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Buying StorageTek: Sun's last big gamble?

Sun's $4.1 billion buyout of StorageTek is a huge bet: It's the last cash deal that size Sun will be able to make.

Sun Microsystems bet $4.1 billion Thursday that buying StorageTek, an established but low-growth company, will help restore Sun's financial fortunes. But it's a huge bet: It's the last cash deal of that size Sun will be able to make.

Sun plans to spend $4.1 billion of its $7.4 billion in cash and marketable securities on StorageTek in a deal expected to close by late summer or early fall. Even with the $1 billion in cash StorageTek will bring, Sun will have a hard time affording any comparable moves.

Sun is trying to rebuild its primary business, selling powerful networked computers called servers, and is trying to elevate its software products with an open-source revamp. The StorageTek acquisition, however, shows that Sun believes storage is the business where it can get the most bang for its buck.

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What's new:
Sun hopes its $4.1 billion acquisition of StorageTek will ignite its storage business, profit from new regulations, provide an entree into new accounts and keep the company on customers' short lists.

Bottom line:
Sun has ample cash left, but if StorageTek doesn't work out, its options will be limited by the fact that it doesn't have enough cash for another deal the same size.

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StorageTek has a stable business, and its sales force of 1,000 will more than triple what Sun has devoted to storage, said Mark Canepa, Sun's executive vice president of storage, in an interview. And that sales force will help Sun show off other products such as servers and identity-management software to choice StorageTek customers with IBM's mainframes. "In Big Blue accounts, they can go open doors," Canepa said.

But what the acquisition doesn't provide, at least immediately, is the revenue growth Chief Executive Scott McNealy said is a top priority. That bothers some on Wall Street.

"We do question the rationale of a transaction which reduces Sun's cash hoard by 40 percent and does nothing to reignite revenue growth or profitability," Prudential analyst Steve Fortuna said in a report Thursday. "We would rather have seen the company buy back a billion shares and fire 10,000 people."

And Bear Stearns' Andy Neff also questioned the wisdom of the move. "Given the weak growth outlook for tape, we don't see strategic benefits for Sun from this acquisition," though buying a company that will boost earnings per share is a good use of cash, he said.

StorageTek was profitable in its most recent quarter, reporting net income of $23 million, the same amount as in the year-earlier period. But the $499 million in revenue StorageTek garnered in the quarter ended April 1 was a 3 percent decline from the $515 million from the year-earlier quarter.

StorageTek said it expects better financial performance for the rest of 2005, though, and Canepa argues that data management is a fast-growing part of the computing industry. Sun said its own earnings will increase within 12 months as a result of the acquisition.

Neff estimated that, based on projections from analysts surveyed by First Call, StorageTek's net income will indeed rise and will likely reach about $200 million for this calendar year.

Risk tolerance
The buyout shows a tolerance for acquisition risk that hasn't been seen at the Santa Clara, Calif.-based company since its ill-fated Cobalt Networks purchase in 2000 for $2 billion in stock. Since then, Sun has mostly bought distressed properties--Tarantella's thin-client server software or Procom's storage operating system software, for example--or unproven start-ups such as Pirus Networks or CenterRun.

Risks are common now at Sun, however, with ambitious strategies such as open-source software, utility computing and servers with Advanced Micro Devices' Opteron. And McNealy said in 2003 that Sun wants to use its cash for more than just sending a signal that the company won't fade away any time soon.

No doubt Sun hopes this acquisition will fare better than past storage buys in its years-long push to penetrate the storage market. In addition to Pirus, whose technology has belatedly come to the market this year in the form of the StorEdge 6920, Sun has bought LSC Software, HighGround Systems and Encore.

Canepa argues that Sun's storage revenue problem stems from an anemic sales force, not from anemic technology. "The size of the business has struggled a bit, but not because of the product portfolio. One of the primary reasons we did this deal (is that) we just do not have enough feet on the street selling storage," he said.

StorageTek chiefly sells tape backup equipment and software to manage storage systems. Its future growth strategy, though, hinges on an idea called information lifecycle management, or ILM, technology that controls how files and e-mail are preserved and deleted over a period of years. It's a timely product, given corporations' difficulties tracking their burgeoning files and following new regulations that require they bring rigor to the task, but competitors such as EMC and Veritas also are active in the market.

That may sound like a bland product line, but Sun didn't have many alternatives, even when spending billions of dollars.

"If you're Sun, you'd want to do a 'Wow!' acquisition. But if you think about it, there are no easy wow acquisitions out there," said Forrester analyst Frank Gillett.

StorageTek's coming ILM products
StorageTek's ILM business has yet to prove itself, Gillett added. "StorageTek has the capability to be competitive, but they haven't publicly come out with anything. It could be that Sun is buying stuff we can't see yet," he said.

It's likely some of what Sun can see will come into view next week, though.

StorageTek plans to debut its first in-house ILM product June 8, a disk-based archiving system that has built-in "intelligence" to automate the process. And StorageTek's ILM push could fit well with Sun's Honeycomb storage equipment coming later this year.

ILM so far is "perceived as more hype than reality," said Data Mobility Group analyst John Webster. "It's got a lot of promise as something that people can put on developmental roadmaps."

One factor keeping it from fulfilling its promise is missing software support, he said. If the applications that actually generate files and data don't dovetail with the ILM systems, ILM is little more than a fancy backup system.

EMC professes to be unfazed by Sun's move. "It remains to be seen as to how relevant the acquisition will be to the industry and customers. The lion's share of the growth in the market today is going to be with focused technology providers such as EMC, Cisco, SAP, Oracle and Intel," spokesman Greg Eden said.

Hewlett-Packard was less reserved. "Sun's move reeks of desperation," the company said in a statement. "Their server market share continues to decline, and they've taken their eye off the ball again with yet another strategic blunder, making an acquisition in an area of storage that does not promise high growth over the long term.

Sun, naturally, has a different interpretation. By buying StorageTek, Sun hopes to have a broad enough product line to keep a place on customers' short lists. And it reinforces Sun's attempt to ease technology hassles by improving and integrating equipment rather than handing the problem over to expensive services personnel.

"Rather than trying to figure out how to make my storage work with my server or work with my switching environment, we believe we can provide a more integrated environment," McNealy said in a conference call. "We believe we can give a simpler answer."

CNET News.com's Martin LaMonica and Jim Kerstetter contributed to this report.

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