Sun made a tiny profit on operations during the quarter ending Dec 29, 2002 but posted its worst ever quarterly results. That the books could show a loss of nearly $2.5 billion for a period during which the company made money is a counter intuitive but natural outcome of the way companies account for the cost of past decisions. In this case $367 million went to restructuring charges and $2.125 billion reflects the devaluation of past acquisitions -primarily Cobalt Networks and HighGround Systems- resulting from reductions in Sun's share price.
At the closing bell last Friday, January 24, Sun had a market cap of about $10.7 billion - not much, if anything, over its short term break up value. If it goes significantly lower the share price could trigger a change in management's responsibilities: from running the company as a going concern to protecting shareholder value from a raider. That might mean having to search for a white knight, perhaps Fujitsu or GE, which could merge Sun into a larger business rather than simply liquidate it.
Sun is a company with a large and loyal customer base, great products, and some of the best technical people anywhere. On the whole they've come through the recent recession better than almost anyone else in the industry with the R&D labs intact and a bulging portfolio of new products in the pipeline. So why is a share that was worth around $65 in September of 2000 (when the Cobalt deal was done) now selling at $3.44 and in serious danger of heading for penny stock territory?
Externally two things are going on, neither a big deal when taken alone, but potentially deadly when applied in combination.
On one side we have analysts and others who consistently talk the company down - regardless of the facts. For example, theregister ran a Computerwire story last October 16th quoting Merrill Lynch analyst Steven Milunovich:
Milunovich said a cut of 8,000 could lower Sun's break-even point from about $3.1bn per quarter to perhaps $2.5bn over time. The analyst noted signs of an imminent reduction are there, as management said it would consider cuts upon getting a better look at fiscal second-half demand.
Chief executive McNealy is reported to have said last week "if Sun isn't making money, we will restructure." Milunovich said the sense of urgency has been heightened by questions at last week's Gartner Group ITxpo about customers' "crisis of confidence in Sun."
Milunovich said, though, the real question is not of viability but relevance, as the company backs an "increasingly retro" Sparc/Solaris combination.
In reality, of course, Gartner Group has been selling its crisis of confidence in Sun for years and that "increasingly retro SPARC/Solaris combination" continues to lead the industry for reliability and SMP performance. Nevertheless this guy's position as a nominally unbiased investment advisor for a large Wall Street player means that his opinions affect the share price - and thus contributed to that $2.1 billion dollar writedown.
The other half of the crunch is coming from an unexpected quarter - the death throes of non Wintel solutions at HP. There are well over a million systems out there running VMS, Tru64, HP-UX, MPE/IX or Non-Stop and every single one of the people involved must be worried that HP will eventually force them to choose between the Microsoft way, or the highway. The problem for Sun here is that far more of these guys will go to IBM than to Sun - not because IBM has better products, but because most of them simply don't like Sun.
What makes this important to Sun isn't so much the loss of business to IBM, but the compounding effect publicity about IBM's gains in market share will have on the stock market.
In reality a decision by a VMS or HP-UX shop to move to Linux on a pSeries machine from IBM has no effect on Sun's revenue or market position - those dollars weren't coming to Sun in the first place. IBM's gains will come at HP's expense, not Sun's, but that's not how the market will see it. To the uninformed every such transition will look like validation for the Gartners and Milunoviches of the world - and lead to more sell recommendations on Sun shares.
Strategically, killing Sun would be a big win for the remaining players, eventually leaving only IBM and Microsoft to split market control between them.
So what can Sun do about this? The long term answer lies in strengthening management because it's management weaknesses, not product weaknesses, that make it possible for competitors to think about having Sun for lunch.
By themselves things like IBM's reputed SUNswat teams or Milunovich's negativism aren't a problem. These are normal competitive behaviors and not unusual in either industry. What makes them a problem is that there's blood in the water and Sun's apparent inability to do much about it could lead to a cascade of bad news and unfavorable opinions that would drop the bottom out of the share price and eventually destroy the company.
To survive Sun has to identify and re-mediate its key weaknesses. I don't believe those have anything to do with Sun's technology. Instead I think the key weaknesses are:
This problem is now becoming a crisis as people who bought large Sun configurations in 98 and 99 scuttle back to IBM while bad mouthing Sun and Unix as the cause of their failure to make those systems work effectively.
These three issues are, of course, very closely related and may well just be three expressions of the same problem: management's substitution of short term "bottom line" thinking for long term strategic focus.
|Sun 6800||Sun V880||Dell 6600|
|Number of Units||1||4||8||Total RAM||128GB||128GB||128GB|
|Total Disk||2 x 5TB||4 x 2.5TB||8 x 1.25TB|
|Approximate list price||$1.8 Million||$920,000||$432,000|
|Approximate negotiated price||$1.3 Million||$760,000||$432,000|
Consider, for example, these three systems configurations and ask yourself what the extra million or so for the Sun 6800 buys.
Some people will tell you that it buys the ability to partition - so they can run the 6800 as if it were three V880s, but they're illustrating point two, above, and what that should buy them is a pink slip. Partitioning made financial sense on the System 370, but it's absurd as a Unix management practice and Sun should be telling people this instead of bowing to demand for it - thereby illustrating, albeit very crudely, points one and three above.
On the other hand, if you don't think this looks like a difficult decision but suspect there must be more to it than a price/megahertz ratio, I have a challenge for you: go to Sun's web site and see if you can find something there that justifies spending the extra million bucks. I don't think you'll find anything convincing - and that fact demonstrates everything that's going wrong with the company.
