We don’t know what’s going on at Sun but somehow feel that there is a ball still in their court.  At first we noted that some of the software assets (Java, MySQL) are very strategic and in some ways the current value of the company ($3.6B TEV at $6.60/share) might be worth these assets.  Of course Sun comes along with over $13B in annual revenue, a bloated cost structre, dysfunctional management and declining viability versus competition from companies like HP to name one.

The IBM deal seemed like a home run for both parties were it not for the anti-trust concerns, some of which seem quite valid in areas of the business.  The deal is highly accretive to IBM even at $12 or $13/share.  So much so that we won’t even bother showing the math here.  (Although you can start with the Sun TEV/R of 0.3x versus the IBM TEV/R at 1.5x and start to get the gist of it.)

Unfortunately Sun has been destroying businesses they acquire and shareholder value for a decade.  (Before everyone throws their long-term charts at us showing what a rise they had in 1999, save it!  They were destroying software companies by acquisition (with one or two clear exceptions) way back then to but it wasn’t recognized by the market and the bubble bailed them out.)   Sun is obsessed with selling servers and so they focus on products like mySQL as a vehicle to move more Sun hardware.  This linkage is artificial and not what customers want.  They seek standardized (and now virtualized) hardware environments where they can efficiently run their underlying software infrastructure and company applications.  They don’t want some specialized solution from Sun or anyone else.  This is true for some esoteric applications but not for mainstream computing.

That Sun management still drives the company with this world view and business model is fatal for all concerned.  We really are not trying to pick on Sun.  And we do sympathize with employees there.  Most of them are not to blame and there’s no question that there’s lots of “good stuff” to be had at Sun.  But the strategy and the management approach have been rotten for so long it doesn’t make any sense to walk on eggshells about it.

We’ve looked at a set of proprietary server spending data from enteprise customers and Sun is in the Novell category in terms of technology roadmap, spending plans and vulnerability.

But would it be that hard for Sun to stop hurting themselves and get more aggressive about coming up with a strategy that is different and works?  IBM was left for dead before Gerstner helped get it sorted out.  There are great assets and opportunities still for Sun and a new approach could unlock them.  The shares would be worth $12 or even more if they could just get on a decent footing.

[Disclosure: Research 2.0 has a small long position in JAVA.]

The big IBM-Sun news has come and gone; so far without an outcome.  It’s going to be ugly for Sun.  A situation like this is absolutely fatal to an organization.  The wheels of employee defection and revised customer spending plans are set in motion and there is little that can be done to stop them.  Sun senior management and the board probably have no idea how much has already happened in the last two weeks.  So whether they understand the urgency to find a solution for shareholders is an open question.

Right after the IBM-Sun deal fell through the speculation turned to Red Hat.  The reason is that we are in a perfect time for open source companies and solutions.  Budgets and spending are under huge pressure and all the growth seems to be at lower price points.  The netbook craze is a good example of this.  There are designs out there that promise formidable performance with HD video and high end graphics at “stupidly cheap prices” according to eager customers.   This has become a motif in many areas of technology adoption and growth.

What is very valuable in this market at Sun is the MySQL database which has become the standard for many web-based applications.  Java has also become the standard for most distributed enterprise applications.  Finally the OpenOffice productivity tools have been a disappointment so far in terms of market penetration but in the hands of IBM they could certainly do some more damage to franchises like Microsoft Office.  (Google and Apple are nipping away there already.) At $6.56 Sun has a market cap of $6.3B but a TEV of $4.9B.  At a TEV/Revenue of 0.4x the company seems hard to resist.  Our guess was that IBM had room to sweeten their offer to do the Sun deal but we were wrong.  (Perhaps not surprisingly since we skipped our regular golf game with Sam Palmisano last weekend.)

It’s not Linux itself that is interesting but these open source products on top of it that can deliver quite a bit of business value at very low cost.  Red Hat purchased JBoss which was a very hot open source application server in the past and could be useful.  IBM already has a full suite of middleware so our guess would be that a Red Hat solution would be aimed more at the SMB market to drive money away from the pockets of Microsoft than being used to drive deeper into enterprise software infrastructure.    You never know though.  Red Hat has been trying to add features on the OS to bring about virtualization and management capabilities.    As of yet their efforts haven’t made much of a ripple in the enterprise market but again in the hands of IBM, maybe they could be more credible.  (Right now VMware continues to be a clear #1 with no viable #2.)  Red Hat is trading with market cap of $3.6B and a TEV of $2.9B or about 4.4x revenues.

