Oracle/Sun Microsystems

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Swooping in before dawn broke over Silicon Valley on Monday, software maker Oracle announced an agreed offer to buy Sun Microsystems. The transaction at $9.50 per share in cash – the price that rival IBM had been expected to pay before negotiations collapsed two weeks ago – launches Oracle into direct competition with IBM and Hewlett Packard.

Does this make sense for the software maker, though? On consensus forecasts, the $5.6bn enterprise value Oracle is paying for Sun equates to eight times expected earnings before interest, tax, depreciation and amortisation of $673m. But that does not factor in considerable scope for cost-cutting. Sun has successively failed to wring out savings over 10 successive restructuring plans. Oracle – typically bullish, without detailing plans and hardly any numbers – believes Sun will add $1.5bn to operating profits in its first year, and $2bn thereafter.

Slashing costs is not the main rationale for this deal, however. Unless Oracle has developed a sudden desire to manufacture servers, Sun’s struggling hardware business will probably be sold on. (Cisco could be a potential buyer.) Rather, the draw is Sun’s software assets. Its key products, Java and Solaris, do not make much money. But they are industry standards, and much of Oracle’s own database software relies on them. Even if the group is unable to extract higher licence revenues from such intellectual property, it removes the risk of a competitor such as IBM stealing a march on Oracle.

Indeed, the deal fits into Oracle’s overall strategy of building a software empire by acquisition, providing it with the ability to offer an “industry in a box” solution to businesses. Whether it will integrate the pieces into a coherent whole remains to be seen – although, as Oracle’s share price has handsomely outperformed its peers since it began its spending spree, investors should give Oracle the benefit of the doubt.

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