciation is due to investor excitement over an improving corporate IT spending environment and that the recent announcement of Solaris 10 will ultimately translate into significantly improving financial results," Sacconaghi wrote. "While our CIO surveys do suggest an improving spending environment and our research indicates solid overall IT demand in Q4, our field checks suggest that SUNW's quarter was ok, but not great - field contacts indicated that momentum may have marginally slowed from last quarter (where revenues fell short of consensus estimates), that high-end sales were relatively slow vs. low end offerings, that end of December sales were uncharacteristically sluggish and that Solaris 10 - which will only be officially be released in January - will take 6-8 quarters to have a financial impact on SUNW, consistent with previous OS upgrades." ®

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