Citrix purchased open source virtualization company Xen some time ago for about $500M.  Like Red Hat they haven’t gained much ground on VMW but are incorporating it into some of their own application and desktop virtualization solutions.  The issue often is service and support if a #2 to VMW is going to be considered.  In most cases it’s not worth the risk.  (The Microsoft solution will be used in Microsoft environments but that’s another story.)  Citrix does have one other aspect that IBM might like uniquely.  They have the #2 position behind WebEx for online meetings. IBM has their own service that is part of Lotus but it’s a distant runner in the race. Now that Cisco is tweaking IBM in the server space it might be fun to do some of it back with the Citrix GoToMeeting family of products.  Citrix has a market cap of $4.5B but a TEV of $3.8B or about 2.4x total revenue.

Scraping the bottom of the barrel is Novell, as usual.  Maybe it’s been a loser too long to be taken seriously any more.  And any purchase of the company might come with a stigma of paying up for something that is already dead.  We’d have to take a closer look at Novell to get a better sense of their software assets but all we can say now is that the company is cheap. I’s on a TEV/Revenue of 0.5x and a bit over 3x tangible book.

Looking over the list it certainly appears that Sun stands out as the bargain.  Their software assets are far more strategic, they have a cadre of top-notch engineers and the marketing, sales, distribution and management team can be reduced drastically to improve profits and company performance.

That JAVA has not declined back (or below) the $5 price where the IBM-Sun news started suggests that many agree Sun looks too tempting not to pick up in this economic environment.  But the most logical (IBM, HPQ) would have anti-trust issues.  Cisco would be a real spoiler and game changer for IBM and HPQ were they to decide to do it.  Dell is saddled with too many of their own problems.  Some have mentioned Oracle and Microsoft.  Seeing either of those firms get into the hardware business in a big way is hard to picture.

If the Sun board doesn’t see a transaction in the wings they need to bring an a new CEO if there is any hope to transform the company into an worthwhile equity investment.  JAVA will be a great trading vehicle for some but a dangerous stock for most.

[Disclosure: Research 2.0 has no position in JAVA at the time of this writing.  See our website for more disclosures.]

Sun (JAVA)-MySQL. Oracle (ORCL)-BEA (BEAS). As I said (see in the Oracle-BEA post put up on this site on January 17), there is one major interconnecting theme in the two major software-supplier acquisitions this week: For users and investors the independent middleware market as we know it is going away.

In Oracle acquiring BEA, the thought process behind that statement is (hopefully) clear and explicit.

In the Sun-MySQL deal, which also will lead to the collapse of middleware independence, it’s actually implicit in Sun’s statement that it wants to get into the database market. That really means Sun wants back into the whole infrastructure stack market, offering a framework from hardware up through business process management, and even applications if you count openOffice.

Think about that (“Sun as a competitor against Oracle in the database market”). That makes Oracle the winner in both deals. Now, instead of worrying about competing against a bunch of hungry nerds toiling away in an aggressive freestanding start-up, conducting guerilla marketing worldwide the way Sun did against DEC and Data General 20 years ago, Oracle just needs to think about Sun as a competitor in the database market.

And on the same day, it put BEA out of its misery!!! A two-fer.

But of course that is not Sun’s objective. Sun wants to take on Oracle, IBM (IBM), SAP (SAP) and others and make sure the others think of Sun as a competitor all the way up and down the stack. As Larry said in the context of his deal, it was “a great day for Java.”

Sun CEO Jonathan Schwartz said the MySQL deal was the “most important acquisition in history of Sun” But he also said the MySQL acquisition was complementary to Sun’s JavaDB (Berkeley) and postgreSQL offerings. The latter are other open source software (OSS) projects in which Sun is involved that compete with MySQL. That the competing projects complement each other may be Sun’s intention but that’s just not human nature.

First point: Watch for a tumultuous period starting almost immediately (the deal will be finalized plus/minus April 1) where the multiple OSS database offerings sort themselves out within Sun’s sales force. This will retard MySQL’s growth from what the OSS database might have otherwise achieved in 2008. MySQL may even lose; IT development and marketing guys play hard ball. We have already seen aggressive PR campaigns badmouthing MySQL product and support quality.

Speaking of MySQL’s revenue, the losers in this acquisition were the OSS pureplays and those OSS dual-license guys that still like to call themselves OSS pureplays. Research 2.0 and others estimate MySQL did about $75 million in revenue in 2007. We applaud Sun’s negotiating skill. Even if MySQL only did $50 million in 2007, the lowest estimate we have heard, it means Sun “only” paid 20x annual revenue. In October 2007, Citrix (CTXS) acquired Xensource for some where north of 100x 2007 revenue. To be fair to Citrix, it believes it paid about 10x 2008 revenue for Xensource. But of course we won’t know if that’s true for a year and Citrix won’t tell us if it was wrong anyways.

