Will Sun Microsystems (NASDAQ:SUNW) and its customers wake up and smell the Java? And are there turnaround prospects for an investor to buy with a margin of safety?
Feeling the competitive heat in servers and software from IBM (NYSE:IBM), Microsoft (NASDAQ:MSFT), Dell (NASDAQ:DELL) and a host of others, Sun announced today a new strategy designed to move its emphasis from hardware to software and to systems integration. It brings down prices and uses the subscription and per employee licensing model.
The Sun Java Desktop System -- a more boring but sensible name than the project's code name Mad Hatter ("I'm late, I'm late, for a very important date...") -- runs on open-source operating systems Linux and offers an applications suite to replace the familiar Windows package. It will join everything-Web to middleware and applications server and more.
To worm its way into the Windows world, the Sun system can work on any PC capable of running Microsoft Office 2000. Companies can license the system for $100 a year per employee, but this reportedly could go as low as $50 annually. The company also plans to upgrade its StarOffice productivity suite and also introduce Java Enterprise System server software.
All the plans together further the shift from a business based on higher-end Unix language servers (and hopes that the Java language alone will allow the Sun God to Rule the World) towards practical and affordable integration of hardware and software systems. No longer will a manager work a single product line. Sun will organize globally to provide solutions. (Where have they been?)
The intense competition in enterprise (a fancy term for "business") software and hardware leads the non-industry-expert investor to one conclusion and two questions. First, prices will fall, which won't help profit margins anywhere. Second and third, does it make sense to own the struggling number two or three or worse in industries characterized by rapid technological change, or will Sun be the Apple of the enterprise world, innovating its way back to some occasional success in a world dominated by others?
Sun closed yesterday at $3.86, with a $12.5 billion market cap and $11 billion enterprise value (EV) -- its $3 billion in cash and short term securities (another $2.7 billion in long term) doubles its total debt -- representing a market cap to free cash flow (FCF) multiple of 19 and EV/FCF of 17 (though lower if you include the long term securities). These are higher multiples than we see for cash rich, debt free, and at least somewhat growing Microsoft. The valuation presents substantial risk.
If the shares were cheap, I might jump on the prospects for a turnaround, but it's tough to see a margin of safety here. Sun is a bet not just on Sun or some rising tide of business capital investment, but more on Linux inroads against Windows and plenty of price-cutting competition. With any sign that the Sun will rise again, the shares could participate in a turnaround, but I don't see a potential return from here to outpace the risk. For now, it's for the speculator or industry expert only to consider whether Sun will play Sun City.
But don't take my word as the last -- or even antepenultimate! Please join our investors, including those knowledgeable on the tech side of the Sun, on our Sun discussion board.
Senior Analyst Tom Jacobs reports that it's 79 degrees and fair in Gaborone, Botswana, where one of his nieces lives. Find his columns in his archive. He owns no shares of companies mentioned in this column but does own others disclosed publicly in his profile. We happy Motley Fools are investors writing for investors.