That million bucks really does buy you something important and valuable: the ability to treat a very large amount of memory as a single, symmetrically accessible, data store and an operating system capable of managing it with near perfect reliability for very long periods of time. A 6800 maintains cache coherency across all 24 CPUs and does so at about three times the comparable throughput rate on the maxed out 16 CPU, five million dollar, z900 mainframe. Getting that to work on the 6800 and its bigger cousins the Starfires is an unbelievable technical feat that's well ahead of the competition.
Unfortunately for Sun it is also well beyond the understood needs of most of its customers. What's most striking about those Dell 6600 units isn't their 32bit memory limitation or the use of Ultra SCSI320 to achieve higher throughout per channel than a zSeries mainframe, it's that progress in building cheap, fast, Intel boxes has caught up with most business requirements. That happened partially through the operation of Moore's law with machines getting faster and cheaper, and partially because the software industry has spent ten years learning how to break work up into pieces small enough to work in Wintel client-server land. Regardless of how it happened, the bottom line is simple: those little machines have grown up to meet problem scale and are now capable enough for use as the building blocks in a corporate systems infrastructure.
Sun's machines, meanwhile, have grown off-scale relative to most business needs. There are jobs they do better than anything else on the market -think large scale business intelligence processing or very fast problem solving -click here for my SafetyJet International example. Unfortunately for Sun those markets are both relatively small and dominated by Tru64 users who are far more likely to go to IBM than Sun now that HP has dead-ended the Alpha.
There's a much larger and more significant market for high speed research computing, but SPARC has both real and a self-inflicted problems there:
Although completely meaningless in business processing, that error is devastating if you're trying to simulate the three body problem over a long period. You can get around this by using extended precision libraries, but that cuts performance significantly.
The main problem is that researchers tend to develop for the box on their desk - and these days that's more likely to be an Intel box running FreeBSD or Linux than a SPARC. As a result, when they do run that code on a SPARC there's nothing there to take advantage of the short array capabilities provided in the hardware, and they get neither the performance nor the accuracy the machine is capable of.
So does this mean Sun is doomed? No, Sun is out of sync with the market -way ahead on large computational systems and behind on delivered, rather than possible, floating point performance. Management has to act to correct that. If they do, then Sun stands a fair chance of becoming the world's most commercially successful computer systems company, but if they chose to do a Digital or HP style self immolation instead, well, how bad do you think a few years of IBM/Microsoft duopoly would be for the country and the industry?
In the longer run Sun's current technical directions with Solaris and SPARC will give us the ability to treat a network of machines stretched across offices around the world as one machine. To run applications anywhere at any time without being concerned about resource management or security - but they have to survive to get there and, more importantly, educate the market to understand and use these new abilities.
In the long run that means rebuilding the techno-culture at Sun: deciding where to focus and doing that; getting professional services under control; building a smarter desktop -- leading the market instead of reacting to it.
Unfortunately those are longer term things, what Sun needs now is to make it through the next year more or less intact so that it can get to the longer term stuff. To do that without a lot of bench depth at Sun, Mr. McNealy is either going to have to take a lot of losses and the consequent layoffs that go with them, or land a hail Mary pass.
There are some opportunities for those. Two I particularly like are:
Sun does not need to buy Apple to head that off; all it has to do is bite the bullet and do whatever it takes to get Apple as a partner on Solaris/SPARC. Technically that's a no brainer: I believe that the MacOS X shell already runs on SPARC and Solaris can as easily run a PowerPC board inside the box for full backward compatibility as it can run an Intel board now. Strategically a deal like this leaves IBM dependent on Microsoft and Intel for the desktop, adds Motorola to the SPARC architecture team, and gives both Apple and Sun a wonderfully coherent desktop-to-server story to tell their customers.
This should have been done two years ago; but it's still not too late - in the short term because this may be Apple's best route to continued independence and in the long term because it indirectly brings Motorola's enormous strength in handhelds into the combined Solaris/MacOS X community.
When Intel introduced the Pentium-Pro as their first true 32bit CPU, it didn't run the older
16Bit code very well. That enabled AMD's K-586, which did, to gain enormous market
share and forced Intel to go back to i80286 compatibility with the Pentium II.
For legal reasons AMD can't clone the Itantium -but it can sledgehammer Intel with x86 compatible 64Bit "opteron" CPUs that run older 32bit x86 code. If Gateway went all Linux, and created a stable base market for AMD's 64bit chips, Intel would again be forced to compete.
The Pentium-pro eventually re-appeared as the Xeon and that's what would happen to Itanium too - but it would it would never threaten SPARC.
There's a better than good answer available: Gateway.
Gateway has an established name, people who know how to sell $1,000 boxes, and a desperate need for cash. Sun has lots of cash, and a need to put some of it out of reach of a raider. So create a tracking stock for a billion dollar loan to Gateway - provided they take over managing Cobalt and become the company VA Linux set out to be.
Turning the third largest PC company into an all Unix production would give Linux and BSD users national retailer support while providing options for the anti-Microsoft crowd -high end PC hardware with no Windows licenses, no exposure to Microsoft audits, and big time commercial support for open source.
There are other, less flamboyant, possibilities too; but in the longer run what counts is management strength and focus. That's the real challenge for Sun: they need to refresh the vision, re-invigorate management, get all that wood behind one arrow again, educate their markets to the value of their products, and, in the words of an executive who has successfully resurrected his technology company, once again make their company "insanely great."