This article is provided to FT.com readers by dealReporter—a news service focused on providing insightful intelligence on event driven situations to investors. www.dealreporter.com
--------------------------------------------------------------------------------------------------------
Sun Microsystems, the Santa Clara-based technology company, may receive limited interest from buyers if activist shareholders force the company to be sold in its entirety, two industry bankers said.
When asked if any of the large technology conglomerates would be interested in acquiring Sun, the first banker said HP and IBM would likely find it “too much of a headache” to purchase. The two large tech companies offer strong product lines, and are unlikely to be willing to do a deal with the assets that Sun owns, the banker said, characterizing those assets as ”less desirable.”
Financial buyers may be more keen than strategics to acquire Sun or one of its divisions, speculated Charles Curran, a general partner at venture capital firm Valhalla Partners. Curran focuses on storage technologies, also an area of focus for Sun.
Both industry bankers agreed that the most attractive asset Sun owns is likely its large patent portfolio, as the company was one of the pioneers in Silicon Valley and is an owner of a broad and deep portfolio of intellectual property.
As its stock price has slumped over a multi-year period, Sun has attracted value-driven Southeastern Asset Management to the list of its largest shareholders. On Wednesday, 22 October, Southeastern reported it has built a 21.2% stake in Sun and noted in a filing that it has held conversations with management and “intends to have ongoing talks with management or third parties.”
Sun is scheduled to hold its 2008 shareholders meeting on 5 November, with all 11 board members up for election. Sun declined to comment on its strategy in advance of its earnings call on 30 October.
A stimulus for change could also be KKR, the large private equity firm, which is an investor in the tech company via the ownership of two convertible bonds equaling USD 700m in face value, the second banker pointed out. KKR has the right to convert its notes into Sun common stock at USD 28.75 per share. Sun closed at USD 4.54 in yesterday’s trading.
KKR’s purchase of Sun’s convertible senior notes in a private placement in early 2007 has not worked out very well, the banker noted. With Sun’s business clearly deteriorating, KKR is left collecting a meager coupon payment on the convert, he noted.
“In the event of an acquisition [of Sun], a buyer would need to do some pretty heavy restructuring,” Valhalla’s Curran noted. To maximize the value of Sun’s core assets, he said, a prospective buyer “would need the proverbial hatchet and the scalpel.”
The banker said he viewed Sun in the category of another Wang, the long-time defunct hardware company. To survive, hardware companies need to become more software or services focused or they disappear. In Sun’s case, it has proven a challenge to make that transition, he noted.
Pacific Crest analyst Brent Bracelin agreed, saying Sun is one of a handful of large incumbent technology suppliers that are struggling to transition to next-generation technology. “A case can be made that their model is broken,” he said. “I would not be surprised if private equity came in and carved it up.” Sun’s share price, which is trading at USD 4.72, down from around USD 22 at this time last year, is evidence the market wants it to do something meaningful to deal with its high exposure to financial and telecom markets, Bracelin said.
Sun does not break out individual product revenues, keeping segments broadly defined as computer systems (45%), storage (17%) and services (38%). Sun’s Computer Systems revenues slid 3% between June 2007 and 2008, according to the company’s annual report. Computer Systems comprises Sun’s software, server, networking and desktop systems products. Sun’s storage line, which was up slightly in 2008 over 2007, is dominated by StorageTek products.
Sun’s storage technology unit could be seen as the company’s most likely divestiture target because of its flat revenues, Curran said. However, companies such as EMC, which may be seen as the most logical acquirers of the division, may not be interested, no matter what the price, he said. “Sun’s storage business is in many ways a legacy business” built around tape-based storage technology. Today, tape-based storage has been eclipsed by newer disk-based storage, he explained, and some observers say Sun’s storage offerings have not evolved rapidly enough to keep up with competitors’ offerings.
“You could compare the difference between tape and disk to the difference between Blockbuster and Netflix,” Curran said. ”It’s legacy technology... If anything, I would say [Sun’s storage business] is more of a leveraged buyout target. The value to a strategic would arguably be minimal.”
Sun designs its own microprocessors, but may be better served buying chips from Intel instead and closing down this unit said BMO Markets analyst Keith Bachman. Sun may also consider shuttering software lines that are not gaining much traction. The company has made numerous software buys over the years, but it is unclear which should be divested or shuttered because the company does not break out these financials, Bachman explained. Sun also launched a desktop initiative, Sun Fire, whose impact is not clear, Bachman said. These businesses do not have obvious buyers, especially given the tight credit markets, he added.
Faysal Sohail of CMEA ventures, an investor in Montalvo Systems, a recent Sun acquisition, said Sun Microsystems will need to focus on fast growth, and high margin businesses to raise its value, including Web 2.0 businesses, emerging markets and high-performance computing companies. Sun Microsystems is “trapped” between its legacy customer base and new fast-growth, high bandwidth companies, he said. “It may make sense for them to get out of their commodity hardware business,” he said. Sohail declined to comment on whether Sun should divest specific businesses because he had not looked closely at its financials. If Sun does divest a business, it may have trouble finding a buyer in this market, he said.
Another analyst suggested Sun may get rid of MySQL, which it acquired at the start of this year. However, a source within MySQL said open source is an integral part of Sun’s software strategy going forward.
--------------------------------------------------------------------------------------------------------
For more information or to inquire about a trial please email sales@dealreporter.com or call Europe/EEMEA: +44 (0)20 7059 6160 Americas: +1 212 686-3076 Asia-Pacific: +852 2158 971
