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Sun shares rattled as analysts ponder future

Analysts' confidence sinks as they consider the company's profit warning as well as competition and world economic factors. Sun's shares drop 13 percent.

Sun Microsystems' European business and its competitive outlook are so grim that the company may not even meet already reduced financial targets, analysts said Wednesday.

Shares tumbled 13 percent just a day after the company's profit warning as analysts pieced together the extent of the damage.

Sun announced Tuesday night in its midquarter update that earnings for its fourth quarter will come in below prior forecasts, and sales will be down from the most recent quarter. Revenue for its fiscal fourth quarter ending June 30 should be in the range of $3.8 billion to $4 billion. Earnings, excluding extraordinary items, will be in the range of 2 cents to 4 cents a share, the company said.

Shares fell $2.44, or 13 percent, to close at $16.43 Wednesday as analysts doubted the company's prospects.

Sun makes a range of products, including Unix-based, number-crunching workstation computers, storage devices and servers for corporate networks.

The company said an economic slowdown in Europe is its latest worry. Demand in Europe has taken a sharp downturn, and signs of sluggishness in Asia have also shown up in the past six to seven weeks, Sun Chief Financial Officer Michael Lehman said in a conference call.

"The demand in Europe has really tailed off," Lehman said. "That's really been in the news in this conference call."

Analysts agreed that the situation in Europe looks dire, and most cited it as the reason for their downward revisions.

"With no crystal ball on demand, the recent deterioration in Europe and potential for spillover into Asia-Pacific, we are compelled to lower the bar for the fourth quarter and fiscal 2002," J.P. Morgan analyst Daniel Kunstler wrote.

And it will take a recovery in the international economy--something that is sure to follow a U.S. rebound, analysts said--to bring Sun back to life. "The pickup in the stock will depend on a turn in the macroeconomic conditions, while business fundamentals will be a lagging indicator," Bear Stearns analyst Andrew Neff said.

The economy wasn't the only factor that troubled analysts.

"While the company attributes the weakness primarily to the broad economic slowdown, we believe at least part of the shortfall is attributable to increasing competitive pressures, particularly from IBM in Unix servers and EMC in storage," ABN AMRO analyst Bill Shope wrote in a research note.

Sun has been reducing its server prices aggressively to compete with IBM, something that Shope speculates has contributed to its big gross margin declines. Nevertheless, it's still losing share to IBM, which grew its share of the Unix market 33 percent year over year in its first quarter.

In the storage sector, Sun seems to be falling behind EMC. Though Sun has acquired several storage companies, it has not "made much progress in networked storage" and is losing its "fragile lead" over EMC, Shope wrote.

The economic situation and competitive worries were enough to spark a second round of downward revisions from Goldman Sachs analyst Laura Conigliaro, who also cut estimates Tuesday. The analyst said she doubts Sun can meet its lowered numbers, as it will have to make major changes to its business.

"We are cutting our numbers pretty much in line with what Sun seems to be targeting," Conigliaro wrote. Aside from fourth-quarter numbers that match Sun's projections, she also extrapolated fiscal 2002 numbers of $19.8 billion in revenue, down from her previous estimate of $20.7 billion, and earnings of 40 cents a share, down from 50 cents a share.

But "we don't expect Sun to ever see these numbers," Conigliaro said.

"Sun will take a hard look at its business model as a consequence of this wakeup call, with the outcome likely to be some uncharacteristic actions that, in the very least, reduce Sun's cost structure," Conigliaro said. Those actions could involve a "move away from some of its sacred cows," including laying off workers and eliminating less critical research and development projects, manufacturer partnerships, and acquisitions, she said.

As Sun is a major technology supplier to the Internet infrastructure sector, its warning rings some alarm bells for stocks like Akamai--down 88 cents, or 8 percent, to $10.25--and Exodus, down 35 cents, or 4 percent, to 7.91.

Sun's update "provides a cautious signpost for the sector," UBS Warburg analyst John Hodulik said. He said he maintains a "cautious stance on the Internet infrastructure services space," with Digex being his top pick.

Exodus "is likely to be the company most affected by a slowdown in Europe and Asia, with five data centers in these markets. We believe any impact should be nominal, however," Hodulik said.