Second point: The value of pureplay-heritage OSS hybrid companies, which is what MySQL was, is dropping by that valuation measurement, coming back to earth from the JBoss, Zimbra and XenSource acquisitions. As I said in my initial blog post on this acquisition, the OSS IPO parade band is turning into a quintet and might simply become a guy accompanying himself on a harmonica by the end of 2008. And as I said when MySQL was beating the IPO drum back in July, a good business case is still more important than a buzzword such as OSS.

In my opinion, the investment opportunities—and OSS’s future—lies on the application functionality side of the market, not the infrastructure side. Alfresco, Compiere, Jaspersoft, etc. are still in the parade but the others best get out of line and find their “proprietary partners” as soon as possible.

As for partners, MySQL allies such as Google (GOOG), HP (HP), IBM (IBM), and Unisys might really be thinking twice about Sun’s acquisition. Intel (INTL), Red Hat (RHT) and SAP (SAP) pulled a few dollars out of the deal because they were major MySQL investors. But presumably SAP would have preferred that MySQL stay independent because it was probably going to bet on MySQL as a counterweight to Oracle (it doesn’t like having its major competitor “owning” most of the file systems its customers’ SAP applications access). With this acquisition, SAP will now be equally beholden to Sun. But SAP can still switch easily to Ingres or postgreSQL, or even–although unlikely–its own SAP DB.

Smaller MySQL partners, many of whom are also OSS companies, should be helped by this move, as explained over at my OSS blog on ebizQ.net, where I research about OSS all the time.

As for users Sun believes it can drive new adoption of MySQL’s database in more traditional applications and enterprises. Today MySQL shows up more in embedded applications and “Web 2.0 stuff.” Sun says, “The integration with Sun will greatly extend the commercial appeal of MySQL’s offerings and improve its value proposition with the addition of Sun’s global services organization.” Schwartz said Sun’s research found that the lack of “peace of mind” by large enterprises was holding MySQL back. But some very large enterprises such as Nokia and Google weren’t having that problem.

The companies also said more than 100 million copies of MySQL’s OSS database software have been downloaded. A very large percentage of those were for Windows but MySQL said that by the time the database gets to production (only one in a thousand downloads turn into business MySQL had said previously), most are on Linux, with Windows and Solaris second and third in popularity.

Third point: So even major Sun partner, Microsoft (MSFT) might get some benefit out the acquisition.

But in the end, the real winner is Oracle.–Dennis Byron

Tags: open source software, OSS, Microsoft, Sun, Oracle, MySQL, SAP

On September 5 Sun (now JAVA on the ticker) met with NYC financial analysts covering a wide range of issues. The meeting had a heavy emphasis on partnering and channels as the two key tactics that will revive growth for Sun’s systems, storage and networking businesses. There were formal presentations by Sun executives and questions from the analysts about the IBM (IBM) and Intel (INTC) partnering agreements as well as an agreement with Juniper Networks (JNPR).

On September 5th, I didn’t hear any mention of or questions about another “long-time” Sun partner, Microsoft (40 months being a long time in the Internet era). Yet the first major partnering news out of Sun, post the NYC meeting, is the September 12 announcement dramatically expanding the Microsoft/Sun relationship.

Sun is to become a Windows Server OEM across the entirety of Sun’s product line. Previously Sun certified Windows on x64 systems but now Sun will pre-install the technology. The deal does not include other Windows components but this arrangement is similar to what Microsoft does with other hardware partners. Systems integrators and other Microsoft partners add the other Windows components such as Exchange, SharePoint and so forth. As an example of how partners might use the pair, they said that together they will be implementing AT&T’s interactive TV on a Sun/Windows platform.

In addition, on September 5, the technology topic of the day was virtualization. Again, there was no mention of Microsoft. On September 12, Sun and Microsoft said the two companies would collaborate closely on cross-platform virtualization. To be fair, at the 9/5/2007 NYC meeting, Jonathan Schwartz did say that most virtualization today is about Windows workgroup servers and compared Solaris as a virtualization platform against Windows and Red Hat (RHT) Enterprise Linux. Because Solaris has virtualization built in, even into its storage solutions, the deal makes sense for Microsoft. And the growth of the Sun x64 business provides Microsoft a good channel for its products, perhaps balancing any business it might be losing to Linux/Unix servers from hardware distributors that were formerly exclusively Windows dealers. Microsoft cited recent IDC numbers on why Sun would care to hook up with people that want Windows.

