Struggling Sun faces difficult choices about future

Vendor may have to shed business units to survive

Bad times just keep getting worse at Sun Microsystems, and the vendor may face hard choices about which parts of its business to keep and which to shed.

Two weeks after reporting a $1.7 billion quarterly loss, Sun announced on Friday that it would lay off 15% to 18% of its workforce. 

It was seen by analysts as a necessary step -- but by no means a cure-all for a company that has been losing money and credibility with investors since the bursting of the dot-com bubble in 2001.

"I just think they had little to no choice," says The 451 Group analyst Jay Lyman.

Lyman speculated in a report several months ago that Sun might be acquired, saying that "Sun's sunken stock price creates a relative bargain considering its roughly $4 billion cash on hand, sizeable intellectual property and patent portfolio, and of course, its respected technology and products." Other analysts have questioned whether potential acquirers such as IBM or HP would even want to buy Sun. It's hard to think of a vendor that would shell out cash for Sun's servers, storage and open source software businesses all in one fell swoop, says Enterprise Strategy Group analyst Brian Babineau.

One common belief is that Sun will sell off portions of its business and focus on those that it believes offer the most chance of long-term success. When Sun announced workforce cuts last week it also detailed a reorganization of business units that reflects a commitment to open source software, an area Sun has a strong foothold in through ventures such as OpenOffice, OpenSolaris, MySQL and open source-based storage.

But several analysts say Sun still hasn't chosen a specific enough focus. "Is it a hardware company? Is it a software company? Is it an open source company?" Lyman asks.

Babineau believes that Sun has to sell part of the company, but it's hard to say which one.

Based on what they report on Wall Street, it's hard to tell what's making money and what's not," Babineau says. "They've been very bullish on their storage business. That generates positive cash flow. I think that really could be funding the rest of their business at this point." (Compare storage products.

A vendor in Sun's predicament could sell off a loss leader and focus on remaining businesses that generate cash flow, or sell one of its more profitable businesses to gain a one-time cash infusion that can be invested in remaining assets, Babineau says.

"I think they can turn it around, but they won't turn it around as is," he says. "They have to shrink it up, take a cash infusion from selling a core asset and grow that smaller business."

In the view of one major investor, Sun is a software company, despite the fact it gets a large majority of its revenue from server and workstation sales. 

"Sun Microsystems is kind of interesting because it's progressively less of a server company and more of a software company; it's more about Solaris and Java," Staley Cates, president of Southeastern Asset Management, which recently bought a 21% stake in Sun, said at a shareholder meeting. "And that's kind of a change that we don't think the market's on to at all."

Southeastern Asset Management may want Sun to sell its hardware business, perhaps to Fujitsu, and focus on providing cloud computing services, an article in The Economist speculates.

But Sun hasn't made a big splash in the emerging cloud computing market, while vendors like IBM have continually harped on the potential of the cloud. "The idea that Sun could become a cloud computing services provider is a bit farfetched," says Pund-IT analyst Charles King.

Lyman thinks it might be a good idea for Sun to sell off its high-end server business to Fujitsu or perhaps HP. Sun and Fujitsu jointly develop Sparc enterprise servers, but this enterprise has been "somewhat of a burden" for Sun, he says.

Sun's second quarter server revenue dropped 7.2% year over year, to about $1.5 billion, while rivals IBM, HP and Dell were able to grow their businesses, according to IDC. 

On the positive side, Sun was able to grow its storage revenue 29% to about $494 million in the same timeframe. Sun attributes its growth to an "open storage" strategy that combines open source software with commodity hardware. Sun is also attempting to gain a foothold in the emerging market for enterprise flash memory.

"Open source in storage is relatively new," Lyman says. "There's some potential here. They have managed to grow that business."

Sun may be banking its future on open source, but with an approach that combines both software and hardware, judging by recent comments from CEO Jonathan Schwartz. "With … the market increasingly looking to open source innovation as a vehicle to escape proprietary vendor pricing, we believe Sun is well positioned to weather the downturn and ultimately become the biggest beneficiary in the open source revolution in both systems and software," Schwartz said in Sun's Oct. 30 earnings announcement.

Sun's Solaris operating system, and the open source version known as OpenSolaris, are promising parts of Sun's software portfolio, King says. Sun is gaining traction with open storage, but that still remains a small part of its overall storage business with $25 million in quarterly sales, a "drop in the bucket," King says.

"Sun's obviously in a very bad situation," King says. "How you pull a large vendor out of a nosedive like this is beyond my business wisdom."

Better marketing might provide some of the answer, says ITIC analyst Laura DiDio, who says Sun has excellent technology, but doesn't do a good enough job bragging about it. Sun customers are generally satisfied, but DiDio says rival IT vendors such as Oracle are much quicker to trumpet customer success stories.

Sun, for instance, offers server management tools guaranteeing 5 9s of uptime, as well as a low-cost alternative for server virtualization known as xVM, DiDio says. But poor marketing has prevented them from making significant headway with IT buyers, she contends.

"One of the big problems they've had all along is communicating their message, marketing in other words," DiDio says. "When Oracle is going to do something, or is even contemplating whether to do something, [CEO] Larry Ellison opens his mouth and speaks with a big bullhorn."

DiDio believes Sun will survive this economic downturn. The question is "can they thrive," she says. "To do that they are going to have to really step it up by orders of magnitude. That means marketing, that means aggressively telling people 'here's our story, here are our customers.'"

Sun's public image probably wasn't helped last month when co-founder Andy Bechtolsheim joined start-up Arista Networks and took a reduced role at Sun. Sun went into spin mode, claiming that Bechtolsheim would "continue his present involvement," when in fact Bechtolsheim said he would work at Sun "no more than one day a week" in an advisory role. 

Executive changes are usually announced in a more organized manner. Even a well-handled departure can harm public perception, DiDio notes.

"When you see founders leave, that erodes confidence unless the person is a raging idiot," she says. "The investment brokers take a look at this and say 'hmm.'"

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