Sun investors size up McNealy

While they may agree with his strategy for turning the company around, investors still wonder if Scott McNealy is up to the task.

Dawn Kawamoto
Dawn Kawamoto Former Staff writer, CNET News
Dawn Kawamoto covered enterprise security and financial news relating to technology for CNET News.
4 min read
Sun Microsystems Chief Executive Scott McNealy is a man driven by passion for Sun's mission and conviction that his company is on track to fulfill it.

If only Sun's investors shared that enthusiasm.

With Sun's share price trading in the $3 to $4 range for the past several years--considerably behind key indexes and the stocks of many competitors--the networking systems giant faces investors who are far from happy as the company struggles to pull off a turnaround after four years of slow sales.

In one of the more public signs of this unhappiness, Sun's investors are pushing two shareholder initiatives to change the way Sun's board compensates executives and fends off possible suitors, according to Sun's proxy, filed recently with the Securities and Exchange Commission. Sun, historically, has faced few shareholder proposals.

Still, while some Sun investors grumble about McNealy's leadership, no one is publicly calling for the charismatic co-founder to step down. That's a powerful indication that, like it or not, investors are willing to give the man who led Sun into this tough spot more time to get his company out of it.

As it has been for some time, backing for McNealy among investors is mostly cautious and, among those interviewed by CNET News.com, rarely enthusiastic.

"I don't know if Scott is the right man to turn the company around, but on the whole, I like Scott, and he knows a lot about the company," said Timothy Guinness, chief investment officer with Guinness Atkinson Asset Management, which owns about 368,000 shares of Sun.

Other institutional investors expressed disappointment with McNealy's leadership.

"This management is 100 percent accountable for the results and the results have been lackluster," said Kevin Rendino, a portfolio manager with Mercury Basic Value B, a Merrill Lynch Investment Managers fund. "I'm not surprised we're starting to see shareholder dissention."

Rendino, whose fund owns 18.3 million Sun shares, said McNealy in particular has done "poorly" so far in his attempts to revive the company.

"I know what he is trying to accomplish and I buy into part of his strategy, but not all of it," Rendino said. "I think what they need to do, and what they haven't done yet, is cut their cost structure further than they have. Their stock will continue to be a $3 stock until they cut more."

"My average cost is $6.50 a share, so I feel stranded."
--Matthew Kelmon, portfolio manager, Kelmoore Investment

He added that one of the attractions of Sun had been its large cash reserve. But with the company's recent acquisitions--including StorageTek for $4.1 billion and SeeBeyond for $387 million--that cushion has been depleted.

Sun contends that even with its acquisitions, the company's cash balance is strong.

"Even with our acquisitions of StorageTek and SeeBeyond, Sun has very strong liquidity with a cash balance of over $4 billion," said a Sun spokeswoman. "Furthermore, Sun believes...acquisitions such as StorageTek and SeeBeyond help Sun expand its global footprint, diversity its product line, add to revenue generation and significantly grow our worldwide customer base. With over $4 billion, the company continues to have financial flexibility to fund ongoing research and development."

Over the past few months, the spokeswoman noted, Sun has introduced a number of new products, including the Solaris 10 operating system, the Galaxy server and the UltraSPARC IV+ processor.

During fiscal 2005, Sun improved its non-GAAP (Generally Accepted Accounting Principles) net income by $881 million and generated $369 million in cash flow from its operations, she said. It was the 16th consecutive year Sun showed positive cash flow from its operations.

While some investors believe Sun is undervalued, one is waiting for the day he can dump the stock.

"My average cost is $6.50 a share, so I feel stranded," said Matthew Kelmon, portfolio manager for Kelmoore Investment, which owns approximately 950,000 shares. "In the fourth quarter, the stock usually trades higher and if it gets back to the levels it did last year, I might use that time to start exiting."

Taking a long-term view, Guinness said he is willing to give McNealy three years to prove his restructuring plans will work and improve Sun's fortunes.

"That amount of time is on the Japanese scale of doing things," Guinness said. "He has a big challenge ahead of him and it will take time to turn things around."

One portfolio manager, John Buckingham of Al Frank Asset Management, believes McNealy will turn the company around and noted he hopes the chief executive will remain with Sun.

"We don't want him to leave, but whether or not he stays or goes, it will not change our opinion of the company," Buckingham said. "It's a value play. It's trading at a low price for a blue chip tech company and from where the company has historically traded. So we're willing to sit patiently."