Sun said twice that 100% of its customers use both Solaris and Windows; I have a problem with that statistic logically (I am checking with Sun on its meaning) but it proves our research findings that users really want open choice, not just open source or just Microsoft.

This agreement represents a continuation of work on web services, interoperability, identity management, thin clients, and other technologies since the big Sun/Microsoft legal settlement in 2004. Specifically Sun incorporated Microsoft’s storage APIs and Microsoft systems management APIs, and the two did a lot of .NET/J2EE –that’s what the Sun guy called it—interoperability efforts.

So why was there no mention of Microsoft by Sun on September 5th?

I wonder if it is because of the ongoing Open Source Initiative controversy with Microsoft over the MS-PL license. Or is it because Bill Gates gave his going-away speech to Microsoft employees last week in Seattle and Jonathan did not want to pre-empt Gates’ chance to sing Sun’s praises. Maybe it’s because Sun is paying so much to lobby governments all over the world in favor of the Open Document Format, which competes with Microsoft’s OOXML.
Does it have anything to do with left-wing anti-war advertising by the Democratic party or Christian conservatism (breaking the old rule about politics and religion in one sentence)?

Or could it simply be that Microsoft is not a strategic partner in Sun’s opinion, despite the September 12 PR? Sun said in NYC that strategically it does not want to “retail other company’s technologies.” But no, that’s too simple and straightforward a reason.

– Dennis Byron

Tags: Sun, Microsoft, IBM, virtualization, Solaris, Windows, Linux, open source software, OSS

Mike Lehman, CFO, presented for Sun Microsystems and was ready to talk about the “new Sun” and the Network is the Computer, the connected society… Oh boy…

There was a complete review of the company plans in April with the new management team and they feel they now have a clear and desirable strategy. Four new products this year already have a $990M run rate. Most feel they are gaining share in servers. Company hasn’t been able to say that since 2000.

Even though IT spending overall isn’t growing Sun is focused on companies that are investing in the network and that growth is much higher than anywhere else. The claim is that they are focused on customers using IT as a competitive weapon and meeting customers on their turf which is something that other server vendors don’t do.

Also trying to take a page out of the EMC play book and claim that they will run on any hardware including HP and IBM to give customers an integrated enviroment. For some reason they claim that they are the only systems vendor with an OS of their own. This is true vis a vis Dell it is less valid when talking about IBM or HP, let alone service products from Amazon or Google.

The Sun Fire X4500 Data Server appears to be doing well. Capacity of 24TB fits in a 4RU form factor and breaks the $2/GB price/performance line.

Company plans to generate 4% operating margin in Q4. Investors still seem concerned about cost reduction and efficiency. There’s a story about how they reviewed everything but it still feels much like those IBM reviews pre-Gerstner. Too many senior smart guys in love with all their projects and not able to be ruthless about making the hard choices. Schwartz probably isn’t the guy to get that done. The language remains along the lines of not “cutting too deeply” given all the great opportunity they have…

The returns from investments in open source come from allowing potential customers to try the products and then follow up with real sales. It attracts customers.

YouTube developed on an non-Sun platform and they totally missed it. By making Solaris open source this should not happen in the future. Took Sun 3 years to engineer out code in Solaris they didn’t own in order to make it open source.

In the end investors are still a little unclear regarding what Sun’s role will be in the enterprise and how their strategy translates into sustainable improvements in growth and margins.

Jonathan Schwartz rang the bell to open NASDAQ today and is holding their customer day in NYC today.

After six years of losing money post the “putting the dot in .com” era Sun is talking about how well all parts of the business are doing and that “all signs are pointing to the right.” Despite that the company is not yet sure they will be profitable this fiscal year.

Last year at this time Schwartz stated that the profit opportunties from utility-style service-oriented computing from arrays of servers would be vastly better than what they were experiencing selling discrete servers. The suggestion was that gross margins would be 30% or higher.

Did he have a price point in mind? Yes, just $1/CPU hour. Since it was pulled out of the air we shouldn’t be surprised when the actual price being charged by companies like Amazon today is $0.10/CPU hour.

Imagine what that does to your gross and net operating margin assumptions!

The bottom line is that Sun probably will be successful driving more units into the market at much lower prices and take some market share but still seems to have their head in the clouds (or sand) with respect to a profitable business model.