Sun's gloomy side

When you're trying to convince the business world you're still relevant, it helps to have a former employee now working in the corner office of arguably the hottest tech company in the world.

In a tightly packed press conference at Silicon Valley's Computer History Museum earlier this month, Sun Microsystems Chief Executive Scott McNealy took the stage with Google CEO Eric Schmidt. Back in Sun's glory days, when it introduced the Java software technology and was making a killing on computer servers, Schmidt was the computer maker's chief technology officer.

Now, as Sun attempts to regain its shine after four years of disappointment, it can't hurt to be associated with Google. And the ever quick-witted McNealy was quick to make a self-deprecating jab at the moment.

"It's a natural for me to be sitting here with an ex-Sun employee," McNealy quipped. "We have littered the industry with ex-Sun employees."

The focus of their partnership, interestingly, is software. Schmidt's Google endorsed Sun's software philosophy and pledged to help with several projects. Among them: Java, which lets the same program run on widely different computers; OpenOffice, the open-source software suite that competes with Microsoft's Office; OpenSolaris, the open-source version of Sun's operating system. Meanwhile, Google is paying Sun so its Toolbar software can piggyback on downloads of Sun's Java.

But as has so often been the case with Sun's software plans over the years, the partnership talk was long on vision and potential but short on specifics. Unless Sun and Google can provide better evidence, the deal "is more Sun trying to huddle under Google's current market halo than a definitive business agreement that will result in real dollars for either party," said Gabriel Consulting Group analyst Dan Olds.

Truth is, there's always been potential in Sun's software business. The same could be said of Sun's long-foundering data storage equipment unit. But for one reason or another--programmers bogged down by too many projects, poor execution, or cheaper alternatives--sales in both areas have routinely disappointed.

Will a new plan to embrace rather than do battle with open-source alternatives in software and an aggressive acquisition in storage make things any better? Sun President Jonathan Schwartz, who ran Sun's software efforts before taking the No. 2 slot at Sun in April 2004, certainly hopes so. "Everything that Sun produces will be open source and free," Schwartz said in a September speech, with Sun trying to make money by selling support to big businesses.

Two projects, the Solaris operating system and Java Enterprise System, dominate Sun's effort to expand into the software business. Sun hopes both will remake the industry; the JES server software through unusual pricing, and Solaris by building an alliance with open-source developers.

JES is a broad collection of server software for handling tasks such as managing the digital identities of computer users or running Java programs. Initially, Sun charged each customer US$100 per year for each employee, no matter which JES packages were used. Sun tweaked the pricing in January, selling JES subsets for US$50 per employee per year or the whole kit and caboodle for US$140 per employee per year.

There is some good news. JES subscriptions jumped by 186,000 to 619,000 in the most recent quarter, and a major contract announced in July with General Motors boosted the tally to nearly 1 million. And the subset approach opens new doors, said RedMonk analyst Stephen O'Grady. "Breaking the JES package up into separate packages allows customers to buy just the functionality they require, at a lower cost," O'Grady said.

And this still has the potential to be a good business for Sun. Between 80 percent and 90 percent of customers renew their JES support subscriptions, Loiacono said.

Sun doesn't disclose JES revenue, but 1 million subscriptions at US$50 apiece means US$12.5 million per quarter--tiny when compared with Sun's server revenue but potentially lucrative if Sun can keep adding new subscribers.

But moving the needle even more could be difficult. Analysts at Gartner in April said IBM led the US$6.7 billion market in 2004, with a 37 percent share. BEA Systems, also run by a former Sun exec, was second with 7.2 percent. Sun wasn't even in the top five. And in a September survey by Merrill Lynch of 100 chief information officers about their preferences for server software, not one said he or she was interested in buying more Sun server software.

That Sun would offer an open-source version of its flagship operating system shows just how seriously the company takes this technology trend. "I was stunned" when Sun announced OpenSolaris, said David Ray, a manager of information systems at a large hotel in St. Louis. "The open-sourcing of Solaris 10 potentially may turn out to have been the most important single initiative" Sun has going, added Mark Stahlman, an analyst at Caris & Co.

So far, 2.8 million copies of Solaris 10 have been downloaded--10 times Sun's expectations, Schwartz said. Most of those copies are running on x86 servers, which could help Sun's efforts to get into that market.

But to some, the new version of Solaris hasn't moved Sun away from a niche provider for its own UltraSparc servers.

"The decision-tree people go through is, 'Do I stay on Windows or not?' If not, chances are 99 percent I'm going to go to Linux," said Allen Smith, chief information officer of accounting firm Virchow Krause & Co. "The discussion I hear these days is Windows versus Linux. It's not Windows versus Linux versus Solaris."

Still, Sun's strength may be its record. Some tech buyers take comfort in buying from a 25-year-old company, rather than younger Linux companies such as Red Hat.

"We like Sun's viability over Red Hat's viability," said Neal Tisdale, vice president of software development for New Energy Associates, which uses Sun's OS on Opteron systems for energy planning simulations. "If you look back over the (years), Sun's made it through a lot of troughs."

Buy, buy, buy
For four years, McNealy liked to brag that his company had a massive US$7.5 billion war chest. Now he's finally putting that money to use.

On Aug. 31, Sun acquired storage tape manufacturer Storage Technology, for about US$3 billion once cash assets are factored out. On Aug. 25, it acquired middleware software maker and SeeBeyond for US$387 million. Annual revenue for the companies is US$2.2 billion and US$167 million, respectively, said Technology Business Research analyst Harold Kim.

StorageTek, which generated $367 million in cash in the last year, is clearly the most financially important of the two because of its existing cash and its ability to help Sun's long-foundering storage business.

Merrill Lynch analyst Richard Farmer raised his fiscal 2006 revenue estimates for Sun from US$11.4 billion to US$13.6 billion and earnings per share from break-even to 8 cents as a result of the acquisitions. However, that figure likely will be reduced by 10 cents per share as Sun begins accounting for stock options as an expense, a change that begins this quarter.

"The biggest revenue generator we see is probably with this StorageTek acquisition, mainly because of the added sales channels and the broader product portfolio," Kim said.

Sun hopes to use StorageTek's 1,000-strong sales force to sell its own wares, which have fared worse than products from storage specialists such as EMC and server rivals IBM, Dell and HP. Sun's storage attach rate--the company's storage revenue as a fraction of core server revenue--has declined to 22.3 percent in the June quarter, down 4.5 percentage points in two years.

Sun hopes the acquisition will help it gain access to IBM mainframe customers who also use StorageTek tape. But there are plenty of skeptics.

"Given that storage has been a challenging business for the company and does not appear to be gaining traction, we continue to question the rationale behind the Sun/StorageTek merger," Sanford C. Bernstein analyst Toni Sacconaghi wrote in a September report.

Still, some analysts say the aggressive acquisition strategy and the in-house software work give Sun a more credible portfolio than it has had in years. "I think you can look at them and see them right in the process of getting their act together," Illuminata analyst Jonathan Eunice said.