Oracle chief executive Larry Ellison unveiled a surprise $7.4bn offer for Sun Microsystems on Monday, turning Sun’s collection of widely-used but undervalued software properties into the next targets for his wholesale consolidation of the software industry.
The agreed offer, which followed closely on the heels of a failed IBM bid for Sun, threw the spotlight squarely onto Sun’s Java, a programming language developed in the mid-1990s to counter Microsoft’s growing dominance of the software industry.
While Sun’s failure to make money from Java has long been a frustration for its shareholders, Mr Ellison declared it “the single most important software asset we have ever acquired” – and at a price, after deducting Sun’s net cash, that is only around half the amount that he paid for PeopleSoft, Oracle’s most famous software acquisition.
News that Sun was being bought mainly for its software assets also confirmed the long decline of the server and storage hardware business for which it is better known. A former star of the technology industry, Sun’s value soared above $100bn at the height of the tech boom as its servers became the workhorses of the early internet years. its shares collapsed, however, as a new generation of lower priced technology took hold, and Sun struggled in recent years to justify its continued high cost base and heavy research and development spending.
Oracle executives, while saying that the combination of hardware and software represented a new step in the database company’s evolution, left little doubt that they would severely cut back Sun’s hardware business after an acquisition, and analysts speculated that parts of the business would eventually be sold off to other tech companies.
Sun’s agreed deal with Oracle, at $9.50 a share in cash, comes two weeks after negotiations for an acquisition by IBM at the same price fell apart.
The deal follows a last-minute intervention by Oracle after IBM was once again in discussions with Sun about a deal of its own, according to a person close to the software maker. Oracle first approached Sun late on Thursday about the possibility of a deal, and signed an accord late on Sunday, according to this person.
The swiftness is in stark contrast to IBM, which hesitated and dropped its offer price after taking a closer look at Sun’s business in recent weeks. This uncovered issues that reduced the attractions of a deal, including a bonus plan that would hand Sun executives a $600m windfall in the event of an acquisition, according to one person close to IBM.
The IBM offer also caused a rift in the Sun camp, as the company debated whether to sell itself to an old rival. Oracle, by contrast, is an old Silicon Valley ally. Along with Netscape and America Online, Sun and Oracle were part of the Gang of Four that stood up to Microsoft at the end of the 1990s, lobbying for the US Justice Department inquiry and long-running lawsuit against what they called the Beast from Redmond.
The deal will accelerate Oracle’s transformation from a database software company into an all-round IT systems supplier. Mr Ellison said the company would now be able to sell “completely integrated systems, hardware and software, [which] should be popular and very profitable.”
The deal caps a series of big software acquisitions by Oracle, the latest of which, for BEA Systems, made it a big competitor to IBM in the market for “middleware”, the software used to stitch together applications that run over multiple computer systems.
Previously, Oracle’s purchases had focused on applications, an area of the software business IBM has chosen not to play in, with the purchases of companies like PeopleSoft and Siebel Systems.
The Sun purchase will be worth more to Oracle financially than the PeopleSoft, Siebel and BEA acquisitions combined, said Safra Catz, Oracle’s co-president. It will add 15 cents to its earnings per share in the first year after the deal, and will lift pro forma operating profits by $1.5bn in the first year and $2bn the year after that, she added.
Oracle gave no other details for how it expected to achieve these profit targets. Instead, its executives on Monday focused squarely on the long-term strategic advantage to Oracle of owning Sun’s leading software assets, principally Java and the Solaris operating system.
Java has become a key part of the software foundation for a generation of IT systems created by companies like Oracle and IBM. Yet even though it is in use on hundreds of millions of PCs, mobile phones and other digital gadgets, Sun has failed to make much money from the software. Licensed cheaply and operated as an open standard, it has become a shared resource for many of the software companies that exist outside the Microsoft camp.
Along with Solaris, Sun’s Unix computer operating system, Java is the overriding reason for Oracle’s decision to swoop in at 11th hour and make an offer of more than $7bn for the company, Mr Ellison and other Oracle executives said.
The central position of Sun’s software points to how the value has shifted in its wide portfolio of technologies as its core hardware business has crumbled. Though known mainly as a maker of servers, Sun has struggled as its customers have turned to cheaper, standardised machines based on chips made by Intel and Advanced Micro Devices.
Oracle made little effort on Monday to disguise the fact that it sees Sun’s hardware business as merely an afterthought. Publicly, its executives said only that they would make sure hardware became a profitable division within Oracle.
According to one person close to the company, that is likely to mean forcing through the sort of aggressive cost-cutting that Sun itself had resisted as an independent company, and narrowing the range of products to focus only on the sort of high-end, complex systems that demand the highest prices.
Oracle has already taken one step into hardware, “bundling” its database software into a machine from Hewlett-Packard so that it can sell a complete system. Likewise, with Sun hardware it will be able to sell servers along with sector-specific software aimed at retailers or banks that amount to an “industry in a box,” said Charles Phillips, co-president.
Yet this ability to combine hardware and software to build complete integrated IT systems, though loudly trumpeted by Oracle executives on Monday, is not the driving force behind the deal.
Rather, Oracle has its eyes set firmly on the Sun software – and combining this with Oracle’s own software throws up a “wildly profitable” opportunity that should make the Sun acquisition much more valuable than any of other deals the acquisitive company has pulled off in recent years, according to the person close to Oracle.
Part of the reason, this person says, is that Oracle believes it can make far more from Java than Sun ever did. That is because Sun decided a decade ago virtually to give the software away to make sure it got wide adoption. Many of the Java licenses – including one that Sun granted to Nokia – were for ten years and come up for renewal next year, implying that in future, Oracle will look to extract a higher price for the technology.
That message will not be lost on IBM, which itself relies heavily on Java for its own highly profitable portfolio of “middleware”. An IBM spokesperson declined to comment on the strategic implications.
However, the person close to Oracle denied that the company would greatly increase the licence fees for Java, or weaken its position as an industry standard by tying it more closely to Oracle’s own software. It was clearly in Oracle’s interest to encourage Java’s continued widespread adoption, so such moves would not make sense, this person said.
Likewise, Oracle is likely to find it hard simply to extract a price for Solaris, the operating system which Sun was forced to turn into an open-source product to try to hold its own against Linux. Yet the fate of Solaris is central to Oracle’s future: the company sells more database software licenses running on Solaris than on any other operating system, Mr Ellison said.
As a result, keeping Java and Solaris out of arch-rival IBM’s hands was likely to have figured high on Mr Ellison’s list of reasons when deciding to mount his own bid for Sun.