Tech Industry

The Starting Line: Sun down but not out

Sun Microsystems had a dreadful August, but analysts say the company could benefit from new products if the economy recovers.

Sun Microsystems has been drubbed over the past month, but it still may be in better shape than its peers.

Sun's troubles largely, if not entirely, reflect the problems of its overall sector. The company's production problems appear to be in the past, and its balance sheet is strong. And with the possible exception of IBM, Sun's rivals, such as Hewlett-Packard and Compaq Computer, aren't in better shape.

To be sure, the near-term future isn't bright. Cliche describes August as the dog days of summer, and few tech companies have been bigger dogs than Sun lately.

Executives are complaining about a Java fight they thought was already won in court. Market research indicates the company lost server market share to IBM. And Sun shares lost 39 percent of their value between Aug. 2 and Aug. 30.

The stock-price decline accelerated last week in the days leading up to Sun's midquarter report, and it turned out that Wall Street's fears were justified. Sun originally hoped to break even or turn a small profit in the current quarter, but now executives believe European and Japanese weakness probably will force Sun to report a loss.

It's not necessarily Sun's fault.

"Sadly, this is almost certainly not a Sun issue," Goldman Sachs analyst Laura Conigliaro said last week. "Most large multinational tech companies have similar international exposure...In fact, our checks with European IT providers specifically point to a weak demand environment not just for Sun but for most hardware vendors, with the demand problem compounded by the overbuying of equipment over the past several years."

Technology spending slowdowns are no surprise anymore, of course, but many observers have argued the company at least could have done more to protect itself.

Manufacturing problems and chip-design flaws slowed the introduction of servers based on Sun's latest processor, the UltraSparc III. At the same time, IBM and Hewlett-Packard in recent quarters have delivered new high-end products.

"IBM is establishing a clear technology lead over Sun in servers," UBS Warburg analyst Don Young said. "We still believe competitive pressures have also contributed to the weak market reception to the new UltraSparc III product rollout."

Sharing the pie
Recent data from Gartner Group/Dataquest shows that IBM's slice of the server market shot up at the expense of Sun and Compaq Computer.

Sun Microsystems
Stock price from August 2000 to present.  
Source: Prophet Finance
Sun insisted it hasn't seen any major deals lost to rivals, and several analysts agreed that competition hasn't been a big source of Sun's problems. Prices, typically the first victim of increased competition, haven't changed much since June, said Michael Lehman, Sun's chief financial officer.

In any case, whether or not rival products have cut into Sun's business, most observers believe the company has gotten over its product woes. The 900MHz UltraSparc III chip was approved in July for volume production. Servers using the chip are expected in a few weeks. And Sun recently unveiled a deal to sell Hitachi storage systems.

"We see more pluses than minuses," said Salomon Smith Barney analyst John B. Jones, who in July upgraded Sun to "buy" from a "neutral" rating.

Wall Street's other major concern with Sun is costs. Companies such as Hewlett-Packard and Compaq announced plans to eliminate thousands of jobs, but Sun's visible cost-cutting efforts have been limited to about 500 job losses--from a work force of more than 43,000--in the current quarter. The company has also asked its employees to use additional unused vacation time before the end of the year.

But Sun already had better cost controls than its rivals.

Sun says it can break even on $3.7 billion in sales. By contrast, Compaq lost money on revenue of $8.4 billion in the June quarter. Hewlett-Packard posted an operational loss of $178 million on computing systems revenue of almost $4 billion in the latest quarter completed. IBM's hardware business reported a gross margin of 29.9 percent, compared with 41.1 percent for Sun.

Ultimately, Sun's future is up to the economy. "Given even a modest upturn, Sun should be one of the better relative performers," Conigliaro said.