Sun Microsystems agrees to acquire Cobalt Networks in a $2 billion stock deal, giving the company a server lineup that spans from $1,000 to $1 million price points. While Cobalt expands the size of Sun's addressable market, the deal also effectively ups the ante on the company's already large bet on an integrated architecture for servers.
By
Under the terms of the deal, each Cobalt share will be exchanged for one-half of a Sun share, which works out to a price of $57.62 per share based on yesterday's closing price. That's not a bad takeout price for a company that went public less than a year ago at $22 per share. However, it's a far cry from the stock's post-IPO, hype-induced high of $168 13/16 per share late last year, which goes to show just how over-extended some valuations got during the 1999 tech frenzy.
To get its money back from the deal, Sun will be looking to turn Cobalt into a profitable part of its Network Service Provider organization as soon as possible. That shouldn't be too awfully hard to do, considering Cobalt had been on a pace to turn its first profits sometime next year, according to analysts. The company's top-line growth has been stellar recently, with revenues growing at about a 35% sequential rate in each of the past two quarters. With synergies expected on the research and development and sales and marketing fronts, Sun should be able to turn Cobalt into a new profit center fairly quickly.
The most obvious aspect of the deal (and, consequently, the angle that will be harped on the most by the mainstream business press today) is that Cobalt launches Sun into the market for low-end, pizza-box servers for Internet and applications service providers, where prices can get down to the $1,000 level. That's a strategic sea change from the high-end servers, such as the six-foot-tall Enterprise 10000, that have propelled Sun's financial results recently, thanks in part to price points that reach into the $1 million range. However, just because Sun is jumping into an area where the pricing environment isn't as lucrative as it is in the high end doesn't mean that the company can't build incremental value through Cobalt.
For the most part, Sun is making two kinds of bets by gobbling up Cobalt. First and foremost, Sun is staking out a presence in a fast-growing market that is still in its early stages of development. The thing to keep in mind is that Cobalt was making substantial inroads into the service provider market as an independent company, and its future growth prospects were already rosy to begin with. As part of the much larger Sun family, the penetration rate for Cobalt's products into the market should only accelerate, providing that there are no operational or product screwups under its new parental umbrella.
However, the much larger bet for Sun involves its belief in a systemic approach to the server market, where everything -- including microprocessors, storage, system software, and middleware -- will be rolled into an integrated hardware offering. Sun President and COO Ed Zander has called this model the "integrated stack," with the end-product being telephone dial-tone dependability for the Web. Cobalt is a mirror-image of Sun in this regard, as the firm's strategy has been to provide its purpose-built hardware along with optimized Linux-based operating software, software applications, and middleware, such as bandwidth management and clustering technology.
In contrast, companies such as Dell (Nasdaq: DELL) and Compaq (NYSE: CPQ) are taking a more layered architecture approach with their server appliance offerings compared to the integrated approach of Cobalt and Sun. Which of these contrasting views of the server world will result in the greatest amount of marketshare in the years to come is one of the major issues confronting investors at this point of the server appliance market's evolution.
Your Turn:
Post your thoughts on today's merger on the Sun Microsystems discussion board.
Related Link:
RSS Headlines
Fool UK
