Scott McNealy's dull voice reflected the deep disappointment his colleagues at Sun Microsystems Inc.'s Santa Clara, Calif., office must feel at the news one of Silicon Valley's iconic information technology star is about to be reduced to a satellite of Oracle Corp.
During a conference call Monday (April 20) to discuss Oracle's $7.4 billion offer to purchase Sun Microsystems, McNeally, chairman of the computing, enterprise software and storage company, seemed drained of life, his voice trailing off the prepared script and failing to reflect the content of what was supposed to a ringing endorsement of the merger.
Sun Microsystems president and CEO Jonathan Schwartz was similarly mournful in an internal memo he reportedly wrote to company employees, saying it was "the toughest e-mail I've ever had to write," even as he noted that the Oracle deal was not "the end of the road, not by any stretch of the imagination. I believe this is the first step down a different path, one that takes us and our innovations to an even broader market, one that ensures the ubiquitous role we play in the world around us."
Few analysts and observers on Wall Street and in Silicon Valley would be shocked to know Sun Microsystems' existence as an independent enterprise is coming to an end, however.
Aside from the company's recently failed acquisition discussions with IBM Corp., there had been speculations for years as to whether Sun Microsystems could survive a gathering storm as competitors nibbled away at its market share and as rival products threaten to turn it into a niche player in several industry segments.
While the company's struggles to keep costs down and improve its competitive position were well known, however, the most significant challenge facing Sun Microsystems—and one which kept the rumor mills spinning—was its inability to show consistent performance, according to analysts. Standard & Poor's credit rating analyst Philip Schrank, for instance, had long said Sun Microsystems was performing at an "inconsistent profitability" level.
"Although Sun has made consistent investment in new product development and has a significant base of relatively consistent service revenues, total revenue growth (excluding the effect of currency) remains a challenge," Schrank said in a report last November.
"Acquisitions have strengthened Sun's position in the enterprise storage and business integration software markets, but have not positively affected the company's business or financial profile."
Sun Microsystems' revenue changed only slightly between 2006 and 2008, rising to $13.88 billion in the 12 months ended June 30, 2008 from $13.87 billion in fiscal 2007 and $13 billion in fiscal 2007. The company reported operating profit of $372 million for fiscal 2008, improving from $309 million in fiscal 2007 and operating loss of $870 million in fiscal 2006.
The annual numbers hide erratic swings in Sun Microsystems' quarterly performance, however. In the three months ended Dec. 28, 2008, Sun Microsystems reported operating loss narrowed to $199 million from operating loss of $1.7 billion in the preceding quarter and operating profit of $108 million in the June 2008 quarter. The company's revenue swung from as high as $3.8 billion in the June 2008 quarter to $3.2 billion in the final quarter of the year.
The wild sales and profitability swings took a toll on the company, fueling concerns it was either buckling under competitive pressures or failing to convert opportunities in the market. With the global economy weakening and as conditions deteriorated in the IT sector in the second half of 2008, it was obvious Sun Microsystems needed to change its strategy by partnering with a stronger rival rather than try to cut its way into profitability.
"If Sun ultimately agrees to merge with a higher rated entity, its ratings could be raised," Standard & Poor's Schrank said in April following the termination of Sun Microsystems' acquisition discussions with IBM.
"Revenues and earnings before interest, taxes, depreciation and amortization have declined year over year for the past four quarters, coupled with the likelihood of a challenging IT spending environment extending through 2009, which could further dampen operating performance."
Sun Microsystems had in the last two years taken steps to improve its financial conditions. The company in November announced plans to reduce payroll by up to 18 percent, or 5,000 to 6,000 employees in a bid to cut costs by "approximately $700 million to $800 million annually."
Apparently, earlier efforts in 2007 to cut costs through workforce reduction had not secured all the benefits the company expected.
At the end of its fiscal year in 2007, Sun Microsystems announced plans to lay off 1,450 employees, costing the company approximately $131 million in severance and benefit costs. Sun Microsystems at the end of its last fiscal year on June 30, 2008 reported it still had 34,900 employees. It's not clear how many of the employees would be retained by Oracle.
It's obvious though that Oracle expects to substantially reduce costs at Sun Microsystems once the transaction closes. Oracle's president Safra Catz said during a conference call following the announcement of the transaction that she expects "to run Sun Microsystems at substantially higher margin" adding "by utilizing Oracle's scale we'll be able to do better than Sun had done."
If Oracle achieves its goal, the old Sun Microsystems could eventually see higher operating margin than the 3 percent the company reported in its last fiscal year. Alas, it would be doing so as part of another company and not as an independent business.