Original URL: http://www.theregister.co.uk/2008/07/10/sun_under_gun/

Shrinking Sun under the gun

Could Fujitsu unite?

By Ashlee Vance

Posted in Servers, 10th July 2008 15:29 GMT

Comment Here, with the stock market melting, we find Sun Microsystems in most uncomfortable territory. It's got a stock market value of $7.7bn, which means that the one-time lord of the servers is a mid-cap company.

Our friends on Wall Street warn that Sun needs to maintain at least a $10bn market capitalization to stay in the large cap territory and part of the large cap funds. Should Sun hang around in $7bn country for too long, then a sell-off will start, making things even worse on Sun investors. (In addition, a whopping 57m shares, nearing 10 per cent of all out-standing shares, are already shorting Sun, up from 25m last month.)

The odds of Sun bounding back to large cap status don't look too good if you focus on the near-term. Sun's due to report fourth quarter results on Aug. 1. Typically, the fourth quarter is Sun's best, although the current economic climate fails to inspire much optimism. "Given Sun's reliance on the transactional server business in a weak IT spending environment and exposure to the no-growth Unix market, we believe that the company will find it challenging to boost revenue growth over the next few quarters, especially if the dollar stabilizes or appreciates," Toni Sacconaghi, an analyst with Sanford C. Bernstein & Co., wrote in a recent research note.

Sun will really need to surprise investors on Aug. 1 to get that JAVA stock heading higher. Without a shocker, Sun shares will likely keep declining.

Sun's stock market value raises other concerns because it leaves the company looking very much like an anomaly among its peers. Try and find another $7bn-$8bn company with 30,000 employees.

We've always admired Sun management's stance of viewing mass layoffs as something to be avoided at all costs. In addition, we've bought into the idea that a revamped Sun could rebound from darker days and grow again, which served as the basis for keeping so many staff on board. Sun Chairman Scott McNealy would often remark that you want warm bodies around when the orders start flooding in, and you want morale as high as possible before that point as well.

It's difficult to see how Sun can cater to such feel good tenets given the realities of its situation.

The company has gone through a number of smallish layoffs. It's made many acquisitions - both large and small. It's rolled out new product lines. It's tried to generate fresh momentum through various, creative open source plays. So far, however, these moves have failed to result in a meaningful, lasting momentum shift that could really accelerate Sun's growth. Sun has been hunting for a dramatic game changer, but such a product or approach has failed to arrive fast enough.

We're left with a company heading toward $7bn in market cap territory that has close to $4bn in cash, an immense intellectual property portfolio, a massive customer base, some very strong technology and a still admired brand.

Enter FuSu.

Enter FuSu

Fujitsu, with $53bn in annual revenue, stands as one company that must be keeping a close eye on Sun's situation.

It already shares costs for producing SPARC chips and servers with Sun. So, Fujitsu knows the SPARC/Solaris business well, meaning that it's familiar with the needs tied to Sun's main product line.

A combined Fujitsu and Sun looks appealing on paper. You'd end up with a company that could really compete quite handily against the massive shops at IBM and HP on a global scale. Fujitsu could pick up some of the best-designed server and storage products going, while also broadening its software portfolio dramatically. Fujitsu would also gain a much stronger presence in the US, while the combined company would be even stronger in Europe (Fujitsu Siemens) and Asia.

In many ways, the companies might even mesh culturally, since Fujitsu still values research and development, continuing, for example, to work its mainframe expertise downstream by creating damn fine Unix boxes.

Sun has always been such an independent force that it would present major integration challenges for a company all the way across the ocean. But Fujitsu could be a nice lifeline. And since it has a market cap around $16bn, Sun and Fujitsu could kind of pitch a merger of equals, making everyone happy.

In addition, Japanese companies tend to shy away from hostile corporate takeovers, while US companies love some old-fashioned hostility. Sun may want to start making nice now with Fujitsu before it gets too late.

Frankly, talking about Sun being absorbed into another company makes us feel a bit ill. Sun has always been that counter-puncher that helps keep everyone else honest.

It's just that we watched Sun drop from Icarus heights to about a $24bn company. And then drop down to about an $18bn company. And now here we are at a $7bn company.

We'd figured that Sun's x86 line would grow larger faster than it has and that it would inject serious new life into the company. But, while the business has done well, it hasn't grown enough to support Sun's current structure, which is more or less based on the idea that the x86 sales would replace all the the lost Unix sales.

There are still a number of bets out there that could revitalize Sun. The Rock-based server family arrives in 2009. The MySQL purchase is only just taking hold. Developers seem very interested in OpenSolaris, and Sun has concocted a fresh take on storage, centering new gear around open source code and general purposes boxes. Meanwhile, its x86 systems really are just about the best Tier 1 gear you'll find on the market.

Some Sun investors have taken all this in and re-upped their faith in the company. Last month, for example, Southeastern Asset Management bought a massive chunk of Sun shares, raising its stake in the company to 10 per cent. Southeastern is behind the Longleaf Partners Fund, which prides itself on finding under-valued companies with solid management.

But at $7bn, you have to wonder if a vulnerable Sun can survive until this latest round of bets has a chance of hitting in late 2009. The woeful economy certainly does not help matters. Nor do recent rumors that Sun is seeking a replacement for CEO Jonathan Schwartz. After all, Schwartz was McNealy's hand-picked successor. If these two fellas can't figure out how to fix Sun, we're not sure who can.

We're pretty convinced that the outside world would see a massive "For Sale" sign in Schwartz's departure. "We tried out best boys. Now, who wants the good bits, and how much are you willing to pay?